Congress Overrides Bush’s Veto of the 2008 Farm Bill
May 27, 2008
Beyond farmer subsidies—the Farm Bill carries implications for energy markets and commodities regulation.On May 22, 2008, Congress overrode President Bush’s veto of the Food, Conservation, and Energy Act of 2008 (Farm Bill). Aside from the extended debate over whether the Farm Bill will subsidize rich farmers, the Farm Bill also includes the reauthorization of the U.S. Commodity Futures Trading Commission (CFTC) for another five years in Title VIII, “CFTC Reauthorization Act of 2008.” The Farm Bill also amends the Commodity Exchange Act (CEA) in several significant ways that are designed to address changes that have occurred in the derivatives markets since the last CFTC reauthorization in 2000 pursuant to the Commodity Futures Modernization Act (CFMA). The amended sections of the statute strengthen the CFTC’s powers with respect to market manipulation and customer protection to enable it to prevent fraud and protect the integrity of commodity markets, particularly with respect to energy and retail foreign exchange (retail forex) trading. In brief, the amendments
- Provide for CFTC oversight of certain exempt commodities traded on electronic exchanges, such as the IntercontinentalExchange, Inc. (ICE)
- Extend antifraud authority to certain principal-to-principal commodity transactions
- Further clarify the CFTC’s jurisdiction over and impose new requirements on certain retail forex transactions
- Increase the civil monetary penalty for manipulation and false reporting violations
Highlights of the New Provisions
Closing the Enron Loophole
The CFMA included a provision exempting from CFTC regulation energy and other exempt commodity contracts traded on over-the-counter (OTC) electronic exchanges by eligible commercial participants. Dubbed the “Enron Loophole,” this exemption allegedly enabled Enron Corporation to engage in manipulative trading practices undetected through EnronOnline. Amaranth Advisors LLC also allegedly was able to carry out its manipulative scheme because it maintained a large portion of its position in a market outside of the CFTC’s jurisdiction. Driven by the fallout from Enron and Amaranth, as well as increased volatility in energy markets, Senator Feinstein, Levin and others repeatedly have tried to close the loophole.
The Reauthorization Act of 2008 brings energy commodities and metals traded on electronic exchanges that are exempt commercial markets (ECMs) within the purview of the CFTC by requiring ECMs to follow certain prescribed core principles with respect to contracts that the CFTC determines serve a “significant price discovery function.” These principles include the following:
- Listing only contracts that are not “readily susceptible to manipulation”
- Monitoring trading to prevent manipulation
- Obtaining and providing the CFTC with information on trader positions
- Adopting where necessary and appropriate speculative position limits or accountability rules
- Making price and volume information available to the public
- Adopting rules whereby the board of trade can exercise emergency authority
In addition, the CFTC Reauthorization Act of 2008 requires traders of such “significant price discovery contracts” (SPDCs) to maintain books and records of positions and transactions on electronic trading facilities and provide large trader reports to the CFTC.
Extending Antifraud Authority to Certain Bilateral OTC Transactions
The Reauthorization Act of 2008 amends the CEA fraud prohibition in Section 4a to prohibit fraud not only by a person or entity that is acting for or on behalf of another (as would be the case with a futures commission merchant (FCM) or a commodity adviser acting on behalf of its client), but also with respect to certain principal-to-principal transactions. This represents a significant expansion of traditional CEA anti-fraud authority.
Note, however, that the amendment specifically provides that it does not obligate transaction counterparties to disclose to each other material nonpublic information except that which is necessary to make representations in connection with the transaction “not misleading.”
Providing Additional Clarification of the CFTC’s Jurisdiction over Certain Retail Forex Transactions
In order to address restrictions on the CFTC’s jurisdiction over the retail forex markets imposed by recent court decisions, the amendment provides extensive details with respect to what forex transactions are covered by the CFTC’s anti-fraud authority. In addition, the CFTC Reauthorization Act of 2008 creates new registration requirements for certain retail forex dealers and imposes minimum capital requirements for FCMs and retail forex dealers that act as counterparties in these transactions. The CFTC considers this jurisdictional clarification to be critical to its customer protection mission and enforcement program.
Increasing Civil Monetary Penalties
The CFTC Reauthorization Act of 2008 also increases the civil monetary penalty for manipulation and other violations of the Act to $1 million per violation.
Next Steps
The Farm Bill requires the CFTC to propose a rule within 180 days (and a final rule within 270 days) identifying the standards to be used for determining which contracts traded on ECMS constitute SPDCs. The CFTC then must identify the contracts that qualify as SPDCs within 180 days after the final rule takes effect.
The amendments to the CEA enacted by the Reauthorization Act of 2008 have significant implications for OTC commodities traders. The changes expand the CFTC’s regulatory and market surveillance authority with the goal of improving market transparency and strengthening oversight in order to prevent future Enron- and Amaranth-type market disruptions.
