Commodity Futures Modernization Act of 2000

The Commodity Futures Modernization Act of 2000 (CFMA) is United States federal legislation that officially ensured the deregulation of financial products known as over-the-counter derivatives. It was signed into law on December 21, 2000 by President Bill Clinton. It clarified the law so that most over-the-counter (OTC) derivatives transactions between “sophisticated parties” would not be regulated as “futures” under the Commodity Exchange Act of 1936 (CEA) or as “securities” under the federal securities laws. Instead, the major dealers of those products (banks and securities firms) would continue to have their dealings in OTC derivatives supervised by their federal regulators under general “safety and soundness” standards. The Commodity Futures Trading Commission's (CFTC) desire to have “Functional regulation” of the market was also rejected. Instead, the CFTC would continue to do “entity-based supervision of OTC derivatives dealers.” ^[1]These derivatives, especially the credit default swap, would be at the heart of the financial crisis of 2008 and the subsequent Great Recession.

Introduction

Before and after the CFMA, federal banking regulators imposed capital and other requirements on banks that entered into OTC derivatives.^[2] The United States Securities and Exchange Commission (SEC) and CFTC had limited “risk assessment” authority over OTC derivatives dealers affiliated with securities or commodities brokers and also jointly administered a voluntary program under which the largest securities and commodities firms reported additional information about derivative activities, management controls, risk and capital management, and counterparty exposure policies that were similar to, but more limited than, the requirements for banks.^[3] Banks and securities firms were the dominant dealers in the market, with commercial bank dealers holding by far the largest share.^[4] To the extent insurance company affiliates acted as dealers of OTC derivatives rather than as counterparties to transactions with banks or security firm affiliates, they had no such federal “safety and soundness” regulation of those activities and typically conducted the activities through London-based affiliates.^[5]

The CFMA continued an existing 1992 preemption of state laws that prevented any such law from treating eligible OTC derivatives transactions as gambling or otherwise illegal. It also extended that preemption to security-based derivatives that had previously been excluded from the CEA and its preemption of state law.^[6]

The CFMA, as enacted by President Clinton, went beyond the recommendations of a Presidential Working Group on Financial Markets (PWG) Report titled “Over-the Counter Derivatives and the Commodity Exchange Act.” (the “PWG Report^[7] ”).

President's Working Group on Financial Markets, November 1999:

• Lawrence Summers, Treasury
• Alan Greenspan, Fed
• Arthur Levitt, SEC
• William J Rainer, CFTC

Although hailed by the PWG on the day of congressional passage as “important legislation” to allow “the United States to maintain its competitive position in the over-the-counter derivative markets”, by 2001 the collapse of Enron brought public attention to the CFMA’s treatment of energy derivatives in the “Enron Loophole.” Following the Federal Reserve’s emergency loans to “rescue” American International Group (AIG) in September, 2008, the CFMA has received even more widespread criticism for its treatment of credit default swaps and other OTC derivatives.^[8]

In 2008 the “Close the Enron Loophole Act” was enacted into law to regulate more extensively “energy trading facilities.”^[9] On August 11, 2009, the Treasury Department sent Congress draft legislation to implement its proposal to amend the CFMA and other laws to provide “comprehensive regulation of all over-the counter derivatives.” This proposal was revised in the House and, in that revised form, passed by the House on December 11, 2009, as part of H.R. 4173 (Wall Street Reform and Consumer Protection Act of 2009). Separate, but similar, proposed legislation was introduced in the Senate and still awaiting Senate action at the time of the House action.^[10]

Background to the CFMA

OTC derivatives regulation before the CFMA

The exchange trading requirement

The PWG Report was directed at ending controversy over how swaps and other OTC derivatives related to the CEA. A derivative is a financial contract or instrument that “derives” its value from the price or other characteristic of an underlying “thing” (or “commodity”). A farmer might enter into a “derivative contract” under which the farmer would sell from next summer’s harvest a specified number of bushels of wheat at a specified price per bushel. If this contract were executed on a commodity exchange, it would be a “futures contract.”^[11]

Before 1974, the CEA only applied to agricultural commodities. “Future delivery” contracts in agricultural commodities listed in the CEA were required to be traded on regulated exchanges such as the Chicago Board of Trade.^[12]

The Commodity Futures Trading Commission Act of 1974 created the CFTC as the new regulator of commodity exchanges. It also expanded the scope of the CEA to cover the previously listed agricultural products and “all other goods and articles, except onions, and all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in.” Existing non-exchange traded financial “commodity” derivatives markets (mostly “interbank” markets) in foreign currencies, government securities, and other specified instruments were excluded from the CEA through the “Treasury Amendment”, to the extent transactions in such markets remained off a “board of trade.” The expanded CEA, however, did not generally exclude financial derivatives.^[13]

After the 1974 law change, the CEA continued to require that all “future delivery” contracts in commodities covered by the law be executed on a regulated exchange. This meant any “future delivery” contract entered into by parties off a regulated exchange would be illegal and unenforceable. The term “future delivery” was not defined in the CEA. Its meaning evolved through CFTC actions and court rulings.^[14]

Not all derivative contracts are “future delivery” contracts. The CEA always excluded “forward delivery” contracts under which, for example, a farmer might set today the price at which the farmer would deliver to a grain elevator or other buyer a certain number of bushels of wheat to be harvested next summer. By the early 1980s a market in interest rate and currency “swaps” had emerged in which banks and their customers would typically agree to exchange interest or currency amounts based on one party paying a fixed interest rate amount (or an amount in a specified currency) and the other paying a floating interest rate amount (or an amount in a different currency). These transactions were similar to “forward delivery” contracts under which “commercial users” of a commodity contracted for future deliveries of that commodity at an agreed upon price.^[15]

Based on the similarities between swaps and “forward delivery” contracts, the swap market grew rapidly in the United States during the 1980s. Nevertheless, as a 2006 Congressional Research Service report explained in describing the status of OTC derivatives in the 1980s: “if a court had ruled that a swap was in fact an illegal, off-exchange futures contract, trillions of dollars in outstanding swaps could have been invalidated. This might have caused chaos in financial markets, as swaps users would suddenly be exposed to the risks they had used derivatives to avoid.”^[16]

”Legal certainty” through regulatory exemptions

To eliminate this risk, the CFTC and the Congress acted to give “legal certainty” to swaps and, more generally, to the OTC derivatives market activities of “sophisticated parties.”

First, the CFTC issued “policy statements” and “statutory interpretations” that swaps, “hybrid instruments” (i.e., securities or deposits with a derivative component), and certain “forward transactions” were not covered by the CEA. The CFTC issued the forward transactions “statutory interpretation” in response to a court ruling that a “Brent” (i.e., North Sea) oil “forward delivery” contract was, in fact, a “future delivery” contract, which could cause it to be illegal and unenforceable under the CEA. This, along with a court ruling in the United Kingdom that swaps entered into by a local UK government unit were illegal, elevated concerns with “legal certainty.”^[17]

Second, in response to this concern about “legal certainty”, Congress (through the Futures Trading Practices Act of 1992 (FTPA)) gave the CFTC authority to exempt transactions from the exchange trading requirement and other provisions of the CEA. The CFTC used that authority (as Congress contemplated or “instructed”) to exempt the same three categories of transactions for which it had previously issued policy statements or statutory interpretations. The FTPA also provided that such CFTC exemptions preempted any state law that would otherwise make such transactions illegal as gambling or otherwise. To preserve the 1982 Shad-Johnson Accord, which prohibited futures on “non-exempt securities”, the FTPA prohibited the CFTC from granting an exemption from that prohibition. This would later lead to concerns about the “legal certainty” of swaps and other OTC derivatives related to “securities.”^[18]

Similar to the existing statutory exclusion for “forward delivery” contracts, the 1989 “policy statement” on swaps had required that swaps covered by the “policy statement” be privately negotiated transactions between sophisticated parties covering (or “hedging”) risks arising from their business (including investment and financing) activities. The new “swaps exemption” dropped the “hedging” requirement. It continued to require the swap be entered into by “sophisticated parties” (i.e., “eligible swap participants”) in private transactions.^[19]

Although OTC derivatives were subject to criticism in the 1990s and bills were introduced in Congress to regulate aspects of the market, the 1993 exemptions remained in place. Bank regulators issued guidelines and requirements for bank OTC derivatives activities that responded to many of the concerns raised by Congress, the General Accounting Office (GAO), and others. Securities firms agreed with the Securities and Exchange Commission (SEC) and CFTC to establish a Derivatives Policy Group through which six large securities firms conducting the great majority of securities firm OTC derivatives activities reported to the CFTC and SEC about their activities and adopted voluntary principles similar to those applicable to banks. Insurance companies, which represented a much smaller part of the market, remained outside any federal oversight of their OTC derivatives activities.^[20]

CFTC/SEC dispute and PWG Report as basis for the CFMA

The dispute

Brooksley Born, CFTC Chair, 1996 - June 1, 1999^[21]

In 1997 and 1998 a conflict developed between the CFTC and the SEC over an SEC proposal to ease its broker-dealer regulations for securities firm affiliates that engaged in OTC derivatives activities. The SEC had long been frustrated that those activities were conducted outside the regulated broker-dealer affiliates of securities firms, often outside the United States in London or elsewhere. To bring the activities into broker-dealer supervision, the SEC proposed relaxed net capital and other rules (known as “Broker-Dealer Lite”) for OTC derivatives dealers. The CFTC objected that some activities that would be authorized by this proposal were not permitted under the CEA. The CFTC also issued a “concept release” requesting comments on whether the OTC derivatives market was properly regulated under the existing CEA exemptions and on whether market developments required regulatory changes.^[22]

Robert Rubin, Treasury Secretary, Jan 1995-Jul 1999

The CFTC’s actions were widely viewed as a response to the SEC’s Broker-Dealer Lite proposal and, at least by Professor John C. Coffee, as perhaps an attempt to force the SEC to withdraw the proposal. The CFTC expressed dismay over the Broker-Dealer Lite proposal and the manner in which it was issued, but also noted it was 18 months into a “comprehensive regulatory reform effort.” The same day the CFTC issued its “concept release” Treasury Secretary Robert Rubin, Federal Reserve Board Chair Alan Greenspan, and SEC Chair Arthur Levitt (who, along with CFTC Chair Brooksley Born, were the members of the PWG) issued a letter asking Congress to prevent the CFTC from changing its existing treatment of OTC derivatives. They argued that, by calling into question whether swaps and other OTC derivatives were “futures”, the CFTC was calling into question the legality of security related OTC derivatives for which the CFTC could not grant exemptions (as described in Section 1.1.2 above) and, more broadly, undermining an “implicit agreement” not to raise the question of the CEA’s coverage of swaps and other established OTC derivatives.^[23]

In the ensuing Congressional hearings, the three members of the PWG dissenting from the CFTC’s “unilateral” actions argued the CFTC was not the proper body, and the CEA was not the proper statute, to regulate OTC derivatives activities. Banks and securities firms dominated the OTC derivatives market. Their regulators needed to be involved in any regulation of the market. Bank regulators and the SEC already monitored and regulated bank and broker-dealer OTC Derivatives activities. The dissenting PWG members explained that any effort to regulate those activities through the CEA would only lead to the activities moving outside the United States. In the 1980s banks had used offshore branches to book transactions potentially covered by the CEA. Securities firms were still using London and other foreign offices to book at least securities related derivatives transactions. Any change in regulation of OTC derivatives should only occur after a full study of the issue by the entire PWG.^[24]

CFTC Chair Brooksley Born replied that the CFTC had exclusive authority over “futures” under the CEA and could not allow the other PWG members to dictate the CFTC’s authority under that statute. She pointed out the “concept release” did not propose, nor presuppose the need for, any change in the regulatory treatment of OTC derivatives. She noted, however, that changes in the OTC derivatives market had made that market more similar to futures markets.^[25]

Congress passed a law preventing the CFTC from changing its treatment of OTC derivatives through March 1999. CFTC Chair Born lost control of the issue at the CFTC when three of her four fellow Commissioners announced they supported the legislation and would temporarily not vote to take any action concerning OTC derivatives. CFTC Chair Born resigned effective June 1999. Her successor, William Rainer, was CFTC Chair when the PWG Report was issued in November 1999.^[26]

Other background events

While the dispute between the SEC and CFTC over OTC derivatives jurisdiction was at the core of pre-2008 narrations of the events leading to the CFMA, two other noteworthy background events occurred. First, in early 1997 CFTC Chairperson Born testified forcefully to Congress against a Senate bill that would have authorized futures exchanges to establish “professional markets” exempt from many regulatory requirements in a manner similar to the “regulatory relief” ultimately provided for an “exempt board of trade” under the CFMA. In her testimony to the Senate Agriculture Committee and in several subsequent speeches during the first half of 1997, Chairperson Born argued OTC derivatives did not create the same “concentration of financial risk” as exchange traded futures and did not perform the “unique price discovery” function of exchange traded contracts. She argued these differences justified different regulatory treatment.^[27]

Chairperson Born’s 1997 testimony on the difference between exchange and OTC markets was consistent with her first speech as CFTC Chair, on October 24, 1996, in which she stated her belief that regulation of the OTC derivatives market should be limited to fraud and manipulation. While her 1997 testimony opposed the Senate bill’s provision to codify in law the existing CFTC regulatory exemptions for OTC derivatives, she also stated the CFTC was “watching” the OTC derivatives market with the PWG and had no plans to modify the existing CFTC exemptions for that market.^[28]

The futures exchanges argued they needed permission to operate “professional markets” free of “regulatory burdens” in order to compete with foreign exchanges and the OTC derivatives market that catered to the same professionals. 1997 news reports attributed the failure of the “professional markets” legislation to disagreements concerning equity derivatives between the Chicago Board of Trade and the OTC derivatives dealers, on the one side, and the Chicago Mercantile Exchange and others futures exchanges, on the other.^[29]

Second, after the 1998 CFTC “concept release” controversy arose, Long-Term Capital Management (LTCM) became headline news with the near collapse of a hedge fund it managed. The near collapse was widely attributed to OTC derivatives transactions. At an October 1, 1998, hearing before the House Banking Committee, Chairperson Born received complements from some members of the Committee for having raised important issues in the May “concept release.” The hearing, however, focused on issues with regulatory oversight of the banks and security firms that had given the LTCM fund high leverage through both loans and OTC derivative transactions.^[30]

The 1999 GAO Report that analyzed the LTCM experience criticized federal regulators for not coordinating their oversight of LTCM’s activities with banks and securities firms. The Report also recommended “consideration of” legislation to grant the SEC and CFTC consolidated supervision authority for securities and commodities firms in order to supervise the OTC derivatives activities of those consolidated entities in a manner similar to the Federal Reserve’s authority over bank holding companies. The GAO Report did not consider, and did not recommend, CFTC regulation of OTC derivatives.^[31]

An effect of the LTCM experience was that the conference committee report adopting the six month moratorium on CFTC action affecting OTC derivative regulation included a statement that “the conferees strongly urge” the PWG to study OTC derivatives transactions of hedge funds and others. Although Chairperson Born had explained at the October 1, 1998, House Banking Committee hearing that the CFTC’s supervisory authority over the LTCM fund as a “commodity pool operator” was limited to monitoring its exchange trading activities, the CFTC’s possession of financial statements for the fund received negative news coverage in November 1998 based on the fact the CFTC was the only federal regulator to receive such reports directly from LTCM and had not shared the information with other members of the PWG.^[32] When the LTCM matter was investigated at a December 16, 1998, Senate Agriculture Committee hearing, the three CFTC Commissioners that had supported the Congressional moratorium, as described in Section 1.2.1 above, reiterated their support and their position that the entire PWG should study the OTC derivatives market and the issues raised in the CFTC’s “concept release.”^[33]

The President's Working Group Report

The PWG Report recommended: (1) the codification into the CEA, as an “exclusion”, of existing regulatory exemptions for OTC financial derivatives, revised to permit electronic trading between “eligible swaps participants” (acting as “principals”) and to even allow standardized (i.e. “fungible”) contracts subject to “regulated” clearing; (2) continuation of the existing CFTC authority to exempt other non-agricultural commodities (such as energy products) from provisions of the CEA; (3) continuation of existing exemptions for “hybrid instruments” expanded to cover the Shad-Johnson Accord (thereby exempting from the CEA any hybrid that could be viewed as a future on a “non-exempt security”), and a prohibition on the CFTC changing the exemption without the agreement of the other members of the PWG; (4) continuation of the preemption of state laws that might otherwise make any “excluded” or “exempted” transactions illegal as gambling or otherwise; (5) as previously recommended by the PWG in its report on hedge funds, the expansion of SEC and CFTC “risk assessment” oversight of affiliates of securities firms and commodity firms engaged in OTC derivatives activities to ensure they did not endanger affiliated broker-dealers or futures commission merchants; (6) encouraging the CFTC to grant broad “deregulation” of existing exchange trading to reflect differences in (A) the susceptibility of commodities to price manipulation and (B) the “sophistication” and financial strength of the parties permitted to trade on the exchange; and (7) permission for single stock and narrow index stock futures on terms to be agreed between the CFTC and SEC.^[34]

In 1998 the CFTC had disagreed with the other members of the PWG about the scope and purposes of the CEA. Whereas the CFTC saw broad purposes in protecting “fair access” to markets, “financial integrity”, “price discovery and transparency”, “fitness standards,” and protection of “market participants from fraud and other abuses,” other members of the PWG (particularly the Federal Reserve through Alan Greenspan) found the more limited purposes of (1) preventing price manipulation and (2) protecting retail investors.^[35]

The PWG Report ended that disagreement by analyzing only four issues in deciding not to apply the CEA to OTC derivatives. By finding (1) the sophisticated parties participating in the OTC derivatives markets did not require CEA protections, (2) the activities of most OTC derivatives dealers were already subject to direct or indirect federal oversight, (3) manipulation of financial markets through financial OTC derivatives had not occurred and was highly unlikely, and (4) the OTC derivatives market performed no significant “price discovery” function, the PWG concluded “there is no compelling evidence of problems involving bilateral swap agreements that would warrant regulation under the CEA.” By essentially adopting the views of the other members of the PWG concerning the scope and application of the CEA, the CFTC permitted a “remarkable” agreement “on a redrawing of the regulatory lines.”^[36]

Rather than treat the “convergence’ of OTC derivatives and futures markets as a basis for CFTC regulation of OTC derivatives, the PWG Report acknowledged and encouraged the growth in similarities between the OTC derivatives market and the regulated exchange traded futures market. Standardized terms and centralized clearing were to be encouraged, not prohibited. Price information could be broadly disseminated through “electronic trading facilities.” The PWG hoped these features would (1) increase “transparency” and liquidity in the OTC derivatives market by increasing the circulation of information about market pricing and (2) reduce “systemic risk” by reducing credit exposures between parties to OTC derivatives transactions.^[37]

The PWG Report also emphasized the desire to “maintain U.S. leadership in these rapidly developing markets” by discouraging the movement of such transactions “offshore.” In the 1998 Congressional hearings concerning the CFTC “concept release” Representative James A. Leach (R-IA) had tied the controversy to “systemic risk” by arguing the movement of transactions to jurisdictions outside the United States would replace U.S. regulation with laxer foreign supervision.^[38]

It can be argued that the PWG Report recommendations and the CFMA as enacted did not change the “regulation” of OTC derivatives because there was no existing regulation under the CEA or securities laws. The change to the CEA, however, would be the elimination of existing criteria for distinguishing OTC derivatives from “futures.”^[39]

The CFMA as implementation and expansion of the PWG Report

Title I of the CFMA adopted recommendations of the PWG Report by broadly excluding from the CEA transactions in financial derivatives (i.e. “excluded commodities”) between “eligible contract participants.” The definition of “eligible contract participant” covered the same types of “sophisticated” parties as the existing “swaps exemption” in its definition of “eligible swap participants”, but was broader, particularly by adding permission for individuals with assets of $5 million rather than $10 million, if the transaction related to managing asset or liability “risk.” The PWG had recommended “considering” an increase in this threshold to $25 million, not a reduction for actual hedging.^[40]

Such “eligible contract participants” could enter into transactions on or off “electronic trading facilities” without being subject to any of the regulatory oversight applicable to futures. The only exception was that the transactions would be subject to the rules for the new “Derivative Clearing Organizations” authorized by the CFMA, if the transaction used such a clearing facility. The CFMA did not require that standardized transaction use a clearing facility. It only authorized their existence, subject to regulatory oversight. The PWG Report had recommended permitting “standardized” contracts, so long as they were subject to regulated clearing.^[41]

Title I’s biggest departure from the PWG Report recommendations was in extending most of the same exclusions to non-financial commodities that were not agricultural. These “exempt commodities” were, in practice, mostly energy and metal commodities. As discussed below in Section 4, these transactions were subject to the “anti-fraud” and “anti-manipulation” provisions of the CEA in some, but not all, circumstances. The PWG Report had recommended that exemptions for such transactions remain in the control of the CFTC, although it had recommended the continuation of those regulatory exemptions.^[42]

Title I also resolved the issue of “hybrid instruments” by defining when such an instrument would be considered a “security” subject to security laws and excluded from the CEA even though it had a “commodity component.” Equivalent treatment of bank products was provided in Title IV.^[43]

Title I retained the CEA’s existing preemption of state gambling and other laws that could render a CFTC exempted transaction illegal. It made that preemption applicable to all exempted or excluded transactions.^[44]

Title I also created a new system under which three different types of exchanges could be established based on the types of commodities and participants on such exchanges.^[45]

Title II of the CFMA repealed the 1982 Shad-Johnson Accord that had prohibited single stock and narrow stock index futures and replaced that with a joint CFTC and SEC regulated “security futures” system.^[46]

Title III established a framework for SEC regulation of “security-based swaps.” The PWG Report had not addressed this issue.^[47]

Title IV established a framework for CFTC regulation of “bank products.” This included coverage of deposit based “hybrid instruments”, but went further. The PWG Report had not dealt with these issues beyond how Title IV overlapped with Title I.^[48]

The CFMA did not provide the CFTC or SEC the broader “risk assessment” authority over affiliates of futures commission merchants or broker-dealers that the PWG Report had recommended.^[49]

Legislative history of the CFMA

H.R. 4541 and S.2697

H.R. 4541 was introduced in the House of Representatives on May 25, 2000, as the Commodities Futures Modernization Act of 2000. Three separate House Committees held hearings on the bill. Each Committee reported out a different amended version of H.R. 4541 by September 6, 2000.^[50][51]

Another Commodity Futures Modernization Act of 2000 was introduced in the Senate on June 8, 2000, as S. 2697. A joint hearing of the Senate Agriculture and Banking Committees was held to consider that bill. The Senate Agriculture Committee reported out an amended version of S. 2697 on August 25, 2000.^[52]

During the House and Senate committee hearings on these bills, Committee Chairs and Ranking Members described a tight legislative schedule for the bills because of the election year’s short Congressional schedule. Sponsors had delayed introduction of the bills as they vainly awaited agreement between the CFTC and SEC on how to regulate the single stock futures contemplated by the PWG Report. That issue dominated the hearings.^[53]

On September 14, 2000, the SEC and CFTC announced they had agreed on a joint regulation approach for “security futures.” Senior Treasury Department officials hailed the “historic agreement” as eliminating “the major obstacles to forming a consensus bill.” ^[54] At the same time, Senator Phil Gramm (R-TX), the Chair of the Senate Banking Committee, was quoted as insisting that any bill brought to the Senate Floor would need to be expanded to include prohibitions on SEC regulation of the swaps market.^[55]

Democratic members of Congress later described a period in late September through early October during which they were excluded from negotiations over reconciling the three committee versions of H.R. 4541, followed by involvement in reaching an acceptable compromise that left some Republicans unhappy with the final version of the bill and some Democrats upset over the “process”, particularly the involvement of Sen. Gramm and House Republican leadership in the negotiations.^[56] Despite indications no agreement would be reached, on October 19, 2000, the White House announced its “strong support” for the version of H.R. 4541 scheduled to reach the House Floor that day.^[57] The House approved H.R. 4541 in a 377-4 vote.^[58]

As so passed by the House, H.R. 4541 contained, in Title I, the language concerning OTC derivatives that became the source for Title I of the CFMA and, in Title II, the language regulating “security futures” that became the source for Title II of the CFMA. Titles III and IV would be added when the CFMA was enacted into law two months later.^[59]

From H.R. 4541 to the CFMA

Senator Phil Gramm

After the House passed H.R. 4541, press reports indicated Sen. Gramm was blocking Senate action based on his continued insistence that the bill be expanded to prevent the SEC from regulating swaps, and the desire to broaden the protections against CFTC regulation for “bank products.”^[60] Nevertheless, with Congress adjourned for the 2000 elections, but scheduled to return for a “lame duck” session, Treasury Secretary Summers “urged” Congress to move forward with legislation on OTC derivatives based on the “extraordinary bipartisan consensus this year on these very complex issues.”.^[61]

When Congress returned into session for two days in mid-November, the sponsor of H.R. 4541, Representative Thomas Ewing (R-IL), described Senator Gramm as the “one man” blocking Senate passage of H.R. 4541.^[62] Senator Richard G. Lugar (R-IN), the sponsor of S. 2697, was reported to be considering forcing H.R. 4541 to the Senate Floor against Senator Gramm’s objections.^[63]

After Congress returned into session on December 4, 2000, there were reports Senator Gramm and the Treasury Department were exchanging proposed language to deal with the issues raised by Sen. Gramm, followed by a report those negotiations had reached an impasse.^[64] On December 14, however, the Treasury Department announced agreement had been reached the night before and urged Congress to enact into law the agreed upon language.^[65]

The “compromise language” was introduced in the House on December 14, 2000, as H.R. 5660.^[66] The same language was introduced in the Senate on December 15, 2000 as S. 3283.^[67] The Senate and House conference that was called to reconcile differences in H.R. 4577 appropriations adopted the “compromise language” by incorporating H.R. 5660 (the “CFMA”) into H.R. 4577, which was titled “Consolidated Appropriations Act for FY 2001”.^[68] The House passed the Conference Report and, therefore, H.R. 4577 in a vote of 292-60.^[69] Over "objection" by Senators James Inhofe (R-OK) and Paul Wellstone (D-MN), the Senate passed the Conference Report, and therefore H.R. 4577, by “unanimous consent.”^[70] The Chairs and Ranking members of each of the five Congressional Committees that considered H.R. 4541 or S. 2697 supported, or entered into the Congressional Record statements in support of, the CFMA. The PWG issued letters expressing the unanimous support of each of its four members for the CFMA.^[71] H.R. 4577, including H.R. 5660, was signed into law, as CFMA, on December 21, 2000.^[72]

The “Enron Loophole”

The section 2(h) “loophole”

The first provision of the CFMA to receive widespread popular attention was the “Enron Loophole"^[73]. In most accounts, this “loophole” was the CEA’s new section 2(h). Section 2(h) created two exemptions from the CEA for “exempt commodities” such as oil and other “energy” products.^[74]

First, any transaction in exempt commodities not executed on a “trading facility” between “eligible contract participants” (acting as principals) was exempted from most CEA provisions (other than fraud and anti-manipulation provisions). This exemption in Section 2(h)(1) of the CEA covered the “bilateral swaps market” for exempt "trading facilities."^[75]

Second, any transaction in exempt commodities executed on an “electronic trading facility” between “eligible commercial entities” (acting as principals) was also exempted from most CEA provisions (other than those dealing with fraud and manipulation). The “trading facility”, however, was required to file with the CFTC certain information and certifications and to provide trading and other information to the CFTC upon any “special call.” This exemption in Section 2(h)(2) of the CEA covered the “commercial entities” for exempt "electronic trading facilities.” ^[76]

While the language of Section 2(h) was in H.R. 4541 as passed by the House, the portion of Section 2(h) dealing with the exempt commercial market had been deleted from S. 2697 when the Senate Agriculture Committee reported out an amended version of that bill. H.R. 4541 served as the basis for Titles I and II of the CFMA. The Senate Agriculture Committee’s removal of the Section 2(h) language from S. 2697, however, served as the basis for later Senate concern over the origins of Section 2(h).^[77]

In 2008 Congress enacted into law over President Bush’s veto an Omnibus Farm Bill that contained the “Close the Enron Loophole Act.” This added to CEA Section 2(h)(2) a new definition of “eletronic trading facility” and imposed on such facilities requirements applicable to fully regulated exchanges (i.e. “designated contract markets”) such as the NYMEX. The legislation did not change Section 2(h)(1) exemption for the “bilateral swaps market” in exempt commodities.^[78]

The section 2(g) “loophole”

Section 2(g) of the CEA is also sometimes called the “Enron Loophole”. It is a broader exclusion from the CEA than the Section 2(h)(1) exemption for the “bilateral swaps market” in exempt commodities. It excludes from even the fraud and manipulation provisions of the CEA any “individually negotiated” transaction in a non-agricultural commodity between “eligible contract participants” not executed on a “trading facility.” Thus, the exclusion from provisions of the CEA for “eligible contract participants” is broader than the Section 2(h)(1) exemption for “bilateral swaps” of energy commodities. The criteria for this exclusion, however, are narrower in requiring “individual negotiation.”^[79]

This exclusion was not contained in either H.R. 4541 or S. 2697 as introduced in Congress. The House Banking and Financial Services Committee added this provision to the amended H.R. 4541 it reported to the House. That language was included in H.R. 4541 as passed by the House. Its final version was modified to conform to the Gramm-Leach-Bliley Act definition of “swap agreement.” That definition requires that the swap be “individually negotiated.” H.R. 4541 had required that each “material economic term” be individually negotiated.^[80]

2002 Senate hearings indicated CEA Section 2(h)(2) was not the“Enron Loophole” used by EnronOnline. That facility was not required to qualify as an “electronic trading facility” under Section 2(h)(2) of the CEA because Enron Online was only used to enter into transactions with Enron affiliates. There were not “multiple participants” on both the buy and sell sides of the trades. Whether such Enron-only trades were covered by the Section 2(h)(1) “bilateral swaps market” exemption for energy products or the broader Section 2(g) exclusion for swaps generally depended whether there was “individual negotiation.”^[81]

Credit default swaps

With the 2008 emergence of widespread concerns about credit default swaps, the CFMA’s treatment of those instruments has become controversial. Title I of the CFMA broadly excludes from the CEA financial derivatives, including specifically any index or measure tied to a “credit risk or measure.” In 2000, Title I’s exclusion of financial derivatives from the CEA was not controversial in Congress. Instead, it was widely hailed for bringing “legal certainty” to this “important market” permitting “the United States to retain its leadership in the financial markets”, as recommended by the PWG Report.^[82]

The insurance law issue

The CFMA’s treatment of credit default swaps has received the most attention for two issues. First, former New York Insurance Superintendent Eric Dinallo has argued credit default swaps should have been regulated as insurance and that the CFMA removed a valuable legal tool by preempting state “bucket shop” and gaming laws that could have been used to attack credit default swaps as illegal. In 1992, the FTPA had preempted those state laws for financial derivatives covered by the CFTC’s “swaps exemption.” As described in Section 1.1.2 above, however, a “gap” in the CFTC’s powers prohibited it from exempting futures on “non-exempt securities.” This “loophole” (which was intended to preserve the Shad-Johnson Accord’s prohibition on single stock futures) meant that, before the CFMA, the CEA’s preemption of state gaming and “bucket shop” laws would not have protected a credit default swap on a “non-exempt security” (i.e. an equity security or a “non-exempt” debt obligation that qualified as a “security”). As before 1992, the application of such state laws to a credit default swap (or any other swap) would depend upon a court finding the swap was a gambling, “bucket shop”, or otherwise illegal transaction. As described in Section 1.2.1 above, legal uncertainty for security-based swaps was an important issue in the events that led to the PWG Report. The PWG Report recommended eliminating that uncertainty by excluding credit default swaps and all security-based swaps from the CEA and by adding to the “hybrid instrument” exemption an exclusion from the Shad-Johnson Accord.^[83]

Former Superintendent Dinallo has written that the CFMA was enacted in part to avoid having OTC derivatives transactions move offshore. He has not, however, addressed whether that could have been avoided if the CFMA had not been enacted. AIG (the insurance company addressed by Mr. Dinallo’s commentary) located its controversial derivatives dealer (AIG Financial Products) in London and conducted its “regulatory CDS” transactions through a French bank (Banque AIG) because of the bank regulatory capital provision that banks (not AAA rated parties) received a reduced credit risk “weighting” for their obligations, including CDS, owed to other banks. General Re, the other insurance company with a very active derivatives dealer affiliate, similarly established that dealer in London.^[84]

The securities law issue

Second, Title II of the CFMA treated credit default swaps tied to “securities” as “security-related swaps” for which the SEC was granted limited authority to enforce “insider trading”, fraud, and anti-manipulation provisions of the securities laws. Before the CFMA, it was generally agreed most swaps were not securities, but the SEC had always maintained that swaps tied to securities were securities, particularly when such swaps could reproduce the attributes of owning the underlying security. In granting the SEC authority over “security-related swaps”, the CFMA specifically prohibited applying any “prophylactic” anti-fraud or anti-manipulation measures. The SEC has complained this has prevented it from collecting information, and requiring disclosures, regarding credit default positions of investors. The SEC has argued this handicaps its ability to monitor possible manipulations of security markets through credit default swaps.^[85]

Centralized clearing

The SEC, the PWG, and others have also expressed concern about the “systemic risk” created by a lack of centralized clearing of credit default swaps. Although (as noted in Section 2 above) the CFMA created the possibility of centralized clearing by removing the pre-CFMA requirements that OTC derivatives not be subject to centralized clearing, the CFMA did not require such clearing, even for “standardized” transactions.^[86]

2009 Treasury Department proposed OTC derivatives legislation

On August 11, 2009, the Treasury Department sent to Congress proposed legislation titled the “Over-the-Counter Derivatives Markets Act of 2009.” The Treasury Department stated that under this proposed legislation “the OTC derivative markets will be comprehensively regulated for the first time.” ^[87]

To accomplish this “comprehensive regulation”, the proposed legislation would repeal many of the provisions of the CFMA, including all of the exclusions and exemptions discussed in Sections 4 above that have been identified as the “Enron Loophole.” While the proposed legislation would generally retain the “legal certainty” provisions of the CFMA, it would establish new requirements for parties dealing in non-“standardized” OTC derivatives and would require that “standardized” OTC derivatives be traded through a regulated trading facility and cleared through regulated central clearing. The proposed legislation would also repeal the CFMA’s limits on SEC authority over “security-based swaps.”^[88]

On December 11, 2009, the House passed H.R. 4173, the so-called Wall Street Reform and Consumer Protection Act of 2009, which included a revised version of the Treasury Department’s proposed legislation that would repeal the same provisions of the CFMA noted above. At that time, similar legislation was pending in the Senate.^[89]

In late April, 2010, debate began on the floor of the Senate over their version of the reform legislation.^[90]

Controversies

The “Enron Loophole”

The section 2(h) “loophole”

The first provision of the CFMA to receive widespread popular attention was the “Enron Loophole"^[73]. In most accounts, this “loophole” was the CEA’s new section 2(h). Section 2(h) created two exemptions from the CEA for “exempt commodities” such as oil and other “energy” products.^[91]

First, any transaction in exempt commodities not executed on a “trading facility” between “eligible contract participants” (acting as principals) was exempted from most CEA provisions (other than fraud and anti-manipulation provisions). This exemption in Section 2(h)(1) of the CEA covered the “bilateral swaps market” for exempt "trading facilities."^[92]

Second, any transaction in exempt commodities executed on an “electronic trading facility” between “eligible commercial entities” (acting as principals) was also exempted from most CEA provisions (other than those dealing with fraud and manipulation). The “trading facility”, however, was required to file with the CFTC certain information and certifications and to provide trading and other information to the CFTC upon any “special call.” This exemption in Section 2(h)(2) of the CEA covered the “commercial entities” for exempt "electronic trading facilities.” ^[93]

While the language of Section 2(h) was in H.R. 4541 as passed by the House, the portion of Section 2(h) dealing with the exempt commercial market had been deleted from S. 2697 when the Senate Agriculture Committee reported out an amended version of that bill. H.R. 4541 served as the basis for Titles I and II of the CFMA. The Senate Agriculture Committee’s removal of the Section 2(h) language from S. 2697, however, served as the basis for later Senate concern over the origins of Section 2(h).^[94]

In 2008 Congress enacted into law over President Bush’s veto an Omnibus Farm Bill that contained the “Close the Enron Loophole Act.” This added to CEA Section 2(h)(2) a new definition of “eletronic trading facility” and imposed on such facilities requirements applicable to fully regulated exchanges (i.e. “designated contract markets”) such as the NYMEX. The legislation did not change Section 2(h)(1) exemption for the “bilateral swaps market” in exempt commodities.^[95]

The section 2(g) “loophole”

Section 2(g) of the CEA is also sometimes called the “Enron Loophole”. It is a broader exclusion from the CEA than the Section 2(h)(1) exemption for the “bilateral swaps market” in exempt commodities. It excludes from even the fraud and manipulation provisions of the CEA any “individually negotiated” transaction in a non-agricultural commodity between “eligible contract participants” not executed on a “trading facility.” Thus, the exclusion from provisions of the CEA for “eligible contract participants” is broader than the Section 2(h)(1) exemption for “bilateral swaps” of energy commodities. The criteria for this exclusion, however, are narrower in requiring “individual negotiation.”^[96]

This exclusion was not contained in either H.R. 4541 or S. 2697 as introduced in Congress. The House Banking and Financial Services Committee added this provision to the amended H.R. 4541 it reported to the House. That language was included in H.R. 4541 as passed by the House. Its final version was modified to conform to the Gramm-Leach-Bliley Act definition of “swap agreement.” That definition requires that the swap be “individually negotiated.” H.R. 4541 had required that each “material economic term” be individually negotiated.^[97]

2002 Senate hearings indicated CEA Section 2(h)(2) was not the“Enron Loophole” used by EnronOnline. That facility was not required to qualify as an “electronic trading facility” under Section 2(h)(2) of the CEA because Enron Online was only used to enter into transactions with Enron affiliates. There were not “multiple participants” on both the buy and sell sides of the trades. Whether such Enron-only trades were covered by the Section 2(h)(1) “bilateral swaps market” exemption for energy products or the broader Section 2(g) exclusion for swaps generally depended whether there was “individual negotiation.”^[98]

See also

• Gramm–Leach–Bliley Act

References

1. ^ Greenspan Testimony to Senate Agriculture Committee in note 18 below (“the Board continues to believe that, aside from safety and soundness regulation of derivatives dealers under the banking or securities laws, regulation of derivatives transactions that are privately negotiated by professionals is unnecessary”). PWG Report defined in note 11 below at 16 (“most of the dealers in the swaps market are either affiliated with broker-dealers or FCMs that are regulated by the SEC or CFTC or are financial institutions that are subject to supervision by bank regulatory agencies. Accordingly, the activities of most derivatives dealers are already subject to direct or indirect federal oversight.”) Opening statement of Congressman Leach at House Banking Committee June 17, 1998, Hearing referenced in note 20 below at 2 (“Five years ago the then minority staff produced a landmark, 900-page study of derivatives markets, along with some 30 recommendations for improved regulatory oversight. In early 1995, I introduced a bill, H.R. 20, which would have provided a legal framework for implementing these recommendations and called for greater coordination among agencies with oversight responsibilities in these markets. While H.R. 20 was not adopted, industry and regulators have, on their own, implemented its major provisions, and as a result, derivatives markets are sturdier and more consistently supervised than they were several years ago.”) In her March 21, 1999, speech to the Futures Industry Association CFTC Chairperson Brooksley Born made the distinction between “entity-based supervision”, which she viewed as inadequate (because it did not “provide oversight of the market generally”) and incomplete (because it only covered the major dealers), with “functional market oversight” by the CFTC, which she viewed as necessary to “provide oversight of the market generally.” For a 1999 defense of entity level regulation see Willa E. Gipson, “Are Swap Agreements Securities or Futures?: The Inadequacies of Applying the Traditional Regulatory Approach to OTC Derivatives Transactions”, 24 Journal of Corporation Law 379 (Winter 1999) at 416 ("Regulatory issues concerning the swap market can best be addressed by focusing regulation on the market participants rather than by classifying the swap agreements as securities or futures for purposes of regulation.”) In a 2009 television interview, former CFTC Chairperson Brooksley Born gave a less complete description of the regulatory effects of the CFMA in not mentioning the “entity-based supervision” that existed before and continued after the CFMA. "FRONTLINE: the warning: video timeline - PBS". pbs.org. http://www.pbs.org/wgbh/pages/frontline/warning/cron/. Retrieved 2009 11 16. "[the act] "took away all jurisdiction of over the counter derivatives from the CFTC. It also took away any potential jurisdiction, ah, on the part of the SEC, and in fact, forbid state regulators from interfering with the over the counter derivatives markets. In other words, it exempted it from all government oversight, all oversight on behalf of the public interest" - PBS interview with Brooksley Born" 
2. ^ GAO 1994 Financial Derivatives Report at 74 to 78 for a description of the then existing bank capital requirements for OTC derivatives and 69 to 84 for a description of then existing overall regulatory requirements. GAO Financial Derivatives Report at 53 to 55 for the later “expanded” regulatory capital requirements and 53 to 69 on the overall “improved” oversight of bank OTC derivatives activities. GAO Risk-Based Capital Report at 118 for a detailed description of bank capital requirement computations for OTC derivatives.
3. ^ GAO 1994 Financial Derivatives Report at 85 to 89 for the then limited oversight of securities and commodity firms (including SEC “risk assessment” authority). 1996 Financial Derivatives Report at 70 to 71, for the establishment of the CFTC’s risk assessment program, and at 44 to 46 and 70 to 76 for the establishment of the Derivatives Policy Group (DPG) and the undertakings and reporting to the CFTC and SEC of its member firms.
4. ^ GAO 1994 Financial Derivatives Report at 11 (commercial bank dealers accounted for about 70% of the total volume at the end of 1992). GAO 1996 Financial Derivatives Report at 27 (for the 15 major dealers tracked by the GAO in the two reports (7 commercial banks, 5 securities firms, and 3 insurance companies) commercial banks accounted for about 69% of total volume each year from 1990 through 1995, securities firms about 27%, and insurance companies about 4%). Ekaterina E. Emm and Gerald D. Gay, “The Global Market for OTC Derivatives: An Analysis of Dealer Holding”, September 23, 2003 (“Emma/Gay Global Markets Study”) (showing in Table 3 that in 1995 the ten largest dealers held 85% of the US volume, with the 5 commercial banks in the listing holding 57.43% of the total and the 5 listed investment banks holding 27.75% and that in 2000 the ten largest dealers holding 92% of total volume with the 4 listed commercial banks holding 61%, the 4 listed investment banks holding 28%, and the two insurance companies (AIG and General Re) holding just over 3%. PWG Report at 16 (noting most dealers were banks or affiliated with securities firms).
5. ^ GAO 1994 Financial Derivatives Report at 90 to 91 (concluding “Derivatives dealer affiliates of insurance companies are subject to minimal reporting requirements and no capital requirement” while noting state insurance regulators informed the GAO “derivatives dealer affiliates voluntarily hold capital against derivatives exposures as part of effective risk-management practices.”) GAO 1996 Financial Derivatives Report at 80 to 81 (concluding “state insurance regulatory oversight remains unchanged” and noting “although the financial results of derivatives dealer affiliates are part of consolidated insurance company financial reports to regulators, these affiliates continue to have no capital or examination requirements.”) GAO 1994 Financial Derivatives Report at 188 (listing AIG, General Re, and Prudential as the three largest insurance company derivatives dealers in 1992.) Emma/Gay Global Markets Study in Table 3 showing AIG And General Re as the largest insurance dealers in 2000. “General Re Securities”, Business Week company snapshot (“The Company was incorporated in 1991 [as General Re Financial Securities Ltd.] and is based in London, United Kingdom”). For AIG FP’s London-based dealer operation, see note 81 below.
6. ^ See notes 43 and 80 below.
7. ^ "Over-the Counter Derivatives and the Commodity Exchange Act.". http://www.treasury.gov/resource-center/fin-mkts/Documents/PWG%20Report%20Final%20January%2013.pdf. Retrieved 11 September 2011. 
8. ^ For the quoted language see PWG December 15, 2000, letters to Senator Thomas Harkin, Ranking Member of Senate Agriculture Committee, at Congressional Record, S. 11896, December 15, 2000, and to Senator Paul Sarbanes, Ranking Member of Senate Banking Committee at Congressional Record, S11946, January 2, 2001. These letters were issued jointly by the four members of the PWG on December 15, 2000, for use in the Senate consideration that day of H.R. 5660 as part of H.R. 4577. While no such letters were introduced in the House during its debate of H.R. 4577, as described in note 69 below, Representative Charles Stenholm (D-TX) stated H.R. 5660 was "broadly supported" by the Administration and the PWG and Representative Sheila Jackson-Lee (D-TX) confirmed that H.R. 5660 was “acceptable” to the United States Treasury Department, CFTC, and SEC. Despite this, as described in note 70 below, the narrative has been widely circulated that a single Senator, Senator Phil Gramm (R-TX), somehow “slipped in” or “sneaked in” to H.R. 4577 the CFMA. See Section 4 below for the “Enron Loophole” and Section 5 for credit default swaps.
9. ^ See Section 4.1 below.
10. ^ See Section 6 below.
11. ^ For the background to and purpose of the PWG Report, see “Over-the-Counter Derivatives Markets and the Commodity Exchange Act”, Report of The President’s Working Group on Financial Markets, November 1999 (PWG Report) at 10 to 18, and Mark Jickling, “The Commodity Futures Modernization Act of 2000: Derivatives Regulation Reconsidered”, RL30434, updated January 29, 2003, Congressional Research Service Report for Congress (CRS Derivatives Regulation Report) at CRS-7 to 8. For definitions of derivatives, see the PWG Report at 4 to 5 and the CRS Derivatives Regulation Report at CRS-2. As described further below in this Section 1.1.1, a farmer would have the possibility to enter into such a pricing contract with a grain elevator or other buyer, in which case the contract might be a “forward delivery” and not a “future delivery” contract. A “futures contract”, however, is not defined by whether it is executed on a commodity exchange. The CFTC has long brought actions against illegal “futures contracts” executed off a regulated exchange. Philip McBride Johnson and Thomas Lee Hazen, Derivatives Regulation (successor edition to Commodities Regulation, Third Edition) (Aspen Publishers 2004, supplemented through 2009 Cumulative Supplement) (“Johnson/Hazen Derivatives Regulation Treatise”) at 50 to 53. Testimony of Brooksley Born, Chairperson Commodity Futures Trading Commission, Concerning the Over-the Counter Derivatives Market, before the U.S. Senate Committee on Agriculture, Nutrition and Forestry, July 30, 1998 (“Born July 1998 Senate Agriculture Testimony”) at 10, in the text leading to footnote 35 for that testimony (“It is the nature of the instruments, and not where they are traded, that determines jurisdiction under the CEA.”)
12. ^ Johnson/Hazen Derivatives Regulation Treatise at 6 to 9. Jerry W. Markham, Commodities Regulation: Fraud, Manipulation & Other Claims Volume 13A Securities Law Series (West Group 1987, supplemented through Release 11, April 2009) (“Markham CF Law Treatise”) at pages 27-18 to 27-19 and 28-1 through 28-7. General Accounting Office (GAO) Report, “The Commodity Exchange Act: Legal and Regulatory Issues Remain”, GAO/GGD-97-50, April 1997 (“GAO CEA Issues Report”) at 5. CRS Derivatives Regulation Report at CRS-5.
13. ^ Ibid. For the Treasury Amendment, see also Johnson/Hazen Derivatives Regulation Treatise at 9 to 10; CRS Derivatives Regulation Report at CRS-6; and PWG Report at 24 to 27. Before the CFTC, a Commodity Exchange Authority under the control of the Secretary of Agriculture regulated commodity exchanges. Jerry W. Markham,The History of Commodity Futures Trading and its Regulation, (Praeger 1987) (“Markham CF Trading History”) at 27 to 60. For background to the reasoning of the PWG Report, see the July 24, 1998 Hearing before the House Committee on Banking and Financial Services (“July 24, 1998, House Banking Hearing”) at pages 150-156 for Alan Greenspan’s extended critique of the application of the CEA to non-agricultural commodities. The transcript excerpts are in Segment 2 because the July 24, 1998, hearing was the second of two hearings by the Committee concerning H.R. 4062, legislation mentioned in Section 1.2 below that ultimately led to a moratorium on CFTC action to change the regulatory status of OTC derivatives. For how the “board of trade” qualification made it difficult for the CFTC to attack currency trading “bucket shops”, see CFTC Chair William Rainer testimony at page 28 of Hearing before the Senate Agriculture Committee on the PWG Report, February 10, 2000, (“Senate Agriculture PWG Report Hearing”) and Markham CF Trading History at 238 to 239.
14. ^ Johnson/Hazen Derivatives Regulation Treatise at 50 to 54. CRS Derivatives Regulation Report at CRS-5. PWG Report at 6. The CEA required that futures contracts be transacted on a “contract market” designated by the CFTC. “Designated contract markets” (such as the Chicago Board of Trade, Chicago Mercantile Exchange, or New York Mercantile Exchange (NYMEX)) are generally referred to as “exchanges” but are also called “boards of trade.” Markham CF Trading History at 15 and 69. For the notion the meaning of “future delivery” evolved, see GAO Report, “CFTC and SEC: Issues Related to the Shad-Johnson Jurisdictional Accord”, GAO/GGD-00-89, April 2000 (“GAO Shad-Johnson Report”) at 14, fn. 35 (“the definition has evolved through judicial and agency interpretations.”) For a broader discussion of the issue see GAO CEA Issues Report at 6.
15. ^ Johnson/Hazen Derivatives Regulation Treatise at 29 to 46. Markham CF Law Treatise at pages 27-21 to 27-26. Markham CF Trading History at 202 to 203 (for “forwards”) and 232 to 233 (for “swaps”). CRS Derivatives Regulation Report at CRS-6. The term “swap” refers to parties exchanging or “swapping” payments. The use of the term expanded to cover derivatives such as “caps” and “floors” under which one party paid a fee in return for the right to receive payments in the future based on whether an interest rate (or other price) exceeded a specified level (a cap) or dropped below a specified level (a floor). Testimony of Richard Grove at page 34 of the Senate Agriculture PWG Report Hearing (“off-exchange principal-to-principal derivatives transactions…are typically referred to as swaps.”)
16. ^ Mark Jickling, “Regulation of Energy Derivatives” RS21401, CRS Report for Congress, updated April 21, 2006 (“CRS Energy Derivatives Report”) at CRS-3. For a broader review of “legal uncertainty” issues and the 1999 PWG’s view of how those issues led to its recommendations that formed the basis for the CFMA, see PWG Report at 6 through 14.
17. ^ GAO CEA Issues Report at 11 to 14 (which explains at 13 that the plaintiffs in the Brent oil case sued for damages for violations of the CEA’s antimanipulation provisions, not to find the transaction illegal, but that the implication of the court ruling could be to make such transactions unenforceable). Johnson/Hazen Derivatives Regulation Treatise at 55 to 60 (for swaps and hybrids) and 67 to 69 (for forward transactions). Markham CF Law Treatise at pages 27-23 to 25. For the effects of the UK court decision, see GAO Report, “Financial Derivatives: Actions Needed to Protect the Financial System”, GAO/GGD-94-133, May 1994, (“GAO 1994 Derivatives Report”) at 64 to 66. A typical “hybrid instrument” would be a bank deposit that provided an “extra” interest amount based on the return on the S&P 500 Index or a security that provided a return tied in part to the appreciation of the yen or some other currency relative to the dollar. For a description of more complex “hybrid instruments”, see Frank Partnoy, F.I.A.S.C.O.: the inside story of a Wall Street trader (Penguin 1999), which describes Professor Partnoy’s experiences “structuring” such securities for Morgan Stanley.
18. ^ GAO CEA Issues Report at 12 to 17. PWG Report at 8 to 10. Markham CF Law Treatise at pages 27-23 to 27-26. Johnson/Hazen Derivatives Regulation Treatise at 43 to 48 and 60 to 66. For the significance of the 1992 legislation’s preemption of state laws, see Born July 30, 1998, Senate Agriculture Testimony at 6 where Chairperson Born describes its role in providing “legal certainty.” As noted in the GAO CEA Issues Report at 15, the Conference Report for the FTPA stated: “The Conferees do not intend that the exercise of exemptive authority by the Commission would require any determination beforehand that the agreement, instrument, or transaction for which an exemption is sought is subject to the Act.” H10937, Congressional Record, October 2, 1992. The entire Conference Report for the FTPA is available by searching “conference report on H.R. 707” at this link for the Search the Congressional Record on the 102d Congress page of The Library of Congress Thomas service (“Thomas LOC”). The Conference Report also stated (at H10936) that “the Conferees expect and strongly encourage the Commission to use its new exemptive powers promptly upon enactment of this legislation in four areas where significant concerns of legal uncertainty have arisen: (1) hybrids, (2) swaps, (3) forwards, and (4) bank deposits and accounts.” The Report went on to explain (at H10937) the “forwards” were the oil market transactions covered by the existing Brent oil market “statutory interpretation.” For the view Congress had thereby “instructed” the CFTC to grant the exemptions, see the testimony of CFTC Chair William Rainer at Senate Agriculture PWG Report Hearing at 15 (“amid strong signals that swap market participants feared their contracts could be declared unenforceable, Congress reacted decisively instructing the CFTC not to regulate swaps entered into by sophisticated parties.”) See also GAO Report “The Commodity Exchange Act: Issues Related to the Commodity Futures Trading Commission’s Reauthorization”, GAO/GGD-99-74, May 1999 (“GAO 1999 CFTC Reauthorization Report”) at 10 (“According to the 1992 act’s legislative history, Congress expected CFTC to use its exemptive authority promptly to reduce legal risk for swaps, forwards, and hybrids.”)
19. ^ Before the FTPA exemptions were issued, the elements required by the CFTC policy statement were (1) individually negotiated (not “standardized”) terms, (2) no “offset” or other termination except as privately agreed, (3) credit exposure between the parties (i.e., no intervening “clearing facility” or full margin requirement guaranteeing against defaults), (4) contracting only in connection with a line of business (including “financial intermediation” for banks and other dealers) or financing such a business, and (5) no marketing to the public. CFTC. “Policy Statement Concerning Swap Transactions”, 54 Federal Register 30694 (July 21, 1989). GAO CEA Issues Report at 12 to 13. PWG Report at 10. Markham CF Law Treatise at page 27-23. Johnson/Hazen Derivatives Regulation Treatise at 43. The exemptions under the FTPA required that the transaction (1) be between “eligible swap participants” (defined as businesses, government entities, investment pools, and high net worth individuals), (2) not be standardized in material economic terms, (3) subject each party to the credit risk of the other, (4) and not be traded on a “multilateral transaction execution facility” on which multiple parties could offer and accept transactions. CFTC, “Exemption for Certain Swap Agreements”, 58 Federal Register 5587 (January 22, 1993). GAO CEA Issues Report at 14 to 16. PWG Report at 10 to 12. Markham CF Law Treatise at pages 27-25 to 26. Johnson/Hazen Derivatives Regulation Treatise at 43 to 44 and 47 to 49 (which notes, at 44, that the swaps exemption retained for qualifying swaps that might still be “futures” the “antifraud and antimanipulation provisions” of the CEA). GAO 1999 CFTC Reauthorization Report at 10 to 11. The FTPA exemption, therefore, more broadly permitted “speculators” in the swaps market and tailored the exemption to the financial “sophistication” of the parties and the absence of both exchange style “netting” of exposures and public availability of offers. For the role of “speculators” in OTC derivatives markets, see Mark Jickling and Lynn J. Cunningham, “Speculation and Energy Prices: Legislative Responses”, RL 34555, CRS Report for Congress, updated August 6, 2008. The requirements for “hybrid instruments” under the 1990 “statutory interpretation” and the 1993 exemption were similar. Both required that the instrument be a security or bank deposit, the commodity dependent value of the instrument be limited, the instrument not be marketed as a commodity option or futures contract, and the instrument not be subject to settlement through a delivery instrument specified by a regulated exchange. While there were further requirements for each, the 1993 exemption moved towards criteria later included in the CFMA in requiring that the instrument be regulated by the SEC or banking regulators and that the issuer receive full payment at the time of sale and not receive future payments from the holder. CFTC, “Statutory Interpretation Concerning Certain Hybrid Instruments”, 55 Federal Register 13582 (April 11, 1990) (for the hybrid instrument statutory interpretation). CFTC, “Regulation of Hybrid Instruments”, 58 Federal Register 5580 (January 22, 1993) (for the hybrid instrument exemption). PWG Report at 28. Johnson/Hazen Derivatives Regulation at 59 to 60. The 1990 “forward transaction” statutory interpretation and 1993 exemption were similar in requiring that the transaction be between “commercial” parties able to make or take delivery of the energy product, that the agreement be subject to individual negotiation between the two parties, and that the contract create binding obligations to make and take delivery, with no automatic right to make cash settlement. CFTC, “Statutory Interpretation Concerning Forward Transactions”, 55 Federal Register 39188 (September 25, 1990). CFTC, “Exemption for Certain Contracts Involving Energy Products”, 58 Federal Register 21286 (April 20, 1993) (issued April 13, 1993, with Acting Chairman Albrecht and Commissioner Dial concurring, and Commissioner Bair dissenting, as noted at 58 Federal Register 21294). GAO 1999 CFTC Reauthorization Report at 38 to 39. Johnson/Hazen Derivatives Regulation at 68 to 69. For the controversy that arose from the 1993 order’s exemption of energy contracts from the CEA’s fraud provisions, see the April 28, 1993, Hearing before the Subcommittee on Environment, Credit, and Rural Development of the House Committee on Agriculture (“1993 House Hearing”). For an influential account of the 1993 House Hearing and of the entire 1992-3 exemption process, which describes former CFTC Chair Wendy Gramm as having cast the deciding vote on the energy contracts exemption and as being the target of criticism by Representative Glenn English (D-OK) at the April 28, 1993, hearing, even though the account also notes she resigned from the CFTC on January 20, 1993, well before the 2-1 vote on the exemption order was taken and the hearing was held, see Public Citizen, “Blind Faith: How Deregulation and Enron’s Influence over Government Looted Billions from Americans” (“Blind Faith”) at 9 to 12. The statement of Rep. English quoted at 12 of Blind Faith is at 45 to 46 at the end of the testimony in the 1993 House Hearing. For the influence of Blind Faith on accounts of the CFMA see note 70 below.
20. ^ Markham CF Law Treatise at pages 27-38 to 27-49. GAO Report, “Financial Derivatives: Actions Needed to Protect the Financial System”, GAO/GGD-94-133, May 1994 (“GAO 1994 Derivatives Report”). GAO Report, “Financial Derivatives: Actions Taken or Proposed Since May 1994”, GAO/GGD/AIMD-97-8, November 1996 (“GAO 1996 Derivatives Report”) at 31 to 32 lists the six 1994 legislative proposals and four derivatives bills pending in 1996, and at 44 to 45 notes the six securities firms in the Derivatives Policy Group accounted for over 90% of the derivatives dealer activities of securities firms. At least in the context of the 1998 Congressional hearings concerning the CFTC “concept release” described in Section 1.2.1 below, Representative James A. Leach (R-IA) stated that by 1998 “the major provisions” of the 900-page 1993 minority staff report mentioned in note 37 below had been “implemented” by “industry and regulators” so that derivatives markets are sturdier and more consistently supervised than they were several years ago. July 17, 1998, Hearing before the House Committee on Banking and Financial Services (“July 17, 1998, House Banking Hearing”) at 2.
21. ^ Born resignation date, rooseveltinstitute.org
22. ^ Markham CF Law Treatise at pages 27-81 to 27-84 and pages 28-30 to 28-31. Johnson/Hazen Derivatives Regulation Treatise at 45 to 46. For a contemporaneous description of how the SEC’s proposal set off the dispute see Professor John C. Coffee’s testimony at pages 77 to 82 of the July 17, 1998, Hearing before the House Committee on Banking and Financial Services (“July 17, 1998, House Banking Hearing”). See also SEC Release 34-39454 (December 17, 1997), the “Broker-Dealer Lite” proposal; CFTC comment letter on Broker-Dealer Lite proposal; and CFTC Over-the-Counter Derivatives Concept Release (May 8, 1998).
23. ^ Markham CF Law Treatise at pages 27-83 to 84 and page 28-20. (At page 27-83 it states, “The CFTC’s action was actually a thinly disguised response to an SEC proposal to pull the derivatives dealers under its regulatory umbrella”). Johnson/Hazen Derivatives Regulation Treatise at 45 to 46. For Professor Coffee’s judgment see pages 82 to 83 of the July 17, 1998, House Banking Hearing. (“It may be in part their game plan that enough pressure, enough pain being caused to all, will lead the SEC to back down and withdraw their deregulatory proposals in their Broker Lite rule. If that happens, a tactic that I think is unfair will have worked, and it will probably be used again in what I think are the likelihood of continuing border wars between agencies that have somewhat overlapping jurisdiction.”) In 2002, Professor Coffee repeated the narrative that a “turf war” led to the CFMA at the July 10, 2002 Hearing before the Senate Committee on Agriculture, Nutrition, and Forestry, “CFTC Regulation and Oversight of Derivatives” at 38 (“let me remind you of something you already know, but I think the record should set this forth clearly, the 2000 Act was precipitated by a turf war between the SEC and CFTC, and as a result of that, there was suddenly a serious question about the legal status of swaps and the possibility that the longstanding 1993 swaps exemption might be repealed suddenly. That sent a friction of fear across Wall Street and the President’s Working Group understandably recommended that financial derivatives be deregulated to the extent they traded over-the-counter.”) For the CFTC’s description of events see Born July 1998 Senate Agriculture Testimony at 5 to 11. The CFTC’s dissatisfaction with the Broker-Dealer Lite proposal and the fact it was issued without a PWG meeting is expressed by Chairperson Born at pages 11-14 of the June 10, 1998, Hearing before House Subcommittee on Risk Management and Specialty Crops (“June 10, 1998, House Agriculture Subcommittee Hearing”). For the argument there had been an “implicit agreement” not to decide whether swaps were futures, see the testimony of John D. Hawke, Treasury Under Secretary for Domestic Finance, at 33 of the June 10, 1998, House Agriculture Subcommittee Hearing (“a lot turns on the decision as to whether swaps are futures..for 10 years, there’s been kind of an implicit agreement on the part of all parties not to resolve that question…the CFTC’s Concept Release implicitly answers that question…if swaps are futures, and the CFTC does not have the authority to exempt swaps based on equities from the exchange trading requirements of the Commodity Exchange Act, it casts a cloud of illegality over that portion of the market.”)
24. ^ July 24, 1998 House Banking Hearing; Testimony of Alan Greenspan, Chairman, Board of Governors of Federal Reserve Board, before the U.S. Senate Committee on Agriculture, Nutrition and Forestry, July 30, 1998 (“Greenspan July 1998 Senate Agriculture Testimony”); Testimony of Treasury Deputy Secretary Lawrence H. Summers for the same July 10, 1998, Senate Agriculture Committee Hearing (“Summers July 1998 Senate Agriculture Testimony”); and Testimony of SEC Chairman Arthur Levitt for that July 10, 1998, Senate Agriculture Committee Hearing (“Levitt July 1998 Senate Agriculture Testimony”). In the July 24, 1998 House Banking Hearing at 171-2, Chairman Greenspan pointed to the growth of the Eurodollar market in the 1960s, which in his account was established as a way to avoid US law limiting interest on deposits, which market did not return to the US even after the regulatory issue was overcome. In the June 10, 1998, House Agriculture Subcommittee Hearing (at 42) Richard Lindsay, Director of the SEC’s Division of Market Regulation, made a similar argument about the loss of US capital market activity to the Eurobond market when “a very simple law change moved the Eurobond market from the United States, where it was a vibrant market, abroad virtually overnight. And that market has never returned.” While Regulation Q (the regulatory limit on deposit interest) is usually cited as the cause for the development of the Eurodollar market, there are competing views that at least a partial cause was fear of US “political risk” focused more on potential US seizures or blocks on foreign (particularly Soviet Union) money in US banks. Milton Friedman,“The Eurodollar Market: Some First Principles”, Selected Papers No. 34, University of Chicago School of Business. Charles P. Kindelberger, A Financial History of Western Europe (2d Ed. Oxford University Press 1993) at 439-441 (for the Eurodollar market) and 441 (for the Eurobond market). For the “forward rate agreement” market, which was often conducted by U.S. banks through “offshore” branches because of concern such agreements looked too much like “futures” traded on U.S. exchanges, see Philip McBride Johnson, Michael S. Sackheim and Thomas A. Hale “Future Rate Agreements: Implications under the Commodity Exchange Act”, Commodities Law Letter, March 1987, at 3-6. See also notes 37, 79 (Summers response to Harkin question at Senate Agriculture PWG Report hearing), and 81 below for the issue of “offshore” booking of OTC derivative transactions.
25. ^ Born July 1998 Senate Agriculture Testimony. In response to the complaint the CFTC had acted “unilaterally”, Chairperson Born notes, at page 13 of this testimony, that the CFTC is the federal regulator with expertise in “derivatives markets” and that statements made by the other members of the PWG indicated they were seeking to usurp control over the issue.
26. ^ Markham CF Law Treatise at pages 27-83 to 84. PWG Report at 12 to 13. GAO 1999 CFTC Reauthorization Report at 12 to 13. Commissioners Spears and Newsome sent a letter to Senator Richard Lugar, Chairman of the Senate Agriculture Committee, on September 11, 1998. At a December 16, 1998, hearing before the Senate Agriculture Committee concerning the recent collapse of Long-Term Capital Management the prepared testimony of David D. Spears and James E. Newsome confirm their continued commitment not to support action on OTC derivatives “prior to September 30, 1999” (in the case of Commissioner Spears) or “prior to Congress having the opportunity to review and analyze issues relating to OTC derivatives” (in the case of Commissioner Newsome, who stated “this commitment of a majority of the Commission was subsequently codified by Congress.”) Commissioner Barbara A. Holum had publicly opposed the “concept release” from the beginning as indicated in her prepared testimony at the same hearing and more extensively in her November 17, 1998, “Remarks before the New York State Bar Association Committee on Commodities and Futures Law”. David Barboza and Jeff Gerth, “Who’s in Charge? Agency Infighting and Regulatory Uncertainty”, New York Times, December 15, 1998. David Barboza and Jeff Gerth “Regulating Derivatives: LTCM Bailout Prompts Calls for Action”, New York Times, December 15, 1998. Chairperson Born’s “resignation” was officially a decision not to seek reappointment. “Chairperson Brooksly Born Announces Her Intention Not to Seek Reappointment to a Second Term”, CFTC News Release, January 19, 1999.
27. ^ Oral Testimony of CFTC Chairperson Brooksley Born to Senate Agriculture Committee”, February 11, 1997 (“Born February 11, 1997, Senate Oral Testimony”) (“exchange trading involves important public interest considerations which require a higher level of regulation than over-the-counter markets. Exchanges create a concentration of financial risk not present in bilateral over-the-counter transactions and therefore pose a more serious systemic threat to our economy. There is also a strong public interest in protecting the price-discovery and price-basing functions uniquely performed by exchanges.”). Written Testimony of CFTC Chairperson Born to the same February 11, 1997, hearing (“Even if an exchange market does not include the small retail customer, exchange trading poses greater public policy implications than over-the-counter trading. While the use of centralized clearing provides important benefits, it also creates a concentration of risk not present in individually negotiated, bilateral over-the-counter transactions. Without careful regulatory oversight, that concentration of risk poses more serious systemic threats than the decentralized risk of the over-the- counter market. The strong public interest in preserving and protecting the price-discovery and price-basing functions performed by the exchanges also distinguishes them from most over-the-counter markets. In addition, centralized markets involve transactions between anonymous parties generally acting through intermediaries. The participants in exchange trading, unlike the participants in the over-the-counter markets, are unable to determine the identity of their counterparties or their creditworthiness. Regulation helps to ensure both the fairness and the financial integrity of exchange-traded transactions. For all these reasons, exchange trading requires a higher level of regulation than trading in over- the-counter markets as they currently exist.”) “The Dangers of Deregulation”, Remarks of CFTC Chairperson Brooksley Born before the Futures Industry International Association 22d Annual International Futures Industry Conference, March 13, 1997 (“The exchanges have said that they should be able to operate in the same unregulated environment as the over-the-counter markets -- a result that the pending legislation would likely achieve. However, exchange trading involves important public interest considerations which require a higher level of regulation than over-the-counter markets. Exchanges create a concentration of financial risk not present in bilateral over-the-counter transactions and therefore pose a more serious systemic threat to our economy. While both exchanges and the over-the-counter markets perform a vital public service in providing hedging opportunities, there is also a strong public interest in protecting the price-discovery and price-basing functions uniquely performed by exchanges.”) Chairperson Born gave the same explanation for the different regulatory treatment of exchanges and OTC derivatives in speeches to the Sixth Annual Washington Policy Council on March 31, 1997, the End Users of Derivatives Third Annual Conference on April 11, 1997, (where she added both “I am sure that, as users of both exchange-traded and over-the-counter derivatives, many members of this audience fully understand and appreciate the differences in these markets” and “All markets are not the same, and the appropriate regulatory framework must depend on an analysis of the characteristics of the particular market.”), the Financial Executive Institutes Committee on Investment of Employee Benefit Assets, on April 16, 1997, the Women in Housing and Finance, Inc. on May 12, 1997 (where she added that the exchanges’ argument “ignores the significant differences in these markets.”), and the New York City and State Bar Associations on May 21, 1997. All of these speeches are available at the CFTC website's archive of 1997 Speeches and Testimony
28. ^ Remarks of CFTC Chairperson Brooksley Born to Chicago Kent-IIT Commodities Law Institute, October 24, 1996 (“in my view, it is appropriate that regulation of this market [“the domestic over-the-counter market”] should be limited to issues relating to fraud and manipulation.”) Born February 11, 1997, Senate Oral Testimony (in which Chairperson Born expressed CFTC opposition to the proposed enactment into law of existing regulatory exemptions for OTC derivatives because that “would eliminate all regulatory flexibility to respond quickly if developments in that market required , but also stated “both the Commission and the President’s Working Group on Financial Markets have been watching and evaluating this enormous and evolving $53 trillion market” and “the Commission has no plans to modify its exemptions.”)
29. ^ Consolidated Tesimony of the Futures Exchanges of the United States to Senate Agriculture Committee, February 11, 1997 (“U.S. futures markets have found it increasingly difficult to compete with foreign exchanges and OTC dealers as our competition's regulatory costs have diminished or remained virtually non-existent while ours have escalated.”) John M. Broder, “Chicago Exchanges Seek to Loosen Yoke of Regulation”, New York Times, June 4, 1997. George Gunsel, “Big Guns Loading for Deregulation Battle”, Chicago Tribune, March 23, 1997 (quoting the CBOT’s president as stating “We were promised an even-handed landscape in 1992 (legislation) and it didn’t happen. We lost business to oversees and the over-the-counter markets.” George Burns, “Deregulation of Futures May be Derailed, CBOT, Merc in Opposing Factions on Key Issues, and Time’s Running Out in Congress”, Chicago Tribune, July 25, 1997 (“the Board of Trade wants Congress to authorize the trading of equity swaps in unregulated markets” and “the Merc worries that giving legal certainty to equity swaps would hurt its stock-index futures contracts.”) Jerry Hegstrom, “Commodity Clash”, Government Executive, October 1, 1997.
30. ^ For the complements directed at Chairperson Born, see October 1, 1998, Hearing before House Committee on Banking and Financial Services concerning Hedge Fund Operations at 155 to 157 for Mr. LaFalce’s questioning and at 170 for Mr. Hinchey’s questioning. For the prepared testimony of the witnesses and the prepared statements of Chairman Leach and Rep. Bachus see the Full Committee Hearing webpage Michael Schroeder, “CFTC Chief Refuses to Take Back Seat in Derivatives Debate”, Wall Street Journal, November 3, 1998 (“Lon-Term Capital’s problems offered Ms. Born a delicious opportunity to tell her critics, “I told you so”…As congressional hearings approached in October, Ms. Born circulated a list of talking points to key lawmakers…She and her staff were elated when lawmakers complimented her on her foresight.”)
31. ^ GAO Report, “Long-Term Capital Management: Regulators Need to Focus Greater Attention on Systemic Risk,” GAO/GGD-00-3, October 1999 (“GAO LTCM Report”) at 16 to 17 (for “regulators did not identify weaknesses in firms’ risk management practices until after the crisis”), 17 to 19 (for “offsite monitoring did not reveal the potential systemic threat posed by LTCM”), and 21 (for “existing coordination could be improved to enhance regulators’ ability to identify risks across industries and markets.”) GAO LTCM Report at 31 (for the recommendation Congress “consider providing SEC and CFTC with the authority to regulate the activities of securities and futures firms’ affiliates similar to that provided the Federal Reserve with respect to bank holding companies.”) “Congressional Agency Faults a Report on Hedge-Fund Risk”, New York Times, November 20, 1999. Michael Schroeder, “General Accounting Office’s Report Urges Tighter Broker-Dealer Oversight”, Wall Street Journal, November 22, 1999. Both news articles stated the GAO recommended Congress enact consolidated supervision of securities and commodities firms, although the GAO Report only stated Congress should “consider” such legislation. Perhaps these news reports more accurately described GAO’s actual intent.
32. ^ Congressional Conference Report on H.R. 4328 at H11302, Congressional Register, October 19, 1998 (for the conferees’ explanation of Section 760) and H11053 (for the Section 760 moratorium language adopted by the conferees). Kathleen Day, “Top Regulator was aware of Fund’s debt; CFTC’s Born failed to act on Long-Term Capital Data”, Washington Post, November 18, 1998.
33. ^ see note 25 above.
34. ^ PWG Report at 15 to 23. CRS Derivatives Regulation Report at CRS-7 to 9. The FTPA had given the CFTC, and a 1990 law had given the SEC, limited “risk assessment” authority, but the PWG recommended expanding that authority. “Hedge funds, Leverage, and the Lessons of Long-Term Capital Management”, Report of the President’s Working Group on Financial Markets, April 1999 at 38-40.
35. ^ For the CFTC’s 1998 view of the scope of its responsibilities, see Born July 1998 Senate Agriculture Testimony, especially at 9. For the much more limited interpretation of the CEA’s purposes, see Alan Greenspan’s testimony at the July 24, 1998 House Banking Hearing at 150-156, as cited above in note 13. Chairperson Born’s initial reply to that interpretation is at 178 of the same transcript (“while manipulation is one of the prohibitions in the CEA, it is only a very small part.”) Treasury Department support for Chairperson Greenspan’s position is available in the Summers July 1998 Senate Agriculture Testimony at 6 to 7 (the “major concerns guiding regulation of American commodity markets” have been “to protect retail investors from unscrupulous traders” and “to guard against manipulation in markets where the scope for such manipulation exists.”) Although this implies those were not the exclusive purposes of the CEA, Deputy Secretary Summers added that the CFTC would need to show evidence of the need for regulation in these areas to justify action. The SEC’s position was that “traditional swaps that are not traded through a multilateral transaction execution facility are not futures and are not subject to regulation under the CEA.” Levitt July 1998 Senate Agriculture Testimony at 2. This reflected the SEC’s 1993 view that the CFTC’s 1993 “swaps exemption” was merely a confirmation of the application of the CEA, because “traditional swaps” are not “futures.” Chairperson Born’s testimony during the hearings related to the “concept release” indicated she believed swaps were covered by the CEA, subject to CFTC exemption. See June 10, 1998, House Agriculture Subcommittee Hearing at 22 where Chairperson Born describes the pre-1993 “policy statements” establishing “as a practical matter” the CFTC would not regulate swaps. Although the FTPA expressly provided any exemptions granted by the CFTC did not require a finding the exempted transaction was a “future”, which the CFTC noted in each of its three exemption orders, Chairperson Born describes the FTPA as giving the CFTC “the power to exempt futures.” The FTPA gave that power, but it also gave the power to exempt transactions that might not be futures. GAO CEA Issues Report at 15.
36. ^ PWG Report at 15 to 16. CRS Derivatives Regulation Report at CRS-7 to 8. Consistent with the Greenspan and Summers testimony described in note 34 above, the analysis was centered around “sophisticated parties” and “susceptibility to manipulation” with points (1) and (2) dealing with the former and points (3) and (4) dealing with the latter. In his testimony at the Senate Agriculture PWG Report Hearing, however, CFTC Chair William Rainer distinguished (at 15) between protecting “price discovery” and protecting against “price manipulation”, concluding that Congress “identified the overarching public mission of the CFTC as that of preventing price manipulation and ensuring price transparency.” Mark Jickling, “The Commodity Futures Modernization Act (P.L. 106-554)”, RS20560, February 3, 2003 (“CRS 2003 CFMA Report”) at 1 (“Apart from its substance, the Working Group’s report was remarkable in that the four agencies, which had a history of jurisdictional quarrels, unanimously agreed on a redrawing of the regulatory lines.”)
37. ^ PWG Report at 16 to 21. CRS Derivatives Regulation Report at CRS-8 to 9.
38. ^ CRS Derivatives Regulation Report at CRS-8. PWG Report at 15 to 21. For Rep. Leach’s views see July 17, 1998, Hearing before the House Banking and Financial Services Committee (“July 17, 1998, House Banking Hearing”) at 2. Rep. Leach had long been considered an independent student, and critic, of OTC derivatives markets. Frank Partnoy, Infectious greed: how deceit and risk corrupted the financial markets (H. Holt 2003 (First Owl books ed. 2004)) (“Infectious Greed”) at 147-8 (“As the leading Republican on the Banking Committee, Jim Leach was an unlikely critic…Why was Leach alone in publicly warning that derivatives markets were out of control and might cause a system-wide collapse? The only discernible difference between Leach and other members of Congress was that Leach did not receive financial support from Wall Street and members of the ISDA.”) Markham CF Law Treatise at page 27-43 (“An aggressive and massive report was prepared at the behest of Representative James A. Leach by the minority staff of the House Committee on Banking, Finance and Urban Affairs.”) See also note 23 above and notes 79 (Summers response to Harkin question at Senate Agriculture PWG Report Hearing), and 81 below for the issue of “offshore” booking of OTC derivatives.
39. ^ For the perspective the CFMA “updated” or “codified” existing regulatory exemptions, see CRS Derivatives Regulation Report at CRS-6 to 7 (for the view the CFMA recognized the new realities of the OTC financial derivatives market) and CRS Energy Derivatives Report at 4 (“Thus, the 2000 legislation did not deregulate the OTC energy derivatives market; that market had been unregulated since its beginnings.”) For the view that the CFMA represented a change through which “the fundamental pillars of futures and commodities options regulation in the United States since 1922 have largely collapsed” so that “for the first time in the history of federal futures law, trading away from regulated markets is now permissible under certain circumstances”, see Johnson/Hazen Derivatives Regulation Treatise at 314 to 317. When the PWG Report was being considered by the Senate Agriculture Committee as a basis for legislation, a similar view was expressed by the Chicago Mercantile Exchange at the Senate Agriculture PWG Report Hearing at 32 to 33 (Jerry Salzman: “by essentially redefining what a swap is to include standardized, cleared, financial future contracts that are traded on electronic exchanges…while calling for legal certainty for a swap, they then redefine swap and call for special treatment for special kinds of exchanges that essentially duplicate what our exchanges are doing.”)
40. ^ CRS 2003 CFMA Report at 2. Cravath, Swaine and Moore, “Memorandum for ISDA Members, Commodity Futures Modernization Act of 2000”, January 5, 2001 (“ISDA CFMA Memo”) at 14 to 17. Markham CF Law Treatise at pages 27-88 to 89. Johnson/Hazen Derivatives Regulation at 330-333. For the PWG Report’s recommendation concerning individuals, see PWG Report at 17 to 18.
41. ^ CRS 2003 CFMA Report at 2. CRS Derivatives Regulation Report at CRS-9. ISDA CFMA Memo at 23 to 28. Dean Kloner, “The Commodity Futures Modernization Act of 2000”, 29 Securities Regulation Law Journal 286 (2001) (“Kloner CFMA”) at 289 to 290. Markham CF Law Treatise at pages 27-88 to 89. Johnson/Hazen Derivatives Regulation at 330-333. For the PWG Report’s recommendation, see PWG Report at 17 (“insofar as transactions are subject to regulated clearing, the exclusion should not prohibit fungibility of contracts or require that creditworthiness be a material consideration.”)
42. ^ CRS 2003 CFMA Report at 2. CRS Derivatives Regulation Report at CRS-9. ISDA CFMA Memo at 29 to 31. Kloner CFMA at 290 to 291. For the PWG recommendation concerning non-financial commodities, see PWG Report at 16 to 17.
43. ^ ISDA CFMA Memo at 32 to 33. Kloner CFMA at 291 to 292. As explained in these sources, the new exclusion eliminated the existing requirement to limit the commodity component of the instrument, but otherwise retained criteria that (1) the instrument be a security regulated by the SEC or a bank product regulated by a federal banking regulator, (2) the instrument be fully paid for at issuance, with the buyer not required to make any further payment, (3) the issuer not be required to post collateral (“margin”) based on any mark-to-market valuation of its obligations, and (4) the instrument not be marketed as an option or futures contract.
44. ^ Johnson/Hazen Derivatives Regulation at 331. ISDA CFMA Memo at 22. For the PWG recommendation on preemption see PWG Report at 18. The Title I preemption provision is Section 117 at pages 104 to 105 of H.R. 5660 as introduced in the House and at pages 404 to 405 of H.R. 4577 as enacted into law as Public Law 106-554. The entire CFMA appears as “Appendix E—H.R. 5660” to that Public Law (pages 367-463). A separate preemption provisions is in Section 408 of H.R. 5660. A provision of that preemption that is potentially broader than Section 117 is the preemption for a “hybrid instrument that is predominantly a banking product.” The definition of “covered swap agreement” generally overlaps with the “aggregate effect’ of the CEA Section 2(d)(1) exclusion for transactions in “excluded commodities“, the Section 2(h)(1) exemption for transactions in “exempt commodities (both limited to transactions transacted off a “trading facility”), and the Section 2(g) exclusion for transactions in either even on an “electronic trading facility.” ISDA CFMA Memo at 28 (noting as a possible difference that the Section 402(d) term “covered swap agreements” would “in the first instance be interpreted by the banking regulators” whereas the Section 105(b) “excluded swap transactions” would “in the first instance be interpreted by the CFTC.”) A difference is that “covered swap agreement” would cover a transaction in “excluded commodities” on an electronic trading facility even if not subject to “individual negotiation” (compare Section 105(b) with Section 402(d)(2) of the CFMA on this).
45. ^ CRS 2003 CFMA Report at 3 to 4. Johnson/Hazen Derivatives Regulation at 320 to 328.
46. ^ CRS 2003 CFMA Report at 3 to 4. CRS Derivatives Regulation Report at CRS-12 to 13. Markham CF Law Treatise at 27-98 to 102. Kloner CFMA at 286 to 288.
47. ^ Kloner CFMA at 287 and 292. ISDA CFMA Memo at 40 to 43. Johnson/Hazen Derivatives Regulation at 340.
48. ^ Kloner CFMA at 287 and 292 to 293. ISDA CFMA Memo at 35 to 40. Johnson/Hazen Derivatives Regulation at 340 to 341. For the PWG Report’s recommendations on hybrid instruments see PWG Report at 28 to 29.
49. ^ CRS Derivatives Regulation Report at CRS-9.
50. ^ Thomas LOC Summary and Status Page for H.R. 4541 and Thomas LOC Committee Page for H.R. 4541. Aside from implementing and expanding on the PWG Report’s recommendations, H.R. 4541 and S. 2697 would “reauthorize” the CFTC. Under the CEA as amended in 1974 to create the CFTC, the Commission was only “authorized” for five years. Since 1974, the “reauthorization” of the CFTC has served as the occasion for “reconsideration” of the provisions of the CEA, most dramatically in 1999 to 2000 with the CFMA. Such “reauthorization” has not always occurred on a timely basis, so that the CFTC has continued in existence on an interim basis, when (as on September 30, 2000) its “authorization” has expired. Markham CF Law Treatise at pages 28-13 to 28-20. For a description of each “reauthorization” see GAO 1999 CFTC Reauthorization Report at 55 to 60.
51. ^ Video of debate, http://www.c-spanvideo.org/videoLibrary/congress.php?bill=97929
52. ^ Thomas LOC Summary and Status Page for S. 2697. Thomas LOC Committee Page for S. 2697. Senate Agriculture Committee Report for S. 2697 (“Senate Agriculture S. 2697 Report”). Joint Hearing before Senate Agriculture and Senate Banking Committees on S. 2697—The Commodity Futures Modernization Act of 2000, June 21, 2000, (“June 21, 2000, Joint Senate Committee Hearing”).
53. ^ Rob Garver, “In Brief: Swaps Measure Delayed as Agencies Argue”, American Banker, May 12, 2000, ( In describing Rep. Ewing’s plan to offer legislation concerning swaps, the article noted Senators Lugar and Gramm “had been expected to introduce similar legislation in the Senate on Thursday, but a debate between the Securities and Exchange Commission and the Commodity Futures Trading Commission over other regulatory matters in the bill has held it up.”) For Senate Committee Chair Lugar’s remarks, see June 21, 2000, Joint Senate Committee Hearing at 2 to 3 and at 37 (“it should have been apparent to the two of you [the CFTC and SEC Chairmen] that we are intent upon passing a bill…why the two of you are not equally arduous”). For House Subcommittee Chair Ewing’s remarks, see Hearing before House Subcommittee on Risk Management, Research, and Specialty Crops, June 19, 2000, (“June 19, 2000, House Agriculture Subcommittee Hearing”) at 10 (for the tight legislative calendar) and at 43 to 55 (for extended “single stock futures” questions). For Commerce Committee Chair Bliley’s remarks, see Hearing before the Subcommittee on Finance and Hazardous Materials on H.R. 4541, July 12, 2000, (“ July 12, 2000, House Commerce Subcommittee Hearing”) at 4 (“If the agencies [i.e. the CFTC and SEC] can’t resolve this dispute [concerning “single stock futures”], Congress will have to do it for them…. we don’t have a lot of time to consider this important legislation, but we will do our best”). For Ranking Member LaFalce’s statement see Hearing before House Committee on Banking and Financial Services on H.R. 4541, July 19, 2000, (“July 19, 2000, House Banking Committee Hearing”) at 14 (“it is unfortunate that we are getting this bill referral that says we have to report it out by September 6th, which means we have to report it out next week.”) See also Committee Chair Leach at 91 (“my own sense is one of great frustration working within the constraints of this Act”). Rep. Leach had introduced on April 6, 2000, his own bill H.R. 4203 to implement, separate from CFTC reauthorization, portions of the PWG Report applicable to OTC derivatives. As the Thomas LOC All Congressional Action Page for H.R. 4203 shows, this bill did not proceed past the Committee referral stage.
54. ^ ”Accord Ends Dispute Between Regulators”, New York Times, September 15, 2000. Remarks by Treasury Under Secretary Gary Gensler to the American Bankers Association Government Relations Council, September 19, 2000 (after describing the previous week’s agreement between the SEC and CFTC to permit single stock futures trading and how that opened the way to enactment of the CFMA, Under Secretary Gensler stated “With this historic agreement, the Congress has a tremendous opportunity to complete this important legislation. We should not miss this opportunity to modernize the regulatory structure of our derivatives markets, reduce systemic risk, and promote the competitiveness of our markets.”) Remarks by Treasury Assistant Secretary Lewis A. Sachs, Alexander Hamilton Awards New York, NY, September 26, 2000 (after describing the OTC derivatives market, Assistant Secretary Sachs promoted the OTC derivatives legislation in Congress because “this legislation would allow the electronic trading and centralized clearing of derivatives, thereby helping to: reduce counterparty risk; promote innovation; make our markets more competitive, transparent, and efficient; and reduce the costs of hedging risk and reducing exposure to other markets. It is important that Congress enact such legislation this year.”)
55. ^ Rob Garver, “Armey Pushes for Compromise on Swaps”, American Banker, September 27, 2000, (“Sen. Gramm said that he would prefer a bill in which the SEC and CFTC have no jurisdiction at all over swaps, but he has suggested a compromise under which the SEC would have the authority to intervene to protect customers from price manipulation or fraud.”) According to internal Enron emails, Sen. Gramm had been blocking Senate action. Eric Lipton, “Gramm and the ‘Enron Loophole’”, New York Times, November 14, 2008 (“Lipton Enron Article”) (quoting an August 10, 2000, email from Chris Long to several Enron recipients “the bill is not moving quickly in the Senate due to Senator Phil Gramm’s desire to see significant changes made to the legislation (not directly related to our energy language.”)
56. ^ The October 19, 2000, House consideration of H.R. 4541 is found at Congressional Record, H10416-10449, December 19, 2000. The preceding House discussion of the necessary “rule suspension” is at Congressional Record, H10411-H10415, October 19, 2000. Representative Charles Stenholm (D-TX) complained (at H10440) about the “bizarre twist” in which after the “bipartisan” development of draft bills in Committees, “the leadership intervened and decided to substitute partisan negotiations in place of the bipartisan discussions that were already under way and that were under way and that were yielding productive results.” He went on to complement the leaders of the House Committees involved, particularly citing Rep. Ewing as “a true consensus builder.” Rep. Edward Markey (D-MA) complained (at H10445) about “the process that has brought this bill to the floor and some of its provisions.” Rep. John Dingell (D-MI) elaborated (at H10445-6) that following “one bipartisan meeting, which from all counts was constructive, Democratic staff were booted out of the negotiations on this bill, at the direction of the Republican leadership.” Only when “2 weeks ago, the Committee on Agriculture majority staff started circulating drafts of legislation for Democratic review and comment” did a bill develop “which is worth moving to the next stage”, although he concluded it would “not be possible to support this bill if it is not significantly improved at the next stage of the process.” In “Extended Remarks” at Congressional Record, E1878-80, Rep. Markey expanded on his Floor statements and noted the presence of Sen. Gramm in the House negotiations as inappropriate (see E1878, noting Democrats were barred from negotiations “after just a few bipartisan staff meeting” and that “the chairman of the Senate Banking Committee was invited into those negotiations—despite the fact that this bill comes within the Agriculture Committee’s jurisdiction over in the Senate and the Senate has not even passed a CEA bill”). For contemporary accounts of the “negotiations” see Rob Garver, “Armey Pushes for Compromise on Swaps”, American Banker, September 27, 2000 (“In a sign that Republicans are serious about passing a bill to revise the laws governing derivatives transactions, Majority Leader Richard K. Armey met Tuesday with representatives of the three House committees-each pushing different versions of the same bill-and urged them to hammer out a deal…Of the three, the Banking Committee version, sponsored by Chairman Jim Leach is most popular with the financial services industry…Rep. Leach’s bill is alaso the most likely to satisfy several requirements laid out by Senate Banking Committee Chairman Phil Gramm…He wants the Securities and Exchange Commission to explicitly be barred from regulating swaps as well.”); Rob Garver, “In Brief: Armey Says Swaps Talks Making Progress”, American Banker, September 29, 2000 (“Lawmakers and administration officials remained locked in complex negotiations Thursday over a bill that would assure the legal enforceability of swaps contracts…One of the three versions of the bill that cleared House committees protected swaps from CFTC regulations, but Senate Banking Committee Chairman Phil Gramm has said that, in order to pass the Senate, SEC regulation of swaps will have to be explicitly banned as well.”); Michele Heller, “Bank Bills May Ride Piggyback”, American Banker, October 11, 2000 (“lobbyists representing financial services firms that offer swap contracts are not happy with a Republican compromise proposal on legislation that would revise the laws governing derivatives transactions. Staff members of the House and Senate Banking and Agriculture committees and the House Commerce Committee sent the Treasury Department and congressional Democrats a 247-page draft written over the weekend.”) In this context Enron emails indicate they it was seeking to influence Sen. Gramm to stop blocking the legislation. Lipton Enron Article (citing an October 13, 2000, email from Chris Long to Tori Wells of Enron and others: “Senator Gramm continues to raise objections unrelated to legal certainty for our business. There are two issues (which we understand have primarily been advanced by Senator Gramm, one on bank products and one on SEC jurisdiction).”
57. ^ Dean Anason, “In Brief: Bottleneck Seen on Swaps Exemption Bill”, American Banker, October 16, 2000, (referring to a statement issued the previous Friday, October 13, the article stated “Senate Agriculture Committee Chairman Richard G. Lugar said prospects are grim for a compromise on legislation that would protect swap contracts from federal regulation.” Sen. Lugar added “failure to pass the Commodity Futures Modernization Act of 2000 will cause grave repercussions throughout the financial markets.”) For similar expectations of a CFTC Commissioner critical of the CFMA see “Remarks of Commissioner Thomas J. Erickson” before the Silver User’s Association on October 18, 2000 (“I think it is important to understand how these bills might work – despite the fact that they probably will not be passed in this session – because I believe they represent the current thinking of many legislators.”) For the Administration’s statement of support, see Statement of Administration Policy: H.R. 4541 - Commodity Futures Modernization Act of 2000, October 19, 2000, (“The Administration strongly supports the version of H.R. 4541, the Commodity Futures Modernization Act of 2000, that the Administration understands will be considered on the House floor.”) The text of the statement was also introduced into the Congressional Record by Rep. Stenholm at Congressional Record page H10441.
58. ^ H10416-10449, Congressional Record, October 19, 2000, with vote at H10448-9. Thomas LOC Page for H.R. 4541
59. ^ Extended Remarks of Representative Thomas Ewing (R-IL), Congressional Record, E2181-2182 (December 14, 2000) introducing H.R. 5660 (the bill “contains the major provisions of the House passed H.R. 4541. These provisions are in Titles I and II of the legislation... “). H.R. 4541 as passed by the House. H.R. 5660 as introduced in the House and enacted into law through H.R. 4577 The two differences between Title I in the two bills that are apparent from the tables of contents (see page 2 for each bill) are that H.R. 5660 eliminated the “Rules of Construction” that were in Section 128 of H.R. 4541 and inserted H.R. 4541’s Section 107 dealing with “Swap transactions” into Section 105 as Section 105(b) of H.R. 5660. The first change led to the colloquy between Reps. Bliley and Combest described in note 69 below, in which they confirmed nothing in the CFMA granted a bank any additional power to own equity securities (which was previously covered by Section 128 of H.R. 4541). The second change lead to an overall “re-lettering” of language in Title I, because the swaps “exclusion” became Section 2(g) rather than 2(h) of the CEA. This meant the CFMA’s exclusions were consecutively “lettered” as 2(c)-(g) with Section 2(h) the “exemptions.” Under H.R. 4541, Section 2(g) would have been the new “exemptions” and Section 2(h) would have been the final “exclusion.” The new Section 2(g) was also modified from H.R. 4541 in its definition of “swap agreement” to require “individual negotiation” but not “individual negotiation” of “each material term” (other than price and quantity) and in adding a Section 105(c) requirement for a PWG study of “retail swaps.” The last change addressed an issue raised by Republican Representatives in the House Floor debate of H.R. 4541 (as described in note 58 below). The PWG issued its “Joint Report on Retail Swaps” in December 2001 and found (at page 9) it was not “necessary at this time to recommend legislative action for swap agreements offered to persons other than ECPs.” Aside from these two changes and various typographical or stylistic corrections, the changes to Title I were: (1) the definition of “hybrid instrument” was expanded to permit delivery of a commodity and the H.R. 4541 definition of “deposit instrument” was replaced by the new Title IV’s definition of “identified banking product” contained in Section 402(b) of H.R. 5660, which did not include the limitations for foreign and other deposits listed in H.R. 4541’s exclusions for subparagraphs (A), (B), and (C) of Section 3(l) of the Federal Deposit Insurance Act (compare pages 21 and 252-253 of H.R. 5660 with pages 20-21 of H.R. 4541); (2) the new Title IV exclusions from the CEA were added to the list of excluded transactions in several parts of Title I (compare the definition of “security future” at 28 of each bill, the description of the application of the CEA in Section 107 (at 50) of H.R. 5660 and in Section 108 (at 48) of H.R. 4541, the description of transactions permitted to be cleared by a Derivatives Clearing Organization (“DCO”) in Section 112 (at 88-9) of H.R. 5660 and in Section 113 (at 86) of H.R. 4541, the preemption of state law in Section 117 (at 105) in H.R. 5660 and in Section 118 (at 101-2) of H.R. 4541, and the contract enforcement provision in Section 120 (at 108) of H.R. 5660 and in Section 121 (at 105-6) in H.R. 4541); (3) the definition of “trading facility” was revised to clarify the listed “exclusions” did not require CFTC confirmation of that status (compare pages 29-31 of H.R. 5660 with pages 28-30 of H.R. 4541); (4) the definition of “excluded electronic trading facility” was expanded to expressly permit submission of transactions to a DCO for clearance without thereby becoming a “trading facility” (compare pages 37-38 of H.R. 5660 with pages 36-37 of H.R. 4541); and (5) a “Derivatives Transaction Execution Facility (“DTEF”) that delegated any duties was given an explicit obligation to address non-compliance with the delegated function (compare Section 113 (at 97) of H.R. 5660 with Section 114 (at 94-5) of H.R. 4541.
60. ^ Even before House passage of H.R. 4541, press reports and statements by Republicans in the Congressional Record indicated Republican unhappiness with the “compromise” reached on H.R. 4541. Dean Anason, “In Brief: Swaps Bill Getting Slim Odds in Senate”, American Banker, October 19, 2000 (“The House was expected to pass as early as Thursday legislation that would revamp the laws on swaps and futures contracts, but observers said the bill may not clear the Senate before Congress adjourns…House Republican leaders and other negotiators have decided to exclude controversial provisions that would have protected a broader range of bank-executed swaps, and those with smaller corporate or retail counterparties…which were supported by Senate Banking Committee Chairman Phil Gramm and House Banking Committee Chairman Jim Leach. The bill also would exclude language favored by Sen. Gramm and others that would have barred the Securities and Exchange Commission from regulating swaps. Observers have predicted that Sen. Gramm will attempt to block Senate passage if the bill excludes those provisions. The Texas Republican's spokeswoman said Tuesday the lawmakers plan to adjourn before the necessary complex negotiations could be completed”); “In Brief: House Backs Swaps Bill; Senate in Doubt”, American Banker, October 23, 2000 (“The House overwhelmingly passed legislation Thursday that would shield swaps and other over-the-counter-derivatives contracts from federal regulation…Treasury Secretary Lawrence H. Summers praised the bill…He also called for quick Senate passage. However, the bill is expected to stall in the Senate because of concerns by Banking Committee Chairman Phil Gramm that its protections would be incomplete. Rep. Richard A. Baker…said he hopes Sen. Gramm, who favors explicitly barring the SEC from regulating swaps, will succeed in strengthening the bill…Senate Banking staff members…were scheduled to meet Friday with officials of the Treasury Department, which sources said had lobbied to water down the bill in the House under pressure from some Democrats.”); Michelle Heller, “In Brief: Bank Legislation Faces Election Deadline”, American Banker, November 1, 2000 (“Legislation to revamp commodities and derivatives laws is still in Senate negotiations. Capitol Hill sources said one draft being considered is similar to legislation passed this year by the House Banking Committee that would create broad legal guarantees for swaps agreements involving banks. The House approved a bill on Oct. 19 that some critics said would insufficiently protect bank products from regulation by the Commodity Futures Trading Commission. Senate Banking Committee Chairman Phil Gramm’s spokeswoman said Tuesday that the senator is still pressing to shield swaps from Securities and Exchange Commission regulation as well.”); William Roberts (Bloomberg News) and Michele Heller, “Congress Likely to Get Election Timeout”, American Banker, November 2, 2000 (describing a “stopgap funding measure” through November 14 that would lead to an eventual reconvening of Congress for two days in mid-November and the final “lame-duck” session in December and adding “The hiatus may help Senate negotiators iron out differences on a commodity and derivatives bill that some critics said would insufficiently protect bank products from regulation by the Commodity Futures Trading Commission” and quoting “a spokeswoman” for Sen. Gramm saying “’work will slow down…but maybe this gives us more time to get things works out’.. Sen. Gramm is still pressing to shield bank swaps from Securities Exchange Commission regulation.”); “Legislative Update”, American Banker, November 9, 2000 (“Negotiations between the Treasury Department and Senate Republicans on the Commodity Futures Modernization Act of 2000….are on hold until after the election. The House passed the legislation Oct. 19, but critics have said it would insufficiently protect bank products from regulation by the CFTC. Sen. Gramm is also pressing to shield bank swaps from Securities and Exchange Commission regulation. Supporters of strengthening the legislation to protect bank products hope the extended congressional session will give negotiators more time to work out their differences.”) While the October 2000 Congressional Record statements of Democrats referenced in note 54 above showed unhappiness with the “process” by which they were excluded from negotiations, with late input leading to an acceptable bill, October 19, 2000, Congressional Record statements by Republican Representatives (in the discussion at H10416-10449 cited and linked in note 54 above) expressed unhappiness the bill did not contain broader “protections.” Rep. Jim Leach (at H10444 and again in “extended remarks” at Congressional Record E1877-8, October 23, 2000 expressed the wish “more could have been done” but said “progressive strides had been made.” Representative Richard A. Baker (R-LA) (at H10448) bemoaned the “compromise” that had stripped the bill of “protections for swaps” He went on to announce he expected to work with Sen. Gramm “because it is evident these problems will not be solved on the House side.” Although Representative Patrick J. Toomey (R-PA) stated that its was “a good bill” he said it was not a “perfect bill” and that he hoped “the other body will eliminate the remaining legal uncertainty that will still shadow the use of these transactions by retail customers. I hope that they will allow greater flexibility in the electronic trading of the over-the-counter derivatives.” In the “rule suspension” discussion at H10411-15 (cited and linked in note 54 above) a “bipartisan” discontent was expressed by Representatives Sue Wilkins Myrick (R-NC) (at H10411) and Melvin Watt (D-NC) (at H10414-15) who criticized the removal of provisions in the House Banking Committee version of the bill that they thought better “protected” electronic trading platforms. This had special significance for the North Carolina based D&I Holdings (as explained by Rep. Watt at H10414). At this time, Enron emails continued to report Sen. Gramm was the obstacle to H.R. 4541 being enacted into law. Lipton Enron Article (quoting an October 25, 2000, email from Kenneth M. Raisler to Tom Briggs of Enron, “explaining how Senator Gramm is holding up the legislation” and an October 27, 2000, email also from Mr. Raisler to Enron executives describing how “Senator Gramm is activiely engaged and his issues are being aggressively negotiated” after Gramm had “been contacted by a number of people including members of our Energy Group and Alan Greenspan urging passage of the bill.”) See also the October 20, 2000, email from Cynthia Sandherr of Enron to Mark Palmer of Enron (“The last deal which needs to be cut is with Senator Gramm (he is the only obstacle to enactment in the Senate.)…it is other issues which do not directly affect Enron which are being negotiated.”)
61. ^ “Remarks of Treasury Secretary Lawrence H. Summers to the Securities Industry Association”, November 9, 2000, (After describing the Gramm-Leach-Blilely law passed in 1999 (i.e. the Financial Modernization Act of 1999) and the Electronic Signatures in Global and National Commerce Act already enacted in 2000, Secretary Summers addressed the Commodity Futures Modernization Act by stating: “And third, we have made significant progress towards the enactment of legislation that would reform the legal and regulatory framework affecting the OTC derivatives market. Taken together, these changes would provide legal certainty, contribute to the reduction of systemic risk, protect retail customers, stimulate the competitiveness of America's financial markets, and thereby help to create jobs and lower costs for American consumers and businesses. We have achieved an extraordinary bipartisan consensus this year on these very complex issues. Let me take this opportunity to urge Congress to enact these reforms as soon as possible.”)
62. ^ Mary Haffenberg, “Singe stock futures bill back in play”, Bridge News, December 5, 2000, contained in December 6, 2000, email from Chris Long of Enron to other Enron employees (“Bridge News December 5, 2000, Article”), which is also available in December 6, 2000 email from Kenneth Raisler to Chris Long of Enron and employees of various other energy companies (after describing a December 4 meeting among Rep. Ewing, Sen. Gramm, and representatives of the Chicago Mercantile Exchange and Chicago Board of Trade at which “the group agreed on several points regarding legal certainty for banking products”, the article detailed how “the sticking point has been Gramm, who has said that the bill will go nowhere unless it contains provisions he thinks are necessary to exclude banking products from the act and to keep certain types of swaps out of the hand of certain regulators. After the House bill passed, Gramm put forth 34 revisions to it. When discussions last left off before the federal elections, Gramm and Treasury had resolved about 15 of those issues. ‘One man, Senator Gramm, is holding up this bill,’ Ewing said at a press conference last month.”) In forwarding the email within Enron, Chris Long noted he had been in contact with “folks on the Hill and Treasury” and that “the article seems accurate.”)
63. ^ Dawn Kopecki, “US Election Has New Commodities Law In Legislative Limbo”, Dow Jones News Service, November 15, 2000, contained in November 15, 2000, email from ISDA to Mark Haedicke of Enron and numerous other interested parties (“Lugar has said in the past that he could bring up the commodities bill that passed the House 377-4, over Gramm’s objections, and attach it to a federal spending bill before Congress adjourns for the year. ‘That’s one of the options being considered’, [Senate Agriculture spokeswoman Tiffany] Steele said”). For a description of Sen. Gramm’s objections as constituting a “hold” on the legislation, see Lipton Enron Article (in describing a December 16, 2000, email from Chris Long, the article states “Mr. Gramm, after getting certain narrow changes in the legislation, removes his hold and lets the bill go to a vote in the Senate.”).
64. ^ Rob Garver, ”Legislators Racing to Get Pro-Bank Swaps Bill Passed”, American Banker, December 11, 2000, (“Legislation drafted late last week by the Senate Banking Committee would amend the Gramm-Leach-Blilely Act to give current and future banking products—particularly swap contracts—ironclad protection from regulation by the Commodity Futures Trading Commission…The proposal is being examined by Treasury Department officials, who received part of the legislative language on Thursday and the remainder on Friday. The Treasury has taken the lead on the bill for the administration, and its verdict is widely seen as the deciding factor in whether or not the legislation moves forward.”); Miriam Eljas, “In Brief: Treasury Engaged in Talks on Swaps Bill”, American Banker, December 12, 2000, (“Representatives from the futures exchanges have agreed to Sen. Gramm’s new version of the legislation, which supporters hope can be revived with the Treasury Department’s blessing and attached to an appropriations bill. Treasury officials, who would not comment Monday on the status of negotiations or on the sticking points, have taken the lead on the bill for the Clinton administration.”) “Legislative Update”, American Banker, December 14, 2000, (“Attempts to jump-start negotiations between the administration and congressional Republicans on the Commodity Futures Modernization Act appear to be failing…Democrats charge that under that plan [i.e. the Republican Senate plan to bar the CFTC from regulating “bank products”] futures exchanges could escape Futures Commission oversight by merging with a bank. The Treasury Department, the lead for the Clinton Administration on this issue, countered late Monday with draft legislation of its own. A Senate Banking Committee spokeswoman described the Treasury offer as a step backwards.”) In the Enron email, however, a December 11, 2000, email from Allison Navin to Mark Haedicke of Enron and others enclosed a December 9, 2000, Congressional Quarterly report that the “commodity laws rewrite” was “alive” after representatives of the “big commodity exchanges” met with “the Senator who has been blocking the bill” with the Senator identified as Sen. Gramm). Lipton Enron Article (which describes December 12, 2000, emails from Stacy Cary of ISDA showing “Mr. Gramm is being pressured to give in and sign off on the legislation, but he is still pushing for certain changes” and from Chris Long showing “Mr. Gramm was able to persuade the players to accept some modest amendments to the legislation, including a change that will further protect swaps from regulation, as he had long sought-a change that would benefit Enron.” It is unclear what Mr. Long means in his email when he describes his “understanding from Treasury that the swap exemption is expanded slightly to say that if you are trading on a facility (MTF) and you are trading on principle-to-principle [sic] basis among eligible contract participants you are no longer subject anti-fraud and anti-manipulation as contained in Sec. 107 of the House passed legislation.” As described in note 57 above and note 74 below, Section 107 of H.R. 4541 contained the same Section 2(h)(1) “bilateral swaps” exemption as Section 106 of H.R. 5660. Both applied the CEA’s anti-fraud and anti-manipulation provisions to “eligible contract participants”, but not the anti-fraud provisions to “principal to principal” transactions between “eligible commercial entities.” Perhaps (1) an intervening draft of the legislation would have changed the Section 2(h)(1) provision from that in H.R. 4541, (2) the provision was further changed back to that in H.R. 4541 after Mr. Long’s conversation, or (3) Mr. Long misunderstood what the Treasury Department told him.
65. ^ “Statement by Treasury Secretary Lawrence H. Summers” (“We are pleased with the agreement reached last night on over-the-counter derivatives. We hope that Congress will now pass this important legislation that will allow the United States to maintain its competitive position in this rapidly growing sector by providing legal certainty and promoting innovation, transparency and efficiency in our financial markets.”) “Treasury Under Secretary for Domestic Finance Gary Gensler Remarks to the Bond Market Association, New York, New York” (“As the markets turn increasingly to swaps to take on some of the functions played by Treasury securities, it is ever more important to provide legal certainty for these OTC derivatives. We have worked vigorously to pass legislation providing legal certainty for swaps under the Commodity Exchange Act. I am very pleased to announce that we reached agreement late last night with Congress on such legislation, the Commodity Futures Modernization Act of 2000. This legislation, if enacted, will provide legal certainty, promote innovation, and enhance the competitiveness of U.S. financial markets.”) Michael Schroeder, “Treasury Officials, GOP Reach Accord on Commodities”, Wall Street Journal, December 15, 2000 (Eastern Edition) at 1 (“Treasury officials and senior Republican lawmakers agreed on a bill to overhaul commodities regulation. The GOP leaders hoped for passage as early as today as part of a year-end budget bill. But last night, the appropriations committees were resisting inclusion of the complex measure...Federal Reserve Board Chairman Alan Greenspan and Treasury Secretary Lawrence Summers have said the legislation is critical to the nation's $80 trillion derivatives industry. Large banks and major corporations use derivatives to hedge risk. The measure exempts the over-the-counter financial contracts from regulation, settling an important derivatives-contract legality issue…After yearlong negotiations, proponents overcame partisan wrangling and a regulatory turf battle between the CFTC and Securities and Exchange Commission. Lifting a ban on futures contracts pegged to a company's stock was among the most contentious issues. In October, the House overwhelmingly passed a version of the bill. In the Senate, Banking Committee Chairman Phil Gramm (R., Texas) objected to certain provisions. The administration adamantly opposed his insistence on including swaps sellable to individual investors. In the compromise, he dropped his support for including retail swaps.”)
66. ^ Thomas LOC All Congressional Actions Page for H.R. 5660 (“H.R. 5660 All Actions Page”). Rep. Ewing’s remarks introducing the bill (at E2181-2 of the December 14, 2000 Congressional Record) were inserted into the Congressional Record as “extensions of remarks”, not actual statements made on the House Floor. They demonstrate this “latest version of the legislation”, although formally assigned to four committees as shown on the H.R. 5660 All Actions Page, was “the final package” reflecting the “many hours working through this language to reach agreement” among the Administration, Treasury, the CFTC, the SEC and the Senate. Charles W. Edwards, J.D., James Hamilton, J.D., L.L.M., Heather Montgomery, J.D., Commodity Futures Modernization Act of 2000: Law and Explanation (CCH Incorporated 2000) (ISBN 0-8080-0600-2) (“CCH CFMA Guide”) at 15 (“After an arduous effort, the 106th Congress passed the Commodity Futures Modernization Act of 2000, H.R. 5660, Public Law 106-554, as Section 1(a)(5) of H.R. 4577, the Consolidated Appropriations Act of 2001. It was signed by President Clinton on December 21, 2000, without change, as introduced on December 14, 2000 in the House of Representatives.”)
67. ^ CRS 2003 CFMA Report at 6 (“identical bills H.R. 5660 and S. 3282 [sic] were introduced”). Thomas LOC All Congressional Actions Page for S. 3283 Sen. Lugar’s introduction of the bill at S11924-6 of the December 15, 2000, Senate bill introductions in Congressional Record, S11918-11930, December 15, 2000 states (at S11924) H.R. 5660 would be the legislation “which will be enacted as part of the final appropriations package today.” Sen. Gramm states (at S11926) “We are introducing the bill today as the finished product of years of work involving half a dozen committees in both Houses of Congress, and as many agencies of the Federal government. This bill is identical to, and is the Senate companion to, H.R. 5660, introduced yesterday in the House and which will be approved by the House and the Senate today. We introduce this bill in the Senate to demonstrate the bicameral authorship and support for this important legislation.”)
68. ^ CRS 2003 CFMA Report at 6 (“H.R. 5660 was incorporated by reference into H.R. 4577”). CCH CFMA Guide at 15. Paul M. Irvin, “Appropriations for FY2001: Labor, Health and Human Services, and Education, CRS Report for Congress, RL30503 Updated January 18, 2001 (“CRS 2001 Appropriations Report”), at CRS-2 (explaining the text of the Conference Report for H.R. 4577 is at H12100-H12439 and H12531). The text of the CFMA (then as H.R. 5660) is in H12320 to H12345 of the full Conference Report contained in Congressional Record, H12100-12439, December 15, 2000. H12100 lists H.R. 5660 as (5) of (9) House bills incorporated into the spending bill. H12439 shows the names of the 15 House Managers and 15 Senate Managers for the Conference, who unanimously approved the Conference Report subject to Rep. Jesse L. Jackson, Jr.’s objections to the four items listed after his name, not including any objection concerning H.R 5660. Sen. Gramm is not listed as a Senate Manager. His ability to keep legislation out of the Conference Report, however, was noted by Representative Barney Frank (D-MA) in the House debate of the Conference Report at Congressional Record, H12442-12502, December 15, 2000, during which (at H12483) Rep. Frank noted a measure with bipartisan support had not been included in the Conference Report because it “was killed by the objection of the senior Senator from Texas.”
69. ^ CRS 2003 CFMA Report at 6. Thomas LOC All Congressional Actions Page for H.R. 4577 (“H.R. 4577 All Actions Page”). Roll Call 603. Congressional Record, H12502, December 15, 2000.
70. ^ H.R. 4577 All Actions Page, which shows December 15, 2000, Senate “consideration” and action. It is noted at Congressional Record page S11855 that the Conference Report was published in full in the House proceedings for December 15, 2000, as described in note 66 above. The Conference Report passed the Senate by "unanimous consent." The H.R. 4577 All Actions Page shows the Senate “discussion” of the Conference Report taking place on December 15, 2000, from pages S11855-S11878 with no vote taking place. When the Senate adopts a rule permitting adoption of legislation by “unanimous consent” the bill or other matter before the Senate is adopted “unless an objection is stated.” At S11876, both Senators James Inhofe (R-OK) (“I rise today to lodge my objection to H.R. 4577. I understand that there will not be a rollcall vote but if there were to be a rollcall vote I would vote no.”) and Paul Wellstone (D-MN) (“I want to voice my strong objection to the process by which this legislation is being passed by the Senate. The Omnibus Appropriations conference report--containing numerous other pieces of unrelated legislation--is being passed by the Senate tonight under a consent agreement that was entered suddenly by the Majority Leader without the normal notification process. We should have had a recorded vote…I want to make it clear; I oppose this legislation and I would like the Record to show that I would have voted no had there been a recorded vote”) derided the procedure. Under the “consent agreement” described by Sen. Wellstone this did not constitute an “objection” that defeated the unanimous consent. Sandy Streeter, “Continuing Appropriations Acts: Brief Overview of Recent Practices”, CRS Report for Congress RL30343, Updated December 22, 2000 ( explaining, in footnote b to Table 1, that “a unanimous consent request is proposed to adopt the measure and if no Member objects, the resolution is adopted.”). Paul M. Irvin, “Appropriations for FY2001: Labor, Health and Human Services, and Education, CRS Report for Congress, RL30503 Updated January 18, 2001, at CRS-2 (explaining the text of the Conference Report for H.R. 4577 is at H12100-H12439 and H12531, that the House debated the Conference Report at H12442-12501, with a roll call vote at H12502, and that the Senate passed the Report by unanimous consent at S11855-11885). Page H12531 is the printing order for the Conference Report that appears at pages H12100-12439.
71. ^ In the House, Representative John LaFalce (D-NY), Ranking Member of the House Banking Committee, was a co-sponsor of H.R. 5660. The House proposed the order to consider the H.R. 4577 Conference Report at Congressional Record, H12441, December 15, 2000, and proceeded to debate it at H12442-12501 (as cited and linked at the end of note 66 above). Representative Charles Stenholm (D-TX), Ranking Member of the House Agriculture Committee, spoke in favor of H.R. 5660 at H12491 (“the agreement is broadly supported by the Administration, the President’s Working Group on Financial Markets, and by the financial services industry…I support the inclusion of CEA reform in this bill, and I congratulate Chairman Ewing for his achievement.”) Representative John Dingell (D-MI), Ranking Member of the House Commerce Committee, spoke at length in support of H.R. 5660 at H12497-8 (“The critical investor protection and market integrity provisions approved overwhelmingly by the House in October remain intact, making it possible for many Democrats to support this important legislation…I have received a letter from the New York Mercantile Exchange stating that: ‘The New York Mercantile Exchange has serious reservations regarding provisions … that would have the effect of removing energy trades conducted on electronic trading systems from nearly all public scrutiny and accountability.’ On December 12, 2000, a coalition that includes the Consumer Federation of America, the Derivatives Study Center, and the Economic Policy Institute wrote members of the Senate and House, complaining that this bill ‘goes too far in deregulating derivatives markets’ and ‘recklessly reduces market protections.’ I want to assure these groups that I have heard their concerns. The changes made by this legislation do not need to yield the dire results that they predict. A great deal will depend on how the law is implemented and enforced by the federal financial regulators and the self-regulatory organizations.”) Representative Sheila Jackson-Lee (D-TX) spoke at H12495 (“The bill is similar to H.R. 4541 that was passed by the House on October 19, but it contains revisions based on negotiations between Senate Banking Committee Chairman Gramm, House Republicans, and the Treasury, SEC and CFTC…This version of the bill is acceptable to the Treasury Department, Securities Exchange Commission, and Commodity Futures Trading Commission…some consumer advocates have expressed concern that the deregulation of derivatives markets in this bill weakens the protections against fraud and manipulation and could lead to future instability in the financial markets.”) Among Republicans, Rep. Ewing, the bill’s sponsor, had introduced H.R. 5660 (as described in note 64 above) and spoke in support at H12485 and H12488-9 (“Secretary Summers in coordination with Chairman Rainer and Chairman Levitt and countless members of their staff put in many hours working through this language to reach agreement.”) Rep. Leach spoke in support at H12498-9 (“After continued negotiation, involving the other body and the Administration, further modifications have been made to the legislation to provide an even greater level of assurance that over-the-counter derivatives will continue to be a vital part of America’s financial innovation and continued success… While this legislation represents a great leap forward there remain issues that will require further scrutiny and due diligence of this body and it will be necessary to closely monitor the application of this bill, with a mindful eye on further innovation, to ensure that the genius of our financial services industry is not again restricted by outdated and burdensome laws.”) Representative Thomas Bliley (R-VA), Chair of the House Commerce Committee, (at H12501) and Representative Larry Combest (R-TX), Chair of the full Agriculture Committee (at H12497) exchanged “statutory interpretation” remarks agreeing that nothing in Title II of the CFMA would give banks increased powers to own securities. In the Senate the two Ranking Members of the Agriculture and Banking Committees introduced letters from the PWG confirming its unanimous “strong support” for H.R. 5660. Senator Thomas Harkin (D-IA), Ranking Member of the Senate Agriculture Committee and a co-sponsor of the equivalent S.3283, was the only Democrat who entered a statement about the bill on December 15, which appears at Congressional Record, S11896-7. Sen. Harkin noted (at S11896) he had worked to eliminate “an outright exclusion” for energy, preferring to continue “the substantial exemption” already provided by the CFTC, but that “further negotiations” brought “the provisions on this subject that are in this bill.” He recognized “the need for compromise” given “the overall importance and positive features of this legislation.“ He also noted (at S11896) he had worked with Senator Lugar on the legislation and that Senators Gramm and Sarbanes had cooperated “in completing this bill.” At S11897 he concluded by complementing Sen. Lugar, Rep. Ewing and “all staff involved for their outstanding work in making this important legislation a reality.” Senator Paul Sarbanes (D-MD) did not speak on December 15, but when Congress returned on January 2, he noted the PWG’s strong support for H.R. 5660 and introduced the version of the PWG letter addressed to him. Congressional Record, S11946, January 2, 2001. During the actual Senate “consideration” of H.R. 4577 (at Congressional Record, S11855-11878, December 15, 2000), Republican Senator Gramm (at S11926) was the only Senator to speak in support of H.R. 5660. In added remarks at Congressional Record, S11878-11885, December 15, 2000 Senator Peter Fitzgerald (R-IL) spoke (at S11878-9) in support of the CFMA. In the December 15, 2000 statements on introduced bills at S11918-11930 Sen. Lugar (at S11924-6) in introducing S. 3283 as the equivalent of H.R. 5660 spoke in support of H.R. 5660. The only change to H.R. 4577 made during the House and Senate consideration of the H.R. 4577 conference report was an amendment to H.R. 5666 made by joint resolution of the two Houses. See amendment as introduced as enacted, and as enrolled. This shows in section 1(a)(4) of H.R. 4577 as enacted into law as Public Law 106-554.
72. ^ CCH CFMA Guide at 15. CRS 2003 CFMA Report at 6. See H.R. 4577 All Action Page for the December 21, 2000, signing into law. After the CFMA became law, early descriptions continued to describe how the law was enacted after Sen. Gramm’s objections were overcome. CCH CFMA Guide at 15 (after describing House passage of H.R. 4541 “However, Senator Phil Gramm, among others, still expressed concern about the legal certainty of derivatives markets, especially with respect to the banking industry. While many thought these concerns greatly diminished the likelihood of the Commodity Exchange Act being reauthorized in the 106th Congress, the revamped CFMA, in the form of H.R. 5660, emerged out of closed-door negotiations with new Titles III and IV added.”) Cadwalader, Wickersham & Taft, "Memorandum: Commodity Futures Modernization Act of 2000” (“Cadwalader CFMA Memo”) at 3 (describes how the Shad-Johnson Accord repeal “debate held up the proposed CEA amendments until the PWG was able to produce a satisfactory resolution in September, 2000. Once that was settled, the last hurdle was Chairman Phil Gramm of the Senate Banking Committee, who finally allowed the bill to move forward after it was peppered with stronger prohibitions against CFTC involvement in bank-related activity.”) See also CRS 2003 CFMA Report at 6 (“On December 14, 2000, [sic] identical bills H.R. 5660 and S. 3282 [sic] were introduced, after negotiations among House and Senate committees, regulators, and executive branch agencies.”). By December 2001, however, a different narrative of events emerged that has become widespread. Audio and NPR Transcript for Terry Gross Interview of Frank Partnoy, “Fresh Air,” March 25, 2009 (“Partnoy Fresh Air Interview”) (at 19’30” into the audio Professor Partnoy describes the CFMA by stating “Phil Gramm added the provision in the evening, just hours before the Christmas break. It was never debated in the House. It was never debated in the Senate. It was shoved into an 11,000 page omnibus budget bill.”); Audio and NPR Transcript Terry Gross Interview of Antonia Juhasz,"Fresh Air", October 7, 2008 (“Juhasz Fresh Air Interview”) (at 2’ 45” into the audio Ms. Juhasz states: “Phil Gramm slipped in what has forever since been known as the Enron loophole into the Commodity Futures Modernization Act, and he added this loophole at the very last minute, snuck it in then to the Omnibus Appropriations Bill, which was then passed at the very end of a lame duck presidency, a lame duck session of Congress, just before - or just after Bush was appointed the presidency by the Supreme Court and shortly before he took office.”); Peter S. Goodman, “Taking Hard New Look at a Greenspan Legacy”, New York Times, October 9, 2008 (“The House overwhelmingly passed the bill that kept derivatives clear of C.F.T.C. oversight. Senator Gramm attached a rider limiting the C.F.T.C.’s authority to an 11,000-page appropriations bill.”); David Corn,“Foreclosure Phil”, Mother Jones, May 28, 2008, (“As Congress and the White House were hurriedly hammering out a $384-billion omnibus spending bill, Gramm slipped in a 262-page measure called the Commodity Futures Modernization Act…the measure had been considered dead-even by Gramm…’Nobody in either chamber had any knowledge of what was going on or what was in it,’ says a congressional aide familiar with the bill’s history.”); Michael Greenberger, Testimony before the U.S. Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs regarding Excessive Speculation in the Natural Gas Futures Market, June 25, 2007, at 5 (referring to the “Enron Loophole” discussed below in Section 4, “The loophole was added at the last minute to a 262 page bill, which was itself belatedly and quite suddenly attached in a lame duck session on the Senate floor by then Senate Finance Chairman Gramm to an 11,000 page consolidated appropriations bill for FY 2001.”); Michael Greenberger, Senate Democratic Policy Committee Hearing, “Lessons from Enron: An Oversight Hearing on Gas Prices and Energy Trading”, May 8, 2006, at 6. (the CFMA “was an over 262 page bill added at the last minute on the Senate Floor by then Senate Finance Chairman Gramm to an over 11,000 page consolidated appropriations bill for FY 2001.”); Sean Gonsalves, Opinion, “Enron Exemplifies ‘Genius of Capitalism’”, Seattle Post-Intelligencer, January 22, 2002, at B5 (quoting from the James Ridgeway article cited next, it describes how the CFMA passed “without undergoing the usual committee hearings and committee votes. (The act) was immediately attached as a rider to an 11,000-page appropriations bill. It passed and was signed into law by President Clinton six days later.”) and available on-line in the same form as published in the January 22, 2002, Cape Cod Times; James Ridgeway, “Phil Gramm’s Enron Favor”, Village Voice, January 15, 2002, (after quoting Blind Faith, as cited next, describes how S. 2697 “never made it to the floor” but on December 15, 2000, “Gramm curiously turned up as co-sponsor of a bill with the same name…which, without undergoing the usual committee hearing and preliminary votes, was immediately attached as a rider to an 11,000-page appropriations bill.”); Blind Faith (this study, referenced and linked at the end of note 13 above, is the source for the narration of the CFMA’s legislative history for the Ridgeway and Gonsalves articles. It describes (1) S. 2697 as a bill that “languished in the Senate, too controversial to get a committee hearing” (compare the hearing transcript and Senate Agriculture Committee Report in note 50 above); (2) H.R. 4541 as a bill passed in the evening in a House where “minority members” have less authority to alter legislation (compare the House proceedings described in notes 54 and 58 above, the lead up to those proceedings described throughout notes 54-58 above, and Rep. Maloney’s call to not provide the 2/3 vote needed to consider H.R. 4541 under a “rule suspension” as described in note 74 below); (3) H.R. 4541 as held up in “the more deliberative Senate” until Sen. Gramm “ensured the bill would not be subject to floor debate” (compare the descriptions of Sen. Gramm activities in notes 53, 54, 58, and 60-63 above); and (4) the CFMA as the “same bill” re-introduced by Sen. Gramm on December 15 in “coordinated trickery” with Rep. Ewing “to get the entire bill attached to the appropriations bill” (compare with the lead up to the CFMA detailed in notes 58-63 above and the PWG letters and Congressional statements in note 69 above). While Sean Gonsalves and James Ridgeway relied on Blind Faith for the factual background they provided, the later cited references do not cite source materials other than David Corn citing a “congressional aide” in the quoted language from his article (compare that with the Congressional statements and other sources in notes 58-69 above) and Professor Greenberger citing Mr. Gonsalves in both of his referenced testimonies. Professor Greenberger also cites a 2002 Supplement to the predecessor edition of Johnson/Hazen Derivatives Regulation. That citation supports the description of the CFMA as 262 page legislation. The 2002 Supplement at 3 (as cited by Greenberger) states “The Commodity Futures Modernization Act (CFMA) is a large document spanning 262 pages in bill form.” The 2002 Supplement is out of print. Johnson/Hazen Derivatives Regulation incorporates into its description of the CFMA most of the language of the 38 pages of description of the CFMA contained in the 2002 Supplement (which description begins on page 3 and ends on page 41 of the 2002 Supplement. Pages 43 through 155 contain the text of the CFMA, and pages 157 through 228 contain proposed CFTC rules to implement the trading facility provisions of the CFMA, as published at 66 Federal Register 14262 (March 9, 2001)). Johnson/Hazen Derivatives Regulation at 314 states “The Commodity Futures Modernization Act (CFMA) is a large document consuming 262 pages.” Sen. Gramm is not mentioned in either the 2002 Supplement or the description of the CFMA in Johnson/Hazen Derivatives Regulation. For 2008 media reports that present a description of events leading to passage of the CFMA more consistent with 2000 and early 2001 sources, see the Enron emails described in Lipton Enron Article and Anthony Faiola, Ellen Nakashima and Jill Drew ”What Went Wrong?”, Washington Post, October 14, 2008 (“The House passed the bill Oct. 19, but then the legislation stalled. Gramm was holding out for stronger language that would bar both the CFTC and the SEC from meddling in the swaps market. Alarmed, SEC lawyers argued that the agency at least needed to retain its authority over fraud and insider trading… Treasury Undersecretary Gary Gensler brokered a compromise: The SEC would retain its antifraud authority but without any new rulemaking power. On the night of Dec. 15…the act passed as a rider to an omnibus spending bill.”) Similarly, in Infectious Greed at 295 Professor Partnoy gives a broader depiction of the CFMA’s origins than in the Partnoy Fresh Air Interview, as he mentions former SEC Chair Levitt’s role in “overseeing” enactment of the CFMA. In Antonia Juhasz, The Tyranny of Oil, (HarperCollins 2008) at 147-8, Antonia Juhasz states “Without any congressional hearings or debate, or any public notice, on December 12, 2000, Phil Gramm slipped what would forever be referred to as the “Enron Loophole” into the 262-page Commodity Futures Modernization Act, of which he was a sponsor. The act was then belatedly but quite suddenly attached to the 11,000-page omnibus appropriations bill that was passed into law by Congress and signed by President Clinton.”) Although she provides no source for this information, other than the added detail that the “Enron Loophole” was added to the CFMA by Sen. Gramm on December 12, 2000, this account by Antonia Juhasz is consistent with the Juhasz Fresh Air Interview, the Blind Faith account, and the accounts that relied on Blind Faith.
73. ^ ^{a b} "The Enron Loophole". Open CRS. http://opencrs.com/document/RS22912/2008-07-07/. 
74. ^ Mark Jickling, “The Enron Loophole”, CRS Report for Congress RS22912, July 7, 2008 (“CRS Enron Loophole Report”)
75. ^ CRS Enron Loophole Report at CRS-2 to 3. Johnson/Hazen Derivatives Regulation at 331 to 332. ISDA CFMA Memo at 29 to 30. Susan Ervin, "CFTC Regulation of Energy Derivatives: An Overview” (“Ervin CFTC Energy Regulation”) at 10. As explained in the referenced pages of the ISDA CFMA Memo and in Ervin CFTC Energy Regulation at 9, an “eligible commercial entity” (“ECE”) was defined as an ECP that was not an individual or State or local government entity that, depending on the nature of the entity, had a specified “exposure” to the underlying commodity.
76. ^ Johnson/Hazen Derivatives Regulation at 332. ISDA CFMA Memo at 30 to 31. Ervin CFTC Energy Regulation at 10
77. ^ For the removal of the exempt commercial market language from the Senate bill, see the Senate Agriculture S. 2697 Report at 9 (“although this exemption is limited to transactions between eligible contract participants that occur off a trading facility, the CFTC is encouraged to use its current exemptive authority, as appropriate and consistent with the public interest, under Section 4(c) of the CEA to exempt transactions between eligible contract participants that occur on an electronic trading facility.”) The revised Senate Agriculture Committee Section 2(h)(1) language, which provided a broader exemption than the CFMA in not requiring that eligible contract participants (“ECPs”) act as “principals”, is at page 42 of the Senate Agriculture S. 2697 Report and at pages 159 to 161 of the reported version of S. 2697, as Section 9. Section 5 of S. 2697 as introduced in the Senate would have excluded from most CEA provisions electronic trading of all energy commodities (which, along with financial commodities, were defined as “Exclusion Eligible Commodities”) by ECPs acting as principals . See pages 23 to 25 of the Senate Agriculture S. 2697 Report or pages 23 to 25 of S. 2697 as introduced in the Senate. For the later Senate Agriculture Committee recriminations concerning the “source” for Section 2(h)(3), see Hearing before the Senate Committee on Agriculture, Nutrition, and Forestry, “CFTC Regulation and Oversight of Derivatives”, July 10, 2002 (“July 10, 2002, Senate Agriculture Hearing”) at 2 (Senator Tom Harkin: “The final version of the legislation included in the omnibus appropriations bill differed from our committee bill regarding energy and metals derivatives markets. I supported the CFMA, although I had some concerns about its treatment of energy and metals. There is a statement I gave on the floor to which I would refer you that is in the Congressional Record regarding that, because I thought at the time it had a number of very positive features. On the whole, I thought it was a good bill, and I still think it is.” As described in note 69 above, Sen. Harkin had entered a statement in the December 15, 2000, Congressional Record in support of H.R. 5660. He had noted his misgivings about its treatment of energy derivatives, but had recognized “the need to compromise.” Although, as described in note 69 above, they had entered in the Congressional Record statements in support of H.R. 5660, Senators Fitzgerald and Lugar had not stated any misgivings about the bill’s treatment of energy derivatives. At the July 10, 2002, hearing they joined Sen. Harkin in expressing dismay over the energy provisions of the CFMA (Sen. Fitzgerald at 9: “somehow, somewhere in the process, somebody slipped in this mysterious exemption for energy and metals trading” and at 58: “As we had it in Committee, it did not have that special carve-out and somehow… special carve-out came and it does not seem to have a father. No one can figure out who did it.” Sen. Lugar at 11: “Somebody in the process of that conference talked about exemption of bilateral trade on electronic platforms, precisely the sort of thing that Enron was to be involved in…We all should have been brighter, perhaps, in reading the type, but nevertheless, that is the one that already occurred and that is why it is here.”) None of Senators Harkin, Fitzgerald, or Lugar discussed at the hearing whether they thought S. 2697, which had never been voted on in the Senate and which was organized differently than H.R. 4541 and H.R. 5660, was the source for H.R. 5660, rather than H.R. 4541, which had passed the House and contained the same Section 2(h)(3) trading facility exemption as the CFMA. As described in note 78 below, CFTC Commissioner Thomas Erickson, who had been a critic of the CFMA back in 2000, explained Section 2(h) was not the “Enron Loophole” used by EnronOnline. At the January 29, 2002, Hearing before the Senate Committee on Energy and Natural Resources to Receive Testimony Concerning the Impact of the Enron Collapse on Energy Markets("January 29, 2002, Senate Energy Hearing") the prepared testimony of Vincent Viola, Chairman of NYMEX, which had “lobbied” against Section 2(h)(3) for exempting from the CEA energy and metals “futures contracts traded on electronic trading platforms from nearly all federal regulatory oversight”, recounted (at 37) that lobbying effort and explained “Thankfully, Mr. Chairman [i.e. Senator Jeff Bingaman (D-NM)], you, Senator Charles Schumer, and Senators Richard Lugar and Tom Harkin (Attachment 3) with the Senate Agriculture Committee, as well as number of members of congress including Congresswoman Carolyn Maloney, Congressmen Peter King, John Dingell, and others recognized the serious policy flaws with this extreme deregulatory measure, and quite courageously challenged Enron and others, preventing it from becoming law in its most draconian form.” In his prepared testimony for the same hearing (at 63), Senator Charles Schumer (D-NY) recalled that effort and stated “During the debate regarding the CFMA, I was greatly concerned about the similar effects that granting electronic trading facilities an exclusion from CFTC oversight would have had on the market, and fought hard against such an exclusion…There would have been no anti-market manipulation rules, among others, to protect the markets. Those of us who were concerned about the ramifications of an ETF exemption fought that provision and won.” In Sen. Schumer’s questioning (at 63-4) he elicited from NYMEX Chairman Viola (at 64) the statement “I think clearly the last minute efforts at sort of not having complete deregulation and exemption occur in the CFMA helped greatly in keeping markets stable…” As described above, at the July 10, 2002 Senate Agriculture Hearing, this Congressional involvement with Section 2(h)(3) was forgotten. Instead, in Sen. Fitzgerald’s words, the “loophole’ had “no father.” In the House considerations of H.R. 4541, the Section 2(h) exemptions for “exempt commodities” was criticized by the CFTC at all three hearings on the bill and by House Floor statements of Representative Carolyn Maloney (D-NY) and, at E1879 of his “extended remarks” cited and linked in note 41 above, by Rep. Markey (“I also have some concerns with the breadth of the exemption in section 106 of this bill, and its potential anticompetitive and anticonsumer effects. There may be less anticompetitive ways to address an energy swaps exemption in a way that provides for fair competition and adequate consumer protections in this market. Such a result would be in the public interest. What is currently in the bill is not, and I would hope that it could be fixed as this bill moves forward.”) On September 28, 2000, at H8436, Congressional Record, September 28, 2000, Rep. Maloney called upon the House to block consideration of H.R. 4541 by refusing the necessary 2/3 vote for a rule “suspension” if the “energy provisions” were not given a “full hearing.” She entered into the record on the same page a letter she had received from CFTC Chair William Rainer describing CFTC opposition to the provision expressed at all four Congressional hearings on H.R. 4541 and S. 2697. On October 19, 2000, in supporting the required “rule suspension”, Rep. Maloney stated (at Congressional Record, H10412, October 19, 2000) that her concerns “had been addressed at least in part” but that “the provision could be further improved by deleting language that favors electronic trading facilities over traditional exchanges.” Rep. Maloney’s statements came after Rep. Leach entered (at Congressional Record, H10365, October 19, 2000) a “Supplemental Report” from the House Banking Committee that showed as an “errata” to the Committee’s earlier report a Committee vote of 20-12 defeating an amendment proposed by Rep. Maloney “to delete the provision providing a partial exclusion from the CEA for exempt commodities entered into solely between eligible contract participants and executed on an electronic trading facility.” For the supplemental report see House of Representative Report 106-711, Part 4.
78. ^ CRS Enron Loophole Report at CRS-4 to 6. Dechert LLP, “CFTC Reauthorization Act of 2008 Enacted into Law” at 2 to 3. Testimony of Michael Greenberger before United States Senate Commerce Committee, June 3, 2008 (“Greenberger June 3, 2008, Senate Testimony”) at 3 to 5.
79. ^ Greenberger June 3, 2008, Senate Testimony at 7, fn. 28. “The Enron Loophole has Closed and Goes Into Effect on September 30, 2009”, citing the Wikipedia article Enron Loophole. Ervin CFTC Energy Regulation at 11 (describing the 2002 ”Feinstein Bill” that would repeal the Section 2(g) swaps exclusion, along with making other CFMA amendments.) The language of Section 2(g) was contained in Section 107 of H.R. 4541, as passed by the House, at page 47, as creating a new Section 2(h) of the CEA. In the CFMA it was Section 105(b) of H.R. 5660 at page 40, as described in note 57 above. During House consideration of H.R. 4541 (as cited and linked in note 54 above), Rep. Dingell (at H10446) objected to this “redundant exclusion” but accepted its “strict’ requirements, including the requirement that “each of the material economic terms of the swap must be individually negotiated.” Although this was changed in Section 105(b) of H.R. 5660 to require only that the swap be “subject to individual negotiation by the parties”, Rep. Dingell did not criticize this provision in his Floor statements on H.R. 5660 (as cited and linked in note 69 above). For the significance of Section 2(g) for energy contracts, see also ISDA CFMA Memo at 27-28.
80. ^ See House Banking Committee Report at 13 for Section 110, which would have added a new Section 2(i) to the CEA as the exclusion for “Swap Transactions” (defined to require that “the material economic terms” be “subject to individual negotiation.”) See H.R. 4541 as passed by the House at 47 for Section 107, which would have added a new Section 2(h) to the CEA as the exclusion for “Swap Transactions.” See the CFMA at 40 for Section 105(b), which created Section 2(g) of the CEA. See the Gramm-Leach-Bliley Act at 58 for Section 206(b), which defines "swap agreement" to be "individually negotiated." For CEA Section 2(g)'s use of the Gramm-Leach-Bliley definition, see ISDA CFMA Memo at 27 to 28 and 39. Kloner CFMA at 292.
81. ^ At the July 10, 2002, Senate Agriculture Hearing, CFTC Commissioner Thomas Erickson, who had been a critic of the CFMA in 2000, explained Section 2(h)(3) was not the “Enron Loophole” used by EnronOnline. He suggested (at 17 to 18, 22 to 23, 25, 26, and 30 to 31) that the bulk of the OTC derivatives market used the 2(g) exclusion for “swaps” and that this was available to EnronOnline. See also Sen. Fitzgerald at 25 (“Enron Online and Intercontinental Exchange are just exempt by statute here with Section 2(g)”) and page 48 for Professor Coffee’s view. While the differences between Commissioner Erickson and CFTC Chair Newsome at the hearing (at 17 and at 30-31) were characterized as a “disagreement” over whether Section 2(g) “trumped” Section 2(h), Chairman Newsome states (at 17-18) that “swap transactions were excluded from our jurisdiction prior to the CFMA by administrative action of the CFTC and they were excluded after the CFMA by codification of Congress.” He goes on to state Section 2(h) is not “trumped by the swap’s exclusion for transactions in energy products that are not deemed to be swaps transactions.” Thus, Chairman Newsome acknowledged Section 2(g) did “trump” Section 2(h) for swap transactions. While the 1993 swaps exemption exempted swaps from the CEA, as described in note 19 above, it did not exempt such transactions from the fraud and anti-manipulation provisions of the CEA to the extent the transactions were “futures” under the CEA. The CFMA granted an exclusion from such provisions. Further testimony at the July 10, 2002, Senate Agriculture Hearing (at 57) explained the Section 2(g) exclusion would apply to “online” transactions in which after agreeing to price the parties would “go offline” and “negotiate the credit terms.” This type of transaction would be eligible for the Section 2(g) exclusion if it dealt with either an excluded or an exempt commodity. The Section 2(h)(1) exemption for “bilateral swaps” would be available if the two parties completed their “private” transaction online without “individual negotitation” but without both the offer and acceptance being available to multiple parties. This is the way Enron OnLine is usually described as having operated, because Enron was always a party to each transaction. Infectious Greed at 320 (‘its trades were judged to be ‘bilateral contracts’ between the two parties trading on Enron’s website”). At the January 29, 2002 Senate Energy Hearing, Chairman Bingaman explained (at 1 to 2) “EnronOnline did not match buyers and sellers. It contracted with each separately, so that Enron was on the other side of every deal.” See also the prepared statement of Patrick Woods, III, Chairman, Fedederal Energy Regulatory Commission, at 14 (“EnronOnline uses a one-to-many trading format, where an Enron affiliate is always on one side of each energy transaction, either as a seller or a buyer. The price of a commodity or derivative on EnronOnline is determined when a buyer or a seller accepts an offer or bid price posted by an Enron trader.” In contrast, Chairman Woods describes the Intercontinental Exchange (“ICE”) as a “many-to-many platform.” A December 16, 2000, email from Chris Long of Enron indicated Enron was aware it would need to change EnronOnline to have Section 2(h)(3) apply to it. (in describing Section 2(f) the email states “This exemption could facilitate expansion of EnronOnline to allow for multi-party transactions, however certain legal requirements will have to be met.”).
82. ^ June 19, 2000, House Agriculture Subcommittee Hearing. July 12, 2000, House Commerce Subcommittee Hearing. July 19, 2000, House Banking Committee Hearing. June 21, 2000, Joint Senate Agriculture and Banking Committees Hearing. Although the exclusions for financial OTC derivatives were not controversial at these hearings, at earlier 2000 hearings considering the PWG Report the issue was discussed, particularly whether a regulatory exemption would be better than a statutory exclusion. Senate Agriculture PWG Report Hearing at 9 (in describing what might happen if “you have a problem that crops up”, Sen. Harkin states “if you have an exclusion, then it would take an act of Congress to do something about it.…if you have an exemption, then the CFTC could respond more readily to something like that.” Treasury Secretary Summers responds: “you are clearly correct that an exemption provides more flexibility than an exclusion, but it is precisely the presence of that flexibility and the recognition that it might be used that undercuts legal certainty and creates a greater possibility that these transactions will take place and be booked abroad where they will not be subject to American law.”) At the May 18, 1999, Hearing before the House Subcommittee on Risk Management, Research, and Specialty Crops concerning Reauthorization of the CFTC in anticipation of the recommendations of the PWG Report, Patrick M. Parkinson, Associate Director, Division of Research and Statistics, Board of Governors of the Federal Reserve System, spoke (at 130) about credit derivatives but dismissed price manipulation and “price discovery” concerns that have become central to critiques of credit default swaps: “some types of OTC contracts that have a limited deliverable supply, such as equity swaps and some credit derivatives, are growing in importance. However, unlike agricultural futures, for which failure to deliver has additional significant penalties, costs of failure to deliver in OTC derivatives are almost always limited to actual damages. Thus, manipulators attempting to corner a market, even if successful, would have great difficulty inducing sellers in privately negotiated transactions to pay significantly higher prices to offset their contracts or to purchase the underlying assets. Finally, the prices established in privately negotiated transactions are not used directly or indiscriminately as the basis for pricing other transactions. Counterparties in the OTC markets can be expected to recognize the risks to which they would be exposed by failing to make their own independent valuations of their transactions, whose economic and credit terms may differ in significant respects. Moreover, they usually have access to other, often more reliable or more relevant, sources of information on valuations. Hence, any price distortions in particular transactions would not affect other buyers or sellers of the underlying asset.”)
83. ^ Eric Dinallo, “We Modernized Ourselves into the Ice Age”, Financial Times, March 30, 2009 (“Dinallo FT Opinon”) (stating “unregulated speculation” was a major cause of the bank panic of 1907, in reaction states passed “anti-bucket shop and gambling laws, outlawing the activity that helped to ruin the economy”, and the CFMA “exempted credit default swaps from these laws” which meant “we might have avoided the worst of the current troubles if we had not overturned laws adopted in response to earlier crises.”) For the PWG’s recommendations to exclude from the CEA (and include in the CEA’s preemption of state laws) OTC derivatives in “non-exempt securities” see PWG Report at 17 (for swaps) and at 29 (for hybrid instruments).
84. ^ In the Dinallo FT Opinion former Insurance Superintendent Dinallo argues (1) “the fear in 2000 was that if we regulated credit default swaps and required holding sufficient capital, the market would go where unregulated sellers could make more money” and (2) banks bought credit default swaps from AIG covering “investments” held by the banks “to avoid regulation” because it allowed them to claim “they no longer had the risk of a default of the bond.” It is difficult to understand how this applies to AIG (which is the company mentioned in the Dinallo FT Opinion) or what the “regulatory arbitrage” credit default swaps (“CDS”) of AIG had to do with the CFMA. AIG Financial Products (“AIGFP”), before 2000 and after the CFMA became law, was located in London. Gretchen Morgenson, “Behind Insurer’s Crisis, Blind Eye to a Web of Risk”, New York Times, September 28, 2008 (“Morgenson Article”) (which dates the establishment of London based AIGFP to 1987); Peter Koeing, “AIG Trail Leads to London Casino”, Telegraph, October 18, 2008; “AIG Blames its London Office” Forbes, March 13, 2009. If US-based CDS counterparties of AIGFP were also internationally active (as the Morgenson Article suggests in noting the “’global swath’ of top-notch entities” that” were counterparties to AIGFP CDS), they likely would have been able to book their CDS transactions with AIGFP through their own non-US offices to avoid the application of the CEA if the CFMA had not been enacted. See notes 23, 37, and 79 (Summers response to Harkin question at Senate Agriculture PWG Report Hearing) above for the issue of “offshore” booking of OTC derivatives. More clearly, the seller of AIG’s “regulatory arbitrage” credit default swaps was Banque AIG, not an insurance company. See pages 133-134 of AIG’s 2008 Form 10-K Report (“AIG 2008 10-K”). This is noted in the Morgenson Article. (“the London-based units…trades were routed through Banque A.I.G., a French institution”). As explained on page 133 of the AIG 2008 10-K, Banque AIG is a French bank regulated under French banking law. As also explained on page 133 of the AIG 2008 10-K, the “regulatory arbitrage” from those CDS was not because they were credit default swaps, but because they operated as guarantees from a bank in an OECD country (i.e. France). See also Daniel K. Tarullo, Banking on Basel: the future of international financial regulation (Peterson Institute 2008) for an explanation (at 57-60) of how the Basel I Accord (as described in the AIG 2008 10-K) established “generic” risk categories so “all loans to nonbanking corporations were risk-weighted at 100 percent” but all “claims on, or guaranteed by, banks incorporated in the OECD” were risk-weighted at 20%. In 1999 U.S. banking regulators reviewed multiple transaction structures similar to the AIGFP “regulatory arbitrage” CDS transactions and concluded a “super senior” exposure held by a bank that was guaranteed by the Banque AIG CDS (as depicted on page 133 of the AIG 2008 10-K) could receive a 20% “risk weighting” without being supported by a bank issued CDS or other form of bank guarantee if certain “stringent” conditions were met. Federal Reserve Board and Office of the Comptroller of the Currency, “Capital Interpretations, Synthetic Collateralized Loan Obligations, November 15, 1999”, Federal Reserve Board Supervisory Release 99-32. (“US Synthetic CLO Interpretation”). To the extent the “stringent minimum requirements” described at pages 6-7 of the US Synthetic CLO Interpretation were met, this would eliminate the need to acquire such CDS. Under the US Synthetic CLO Interpretation, one important element was that an outside investor acquire an interest in the relevant loan pool that would be subordinate to the “super senior” exposure but still be rated AAA. This requirement is why the bank retained exposure is considered “super senior.” As depicted on page 133 of the AIG 2008 10-K, this is the type of “super senior” exposure covered by the AIG “regulatory arbitrage” CDS. As the AIG 2008 10-K also explains at page 133 the implementation of Basel II eliminates the need for the Banque AIG “regulatory” CDS, because Basel II recognizes the low risk nature of the “super senior” exposure and requires corresponding capital, not a flat 8% requirement based on a “generic” capital requirement. U.S. banking regulators described in 1996 when CDS or other credit derivatives would operate as bank guarantees for purposes of capital rules and how the bank providing such a guarantee would be required to hold regulatory capital equal to that required if it directly held the guaranteed bond or other obligation. Federal Reserve Board Division of Banking Supervision and Regulation, “Supervisory Guidance for Credit Derivatives”, SR 96-17 (GEN), August 12, 1996. Nevertheless, similar to the Dinallo FT Opinion, Joe Nocera, “Propping Up a House of Cards”, New York Times, February 28, 2009, describes AIG’s “regulatory arbitrage” CDS by stating (1) it allowed “banks to make their balance sheet look safer than they really were” because of AIG’s AAA rating (when the European banks acquiring the CDS protection received reduced regulatory capital requirements because the CDS represented an OECD country bank guarantee, regardless of the rating of that bank); (2) because the CDS “were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses” (when the regulatory capital requirement for the CDS would be determined by French banking law, not any insurance regulator, and the US banking regulators would have required regulatory capital equal to that required for the underlying exposure); (3) that this was only possible because a “misguided set of international rules that took hold toward the end of the 1990s” permitted banks “to use their own internal risk measurements to set their capital requirements” (when those “misguided” rules, known as Basel II, are what is ending the need for the “regulatory arbitrage” provided by the Banque AIG CDS, as described on page 133 of the 2008 AIG 10-K, and only the earlier Basel I standards provided the “generic” 20% risk-weighting for bank obligations, including bank guarantees.) For the location of General Re’s derivatives dealer in London and the difficulties incurred by Berkshire Hathaway in winding down that dealer after it acquired General Re, see “General Re Securities Limited”, Business Week, Snapshot (click on Detailed Description for the 1991 UK incorporation) and Ari Weinberg, “The Great Derivatives Smackdown”, Forbes, May 9, 2003, which contrasts the Alan Greenspan and Warren Buffett views of derivatives, mentions the shuttering of General Re Securities with a remaining derivatives book, and curiously refers to AIG’s “extensive disclosures” and lists AIG FP’s credit derivative disclosures.
85. ^ Erik Sirri, Director, Division of Trading and Markets, U.S. Securities and Exchange Commission (“Sirri”), Testimony Concerning Credit Default Swaps Before the House Committee on Agriculture, November 20, 2008; Sirri, Testimony Concerning Credit Default Swaps Before the House Committee on Agriculture, October 15, 2008; Dechert LLP, “Derivatives Developments: Tackling the $50 Trillion Credit Default Swap Market and Beyond”, December 2008; Pillsbury Winthrop Shaw Pittman LLP, “SEC Seeks to Regulate Credit Default Swaps”, November 10, 2008. The pre-CFMA status of swaps as “securities” under the securities laws is discussed in Johnson/Hazen Derivatives Regulation at 12 to 13 (“Most commodities, and hence futures contracts, do not fall within the definition of security.…In contrast to the typical raw material or bullion contract, if the underlying commodity is itself a security, such as with government bonds, the securities laws, on their face, would seem to apply.”); Markham CF Law Treatise at 28-27 to 28-28 (describing a federal district court ruling finding an “equity swap” not to be a “security”, which was overruled by a federal circuit court finding it was); James Hamilton, J.D., L.L.M., Kenneth R. Benson, J.D., Matthew W. Lisle, J.D., A Guide To Federal Regulation of Derivatives, (Commerce Clearing House 1998) at 49 to 50 (describing how the “risk shifting” function of derivatives has been viewed as not meeting the “common enterprise and expectation of profits from the efforts of others” requirements established for defining “securities” given their “capital raising” function). ISDA CFMA Memo at 9-10 and 40-43 (describing at 41 how the CFMA provisions “effectively end any confusion about the status of swaps under the U.S. securities laws” and at 9-10 how the security law description of swaps adopted the new definition that the “material terms (other than price and quantity) are subject to individual negotiation” rather than the less stringent Gramm-Leach-Bliley Act definition that the swap be subject to individual negotiation, as described in notes 57 and 76 above). For the post-CFMA view of then SEC Commissioner Annette Nazareth, who was SEC Director. Division of Trading and Markets, at the time the CFMA was debated and passed by Congress, see “SEC Historical Society Interview with Annette Nazareth Conducted on November 4, 2005, by Kenneth Durr” (at 19 to 22 describing the SEC’s involvement with the CFMA and at 19 stating “while the whole package was quite deregulatory, there was some additional certainty that we were able to achieve with respect to derivatives that were securities-based swaps—securities-based swaps were subject to anti-fraud provisions. We thought it was clear but it was awfully good to get it in the legislation.”)
86. ^ See the two Sirri testimonies cited in note 82 above. Treasury Department Press Release, HP-1272, “PWG Announces Initiatives to Strengthen OTC Derivatives Oversight and Infrastructure”, November 14, 2008; Pillsbury Winthrop Shaw Pittman LLP, “Regulators and Market Participants Target Future Regulation of Credit Default Swaps”, December 22, 2008
87. ^ Treasury Department News Release, “Administration’s Regulatory Reform Agenda Reaches New Milestone: Final Piece of Legislative Language Delivered to Capitol Hill”, TG-261, August 11, 2009. The draft legislation titled “Over-the-Counter Derivatives Markets Act of 2009” (the “OCDMA”).
88. ^ Sullivan & Cromwell LLP, “Treasury OTC Derivatives Legislative Proposal”, August 17, 2009; Ropes & Gray LLP, “U.S. Treasury Proposes Bill for Increased Federal Regulation of OTC Derivatives”, August 14, 2009; Alston+Bird LLP, “U.S. Treasury Delivers Proposed Legislation on OTC Derivatives to Congress” August 12, 2009; Representative Collin Peterson, Chairman House Agriculture Committee, Representative Barney Frank, House Financial Service Committee, Concept Paper, “Description of Principles for OTC Derivatives Legislation”, July 30, 2009. The proposed repeals of Sections 2(d), (e), (g) and (h) of the CEA can be found at 15 in Section 713(a) of the OCDMA. The proposed repeal of limits on SEC regulation of security-based swaps is at 72 in Section 752 of the OCDMA.
89. ^ Alison Veshkin, “House Passes Rules for Wall Street Over Objections”, Bloomberg, December 11, 2009. Roll Call 968 on House enactment of H.R. 4173. The OTC derivatives legislation is in various amendments to H.R. 4173 contained in House Report 111-370. The largest portion of OTC derivatives legislation, including the repeals of CFMA provisions noted above, is in Amendment 3 offered by Representative Colin Peterson (D-MN) as the Derivative Markets Transparency and Accountability Act, Title III to H.R. 4173, which begins at page 103 of House Report 111-370. This amendment was adopted by voice vote on December 10, 2009, as noted on pages H14708-14709 of the House consideration of H.R. 4173 contained in Congressional Record, H14496-H14728, December 10, 2009. Pages H14682-H14705 repeat the text of Amendment 3 and pages H14705-14709 contain the House discussion of Amendment 3. House Agriculture News Release “House Passes Peterson-Frank Amendment to Strengthen Regulation of Over-the-Counter Derivatives”, December 10, 2009. For a description of pending Senate legislation to regulate over-the-counter derivatives, as part of broader financial regulation reform, see page 6 of “Summary: Restoring American Financial Stability: Committee Print”, issued by Senator Christopher Dodd (D-CT), as Chairman of the Senate Banking Committee.
90. ^ http://thehill.com/homenews/senate/94901-gop-expected-to-let-wall-street-bill-come-to-floor
91. ^ Mark Jickling, “The Enron Loophole”, CRS Report for Congress RS22912, July 7, 2008 (“CRS Enron Loophole Report”)
92. ^ CRS Enron Loophole Report at CRS-2 to 3. Johnson/Hazen Derivatives Regulation at 331 to 332. ISDA CFMA Memo at 29 to 30. Susan Ervin, "CFTC Regulation of Energy Derivatives: An Overview” (“Ervin CFTC Energy Regulation”) at 10. As explained in the referenced pages of the ISDA CFMA Memo and in Ervin CFTC Energy Regulation at 9, an “eligible commercial entity” (“ECE”) was defined as an ECP that was not an individual or State or local government entity that, depending on the nature of the entity, had a specified “exposure” to the underlying commodity.
93. ^ Johnson/Hazen Derivatives Regulation at 332. ISDA CFMA Memo at 30 to 31. Ervin CFTC Energy Regulation at 10
94. ^ For the removal of the exempt commercial market language from the Senate bill, see the Senate Agriculture S. 2697 Report at 9 (“although this exemption is limited to transactions between eligible contract participants that occur off a trading facility, the CFTC is encouraged to use its current exemptive authority, as appropriate and consistent with the public interest, under Section 4(c) of the CEA to exempt transactions between eligible contract participants that occur on an electronic trading facility.”) The revised Senate Agriculture Committee Section 2(h)(1) language, which provided a broader exemption than the CFMA in not requiring that eligible contract participants (“ECPs”) act as “principals”, is at page 42 of the Senate Agriculture S. 2697 Report and at pages 159 to 161 of the reported version of S. 2697, as Section 9. Section 5 of S. 2697 as introduced in the Senate would have excluded from most CEA provisions electronic trading of all energy commodities (which, along with financial commodities, were defined as “Exclusion Eligible Commodities”) by ECPs acting as principals . See pages 23 to 25 of the Senate Agriculture S. 2697 Report or pages 23 to 25 of S. 2697 as introduced in the Senate. For the later Senate Agriculture Committee recriminations concerning the “source” for Section 2(h)(3), see Hearing before the Senate Committee on Agriculture, Nutrition, and Forestry, “CFTC Regulation and Oversight of Derivatives”, July 10, 2002 (“July 10, 2002, Senate Agriculture Hearing”) at 2 (Senator Tom Harkin: “The final version of the legislation included in the omnibus appropriations bill differed from our committee bill regarding energy and metals derivatives markets. I supported the CFMA, although I had some concerns about its treatment of energy and metals. There is a statement I gave on the floor to which I would refer you that is in the Congressional Record regarding that, because I thought at the time it had a number of very positive features. On the whole, I thought it was a good bill, and I still think it is.” As described in note 69 above, Sen. Harkin had entered a statement in the December 15, 2000, Congressional Record in support of H.R. 5660. He had noted his misgivings about its treatment of energy derivatives, but had recognized “the need to compromise.” Although, as described in note 69 above, they had entered in the Congressional Record statements in support of H.R. 5660, Senators Fitzgerald and Lugar had not stated any misgivings about the bill’s treatment of energy derivatives. At the July 10, 2002, hearing they joined Sen. Harkin in expressing dismay over the energy provisions of the CFMA (Sen. Fitzgerald at 9: “somehow, somewhere in the process, somebody slipped in this mysterious exemption for energy and metals trading” and at 58: “As we had it in Committee, it did not have that special carve-out and somehow… special carve-out came and it does not seem to have a father. No one can figure out who did it.” Sen. Lugar at 11: “Somebody in the process of that conference talked about exemption of bilateral trade on electronic platforms, precisely the sort of thing that Enron was to be involved in…We all should have been brighter, perhaps, in reading the type, but nevertheless, that is the one that already occurred and that is why it is here.”) None of Senators Harkin, Fitzgerald, or Lugar discussed at the hearing whether they thought S. 2697, which had never been voted on in the Senate and which was organized differently than H.R. 4541 and H.R. 5660, was the source for H.R. 5660, rather than H.R. 4541, which had passed the House and contained the same Section 2(h)(3) trading facility exemption as the CFMA. As described in note 78 below, CFTC Commissioner Thomas Erickson, who had been a critic of the CFMA back in 2000, explained Section 2(h) was not the “Enron Loophole” used by EnronOnline. At the January 29, 2002, Hearing before the Senate Committee on Energy and Natural Resources to Receive Testimony Concerning the Impact of the Enron Collapse on Energy Markets("January 29, 2002, Senate Energy Hearing") the prepared testimony of Vincent Viola, Chairman of NYMEX, which had “lobbied” against Section 2(h)(3) for exempting from the CEA energy and metals “futures contracts traded on electronic trading platforms from nearly all federal regulatory oversight”, recounted (at 37) that lobbying effort and explained “Thankfully, Mr. Chairman [i.e. Senator Jeff Bingaman (D-NM)], you, Senator Charles Schumer, and Senators Richard Lugar and Tom Harkin (Attachment 3) with the Senate Agriculture Committee, as well as number of members of congress including Congresswoman Carolyn Maloney, Congressmen Peter King, John Dingell, and others recognized the serious policy flaws with this extreme deregulatory measure, and quite courageously challenged Enron and others, preventing it from becoming law in its most draconian form.” In his prepared testimony for the same hearing (at 63), Senator Charles Schumer (D-NY) recalled that effort and stated “During the debate regarding the CFMA, I was greatly concerned about the similar effects that granting electronic trading facilities an exclusion from CFTC oversight would have had on the market, and fought hard against such an exclusion…There would have been no anti-market manipulation rules, among others, to protect the markets. Those of us who were concerned about the ramifications of an ETF exemption fought that provision and won.” In Sen. Schumer’s questioning (at 63-4) he elicited from NYMEX Chairman Viola (at 64) the statement “I think clearly the last minute efforts at sort of not having complete deregulation and exemption occur in the CFMA helped greatly in keeping markets stable…” As described above, at the July 10, 2002 Senate Agriculture Hearing, this Congressional involvement with Section 2(h)(3) was forgotten. Instead, in Sen. Fitzgerald’s words, the “loophole’ had “no father.” In the House considerations of H.R. 4541, the Section 2(h) exemptions for “exempt commodities” was criticized by the CFTC at all three hearings on the bill and by House Floor statements of Representative Carolyn Maloney (D-NY) and, at E1879 of his “extended remarks” cited and linked in note 41 above, by Rep. Markey (“I also have some concerns with the breadth of the exemption in section 106 of this bill, and its potential anticompetitive and anticonsumer effects. There may be less anticompetitive ways to address an energy swaps exemption in a way that provides for fair competition and adequate consumer protections in this market. Such a result would be in the public interest. What is currently in the bill is not, and I would hope that it could be fixed as this bill moves forward.”) On September 28, 2000, at H8436, Congressional Record, September 28, 2000, Rep. Maloney called upon the House to block consideration of H.R. 4541 by refusing the necessary 2/3 vote for a rule “suspension” if the “energy provisions” were not given a “full hearing.” She entered into the record on the same page a letter she had received from CFTC Chair William Rainer describing CFTC opposition to the provision expressed at all four Congressional hearings on H.R. 4541 and S. 2697. On October 19, 2000, in supporting the required “rule suspension”, Rep. Maloney stated (at Congressional Record, H10412, October 19, 2000) that her concerns “had been addressed at least in part” but that “the provision could be further improved by deleting language that favors electronic trading facilities over traditional exchanges.” Rep. Maloney’s statements came after Rep. Leach entered (at Congressional Record, H10365, October 19, 2000) a “Supplemental Report” from the House Banking Committee that showed as an “errata” to the Committee’s earlier report a Committee vote of 20-12 defeating an amendment proposed by Rep. Maloney “to delete the provision providing a partial exclusion from the CEA for exempt commodities entered into solely between eligible contract participants and executed on an electronic trading facility.” For the supplemental report see House of Representative Report 106-711, Part 4.
95. ^ CRS Enron Loophole Report at CRS-4 to 6. Dechert LLP, “CFTC Reauthorization Act of 2008 Enacted into Law” at 2 to 3. Testimony of Michael Greenberger before United States Senate Commerce Committee, June 3, 2008 (“Greenberger June 3, 2008, Senate Testimony”) at 3 to 5.
96. ^ Greenberger June 3, 2008, Senate Testimony at 7, fn. 28. “The Enron Loophole has Closed and Goes Into Effect on September 30, 2009”, citing the Wikipedia article Enron Loophole. Ervin CFTC Energy Regulation at 11 (describing the 2002 ”Feinstein Bill” that would repeal the Section 2(g) swaps exclusion, along with making other CFMA amendments.) The language of Section 2(g) was contained in Section 107 of H.R. 4541, as passed by the House, at page 47, as creating a new Section 2(h) of the CEA. In the CFMA it was Section 105(b) of H.R. 5660 at page 40, as described in note 57 above. During House consideration of H.R. 4541 (as cited and linked in note 54 above), Rep. Dingell (at H10446) objected to this “redundant exclusion” but accepted its “strict’ requirements, including the requirement that “each of the material economic terms of the swap must be individually negotiated.” Although this was changed in Section 105(b) of H.R. 5660 to require only that the swap be “subject to individual negotiation by the parties”, Rep. Dingell did not criticize this provision in his Floor statements on H.R. 5660 (as cited and linked in note 69 above). For the significance of Section 2(g) for energy contracts, see also ISDA CFMA Memo at 27-28.
97. ^ See House Banking Committee Report at 13 for Section 110, which would have added a new Section 2(i) to the CEA as the exclusion for “Swap Transactions” (defined to require that “the material economic terms” be “subject to individual negotiation.”) See H.R. 4541 as passed by the House at 47 for Section 107, which would have added a new Section 2(h) to the CEA as the exclusion for “Swap Transactions.” See the CFMA at 40 for Section 105(b), which created Section 2(g) of the CEA. See the Gramm-Leach-Bliley Act at 58 for Section 206(b), which defines "swap agreement" to be "individually negotiated." For CEA Section 2(g)'s use of the Gramm-Leach-Bliley definition, see ISDA CFMA Memo at 27 to 28 and 39. Kloner CFMA at 292.
98. ^ At the July 10, 2002, Senate Agriculture Hearing, CFTC Commissioner Thomas Erickson, who had been a critic of the CFMA in 2000, explained Section 2(h)(3) was not the “Enron Loophole” used by EnronOnline. He suggested (at 17 to 18, 22 to 23, 25, 26, and 30 to 31) that the bulk of the OTC derivatives market used the 2(g) exclusion for “swaps” and that this was available to EnronOnline. See also Sen. Fitzgerald at 25 (“Enron Online and Intercontinental Exchange are just exempt by statute here with Section 2(g)”) and page 48 for Professor Coffee’s view. While the differences between Commissioner Erickson and CFTC Chair Newsome at the hearing (at 17 and at 30-31) were characterized as a “disagreement” over whether Section 2(g) “trumped” Section 2(h), Chairman Newsome states (at 17-18) that “swap transactions were excluded from our jurisdiction prior to the CFMA by administrative action of the CFTC and they were excluded after the CFMA by codification of Congress.” He goes on to state Section 2(h) is not “trumped by the swap’s exclusion for transactions in energy products that are not deemed to be swaps transactions.” Thus, Chairman Newsome acknowledged Section 2(g) did “trump” Section 2(h) for swap transactions. While the 1993 swaps exemption exempted swaps from the CEA, as described in note 19 above, it did not exempt such transactions from the fraud and anti-manipulation provisions of the CEA to the extent the transactions were “futures” under the CEA. The CFMA granted an exclusion from such provisions. Further testimony at the July 10, 2002, Senate Agriculture Hearing (at 57) explained the Section 2(g) exclusion would apply to “online” transactions in which after agreeing to price the parties would “go offline” and “negotiate the credit terms.” This type of transaction would be eligible for the Section 2(g) exclusion if it dealt with either an excluded or an exempt commodity. The Section 2(h)(1) exemption for “bilateral swaps” would be available if the two parties completed their “private” transaction online without “individual negotitation” but without both the offer and acceptance being available to multiple parties. This is the way Enron OnLine is usually described as having operated, because Enron was always a party to each transaction. Infectious Greed at 320 (‘its trades were judged to be ‘bilateral contracts’ between the two parties trading on Enron’s website”). At the January 29, 2002 Senate Energy Hearing, Chairman Bingaman explained (at 1 to 2) “EnronOnline did not match buyers and sellers. It contracted with each separately, so that Enron was on the other side of every deal.” See also the prepared statement of Patrick Woods, III, Chairman, Fedederal Energy Regulatory Commission, at 14 (“EnronOnline uses a one-to-many trading format, where an Enron affiliate is always on one side of each energy transaction, either as a seller or a buyer. The price of a commodity or derivative on EnronOnline is determined when a buyer or a seller accepts an offer or bid price posted by an Enron trader.” In contrast, Chairman Woods describes the Intercontinental Exchange (“ICE”) as a “many-to-many platform.” A December 16, 2000, email from Chris Long of Enron indicated Enron was aware it would need to change EnronOnline to have Section 2(h)(3) apply to it. (in describing Section 2(f) the email states “This exemption could facilitate expansion of EnronOnline to allow for multi-party transactions, however certain legal requirements will have to be met.”).

External links

• CBS's 60 Minutes video on Credit Default Swaps