Written Statement of A. Duane Fry
Georgia Securities and Business Regulation Division
Office of the Secretary of State
Chairman of the Commodities Committee of the
North American Securities Administrators Association
April 29, 1997
The North American Securities Administrators’ Association, Inc. (“NASAA”), appreciates the opportunity to comment on certain provisions of the Commodity Exchange Act Amendments of 1997. NASAA is the oldest international organization devoted to investor protection. We are the collective voice of 50 state securities regulators and those provincial regions of Canada, Mexico, the District of Columbia and Puerto Rico. State securities agencies are the local “cops on the beat;” in 1995, the states initiated 6,840 enforcement actions to protect investors compared to 486 by our federal counterparts. Our mission is to protect the small investor and it is a mission, which if performed effectively, promotes capital formation.
NASAA agrees a periodic review of the Commodity Exchange Act (“CEA”) is appropriate to ensure fair but adequate regulation and respond to changes in the futures and options markets. NASAA shares the interest of the SEC and the CFTC in ensuring that any legislative proposals that impact the nation’s financial markets also preserve market integrity. That paramount interest is what leads to our concern about the professional markets exemption.
We believe any changes need to balance the competitive and innovation demands of the derivatives industry with the goal of customer and market protection. The professional markets exemption would likely result in a broad elimination of regulation of the futures markets. “Appropriate persons” who would be eligible to trade in an unregulated environment include small businesses, pension funds, mutual funds, insurance companies, commodity pools and municipalities. We are concerned that individuals investing in such funds will do so and be under the false impression their investments are under the regulatory scrutiny of the CFTC.
The bill only preserves jurisdiction to bring fraud and manipulation claims after the fact. The CFTC would be removed from routine oversight and surveillance of the professional markets, making it harder to detect fraud and manipulation. Trading by the large market participants would not be subject to audit trail, books and records and surveillance requirements that are essential in detecting and deterring fraud and manipulation. All are important tools in the enforcement process.
Section 12(e) of the Commodity Exchange Act was originally enacted because of pervasive Federal regulatory oversight of the futures markets. However, if the pro-market exemption becomes law, there will be very little direct CFTC regulation over this segment of the industry, and the states will continue to be preempted from regulatory oversight.
Finally, a two-tiered market in which 90% of all trading occurs in a separate, unregulated environment would impair market liquidity for small business and retail participants in the non-professional market. The economic benefits of trading in an active, liquid market would be lost.
NASAA is also concerned about the private transaction exemption including over-the-counter (OTC) derivatives based on securities, such as equity swaps. Among the provisions from which these transactions would be exempt is section 6d of the Commodity Exchange Act which authorizes the states to sue on behalf of their residents for violations of the CEA.
The exemption does not extend to sections 4b and 4c of the CEA any antifraud rule promulgated by the CFTC under section 4c(b), nor to the anti-manipulation provisions of the CEA. We are concerned, however, that the retention of CFTC antifraud authority under section 4b may prove illusory for securities-based OTC transactions. We are further concerned that the bill, as drafted, may preclude application of the antifraud provisions of the securities laws to OTC securities-based derivatives.
The primary antifraud provision of the CEA is section 4b. NASAA is concerned that the application of section 4b to the securities-based OTC transactions which the legislation would exempt from the CEA may prove difficult or impossible. There is no brokercustomer relationship in these transactions; they are principal to principal transactions. If section 4b was found not to apply to fraud in connection with exempt securities-based OTC transactions, we are concerned that there would be no federal remedy for fraud involving these transactions.
As the SEC explained in its February 12 letter to Senator Richard Lugar and reiterated in recent Congressional testimony, an exemption “raises the concern that some may argue that the exempted product is a future and thus excluded from any regulation, not just the CEA.” This result would be of concern to NASAA. We urge Congress to explore all available avenues to insuring that an effective antifraud prohibition applies to securities-based OTC transactions. These alternatives include an exclusion from the CEA, rather than an exemption, as proposed by the SEC, as well as clarifying changes to section 4b of the CEA, as proposed by the CFTC.
NASAA continues to gather information and study the implications of these proposals and is willing to provide additional input as the deliberations continue.
April 29, 1997