Hearing of the Senate Committee on Appropriations - The Commodity Futures Trading Commission and Securities and Exchange Commission's Budget Requests and Justification for Fiscal Year 2009

Statement

SEN. DURBIN: (Sounds gavel.) I'd like to call to order this meeting of the Senate Appropriations Subcommittee on Financial Services and General Government. The hearing this afternoon will consider funding requests for two federal regulatory agencies that are part of the jurisdiction of our subcommittee. My colleagues will be joining me a little bit later.

I'm pleased to welcome acting Chairman Walter Lukken of the Commodity Futures Trading Commission.

And I'm told that CFTC Commissioners Mike Dunn -- please indicate, Mike, where you are. Mike, good to see you again.

Bart Chilton -- is Bart here?

Bart, thank you for joining us.

Jill Sommers -- present.

Jill, thank you for attending.

I also understand that Chairman Chris Cox of the Securities and Exchange Commission, if he's not here --

MS. : He's en route.

SEN. DURBIN: He's en route.

I'm going to waive the reading of my opening statement in the interest of having more time to ask questions. And I ask consent that it be put in the record. Without Senator Brownback's objection, it will be.

So, Senator, if you would like to make any kind of an opening statement, you're welcome to.

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SEN. DURBIN: Chairman Lukken, your graphs tell the story about a dramatic increase in trade that you are responsible to oversee. And as I understand it, if you are able to replace employees that have left, the president's new budget request will give you an additional 10 employees over the 465 that you're targeting. I can't imagine that gets close to matching the volume increase that this agency faces in terms of the market that you supervise. Does it?

MR. LUKKEN: Well, we, I think, our fighting weight as an agency historically has been in the mid-500s and we're trying to build up over a series -- a period of years to get to that -- those levels, and we're hopeful to reach that. I think the 10 that we've requested in '09 is the minimum we need to ensure our responsibilities at the agency, and the technology is very important in ensuring that we're productive in those 10 individuals. So we're looking over long-term horizon to make sure that we get to where we need to be, but we think 10 is a good start in that venture.

SEN. DURBIN: So let me try to be more specific in the next question about another issue. As I understand your testimony and your agency's responsibility, you look for illegal conduct, market manipulation, evidence of corruption, and obviously do your best to keep transparency and credibility, integrity in the marketplace and that is an important part of your role. But you've also initiated several discussions that relate to the overall market and the role it has in our economy as it relates to specific commodities.

Now, being more specific, when it comes to energy contracts, that's one that's in the news. And there are a lot of people, including some of my colleagues I respect very much, who think that the speculation and trading in energy futures has driven up the price of oil, for example.

Some even -- one of my colleagues today said he thought of $120 a barrel maybe $30 of it, maybe more, was attributable just to speculators driving up the price of the commodity. And there's also a question about margin requirements when it comes to these energy futures.

Let me throw in the third element, of course: global competition. In London, ICE is selling many of the same contracts or contract similar to them. That's as soft a pitch as I can throw you on this, but I'd like your feedback on the speculation on this issue.

MR. LUKKEN: Well, certainly we closely follow the market participants and track what speculators may be doing in our markets. As I mentioned, we receive every day the trade positions of all traders in our markets above a certain threshold. That ensures that we can see what sort of controlling positions they may have as traders on a given market.

Our economists also closely follow fundamentals of those markets to ensure that those types of traders aren't using their positions in order to manipulate or cause some sort of illegal behavior in our markets. And so we closely follow that, like I said. Every day we're looking at who the largest traders might be and whether they're, either themselves or colluding with others, to try to manipulate the markets.

SEN. DURBIN: Do you think that's happening now? Do you think that the observation that 20 or 30 dollars on a barrel of oil can be attributed to speculation is a valid observation?

MR. LUKKEN: Well, I think as far as illegal behavior, where an individual or a set of individuals are trying to manipulate the market, I can say with a high degree of confidence that we are not seeing that.

There is, you know, with regards to speculation, we do also have controls in place for speculators. Each month as the contract is about to expire they have to get down to certain positions in agricultural markets and in other -- energy contracts so that there's a less chance that they may be able to manipulate the market, and those controls are currently in place. And so between seeing the transparency of the reporting that we receive, plus the controls, the position limits we have in place, we have a high degree of confidence that people are not manipulated --

SEN. DURBIN: And what are the margin requirements on these energy contracts?

MR. LUKKEN: The margin requirements -- as you know, in the futures industry margin is set based on a risk modeling that the exchanges perform, and this is meant to cover a one-day price move so that the winners can -- the losers can pay the winners every day and the markets (mark to market ?) at least twice a day. And this rings the risk -- credit default risk out of the marketplace so that losses can't accumulate over a period of days. And so every day everybody starts afresh. And so this has worked very well to protect --

SEN. DURBIN: Is there a margin requirement?

MR. LUKKEN: For?

SEN. DURBIN: For energy futures?

MR. LUKKEN: Yes, there is. There is, to cover a potential one- day price move, and again, this is based on statistical -- historical statistical evidence of what that might be.

SEN. DURBIN: How does that compare with other commodities, the actual margin requirement?

MR. LUKKEN: It's based on volatility and I'll have to ask our staff whether we can get you figures on percentages, but oil, I think is sort of middle of the pack as far as volatility compared to some of the other commodities, but we can give you specific numbers.

SEN. DURBIN: Last question -- I'm sorry to go over a minute, but I didn't give my entire opening statements so I could have an extra minute here -- so if we passed a law calling on you to substantially increase the margin requirements on energy futures, particularly as it relates to crude oil, what impact would that have, in your estimation, on migration to another marketplace like ICE in London as an alternative market to pursue the same type of futures?

MR. LUKKEN: I think there would be migration off exchanges. It would be a tax on a type of trader. These traders -- I know that there is a lot of people who have disparaging remarks about speculators, but they do provide liquidity for a lot of these markets and have for years. And that's necessary to make sure that the commercial participants in the markets -- the producers, the farmers and everybody -- has a buyer for every seller and a seller for every buyer.

SEN. DURBIN: What percentage of those who trade in, for example, in these energy commodities actually take possession?

MR. LUKKEN: Very few. Very few actually ever deliver on -- it's a vast majority of the contracts never deliver the physical commodity. The futures markets are not a marketing tool for product. It is a risk management tool and people utilize it as a risk management tool. There has to be a delivery as part of the mechanism to ensure that the cash price and the futures price eventually converge, but the truth is that most people get out of these contracts way before delivery ever occurs.

SEN. DURBIN: Senator Brownback?

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SEN. DURBIN: Senator Allard, I'm going to pass down this performance and accountability report I had not seen before but the staff shared with me and let's take a look at it. It may address some of your earlier questions and see if it does.

SEN. ALLARD: Yeah, we just pulled this off the Internet just before I came here to committee meeting, so maybe it's not updated there.

SEN. DURBIN: Okay, thank you.

SEN. ALLARD: It's probably the same as what we've got in here.

SEN. DURBIN: All right.

Chairman Lukken, last month you had a roundtable at CFTC to talk about changes in the marketplace. I'm glad you did it. In your opening remarks you said: "During the last year the price of rice has increased 118 percent, wheat 95 percent, soybeans 88 percent, corn 66 percent, cotton and oats by 47 percent. These price levels, combined with record energy costs, have put a strain on consumers as well as many producers and commercial participants that utilize the futures market to manage risk and discover prices."

Now, the big question we're facing is the impact of the biofuels mandate on this this (sic) phenomena. And I wonder if you could tell me whether or not you considered that element and have an opinion as to whether this biofuels mandate can be linked to any of these price increases.

MR. LUKKEN: Well, I think the economists that follow those markets very closely, our agricultural markets, believe ethanol is a factor that is affecting the price of not only corn but other commodities around that may substitute acreage from corn.

So this is something that we close -- I can't comment on the mandate itself, but certainly when corn production -- when nearly a third of corn production is going now for biofuels, that's going to have an impact on corn, on wheat, on soybeans and others that may be involved or be interrelated to the price of corn. So certainly --

SEN. DURBIN: Have you considered -- I'm told that there's still more American corn exported than converted to ethanol. Have you considered why that element is still there, if in fact we have a short domestic market in corn?

MR. LUKKEN: I'm not sure if that's something we've studied intensively or not. But it's something we can get back to you on later.

SEN. DURBIN: Would you, please?

MR. LUKKEN: Yeah, certainly.

SEN. DURBIN: Okay. The last question I have relates to the next panel and that is the memorandum of understanding that I understand you and SEC Chairman Cox have worked on. Could you comment on that and how you are trying to coordinate the activities of your two agencies?

MR. LUKKEN: Well, I think both Chairman Cox and I recognize how our agencies have to collaborate more as our markets become more intertwined. So this was the fruits of that labor to sign an MOU that allows for information sharing and for us to discuss the possibility of allowing novel derivative products to get to market quickly.

So we've taken it out for a test ride. There's a couple of Chicago exchanges in fact that are -- that have submitted products to us that we are -- that are out for comment on ETF gold products. We hope that those are finalized in the coming months.

But we also hope to tackle other big issues such as portfolio margining; to allow more efficient use of margin between the two marketplaces I think would be enormously helpful in allowing more product choices to consumers.

SEN. DURBIN: Have you run into any conflicts with the SEC trying to figure out where a new product coming to market should be regulated?

MR. LUKKEN: Well, certainly we have differing missions. Theirs is capital formation. They have insider trading provisions that they have to think about. Ours are risk management markets. And so we come at this from different angles, and certainly we have to discuss our mandates and make sure that we can align those mandates properly. So certainly we have differences of opinion, but we try to work through them in understanding that collaboration is the way forward for both of our agencies.

SEN. DURBIN: Thank you.

Senator Brownback.

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SEN. DURBIN: Chairman Lukken, thank you very much. I appreciate your testimony today. I look forward to sending you some questions in writing myself and other members of the committee and hope you can give us timely answers.

MR. LUKKEN: Thank you for allowing me to testify. Thank you.

SEN. DURBIN: You bet.

Chairman Cox, welcome to the subcommittee. Senator Brownback and I are minimizing our opening statements so that we'll have a few more moments to ask questions and not take too much of your own time. And if you would like to summarize your opening statement, the entire written statement will be made part of the record.

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SEN. DURBIN: Thank you very much, Chairman Cox.

Let me try to reconcile budget requests with some of the policy statements that you've made. If I understand the president's budget request for 2009, it calls for 3,409 permanent staff at the SEC, which would be a reduction of anywhere between 94 and 100 employees. And over the last three or four years you've had about 11 percent reduction in your enforcement activities. Does that sound about right?

MR. COX: All the way up to the 11 percent reduction in enforcement activities.

We have within our overall budget, which is --

SEN. DURBIN: Staffing reduction -- I'm sorry, staffing reduction at 11 percent since 2005.

MR. COX: Yes, yes, we have had budget freezes, as you know, from Congress through continuing resolutions in 2006 and 2007. And so holding at the same dollar figure for two fiscal years in a row, combined with the fact that we have a built-in ratchet of about 5 percent just standing steady because of cost of living allowances, merit pay and promotions within the agency and a historically low turnover rate, means that two-thirds of the total budget going to personnel, it is impossible to maintain, even at higher dollar levels, the same staffing numbers year to year.

But what we have done within the overall budget number is to prioritize enforcement and also the division of trading and markets and its market supervisory responsibilities so that in the last fiscal year we have set the record for bringing the most number of enforcement actions in the agency's 74-year history. Likewise, we have the highest number of respondents in actions by quite a wide margin.

SEN. DURBIN: I want to applaud your efficiencies and what you have achieved, but if you continue to reduce the number of staff that are working in some of these sections, some of these agencies within the SEC, it clearly would have an impact on your future activity.

And one of the things that you raise is something that I'm concerned about. You mentioned the Bear Stearns situation, in which the head of the Federal Reserve as well as the secretary of the Treasury decided to step in and to help Bear Stearns through a rough patch. Without judging the wisdom of that decision -- and I think it was necessary, personally -- it seems to have opened up a new area of concern and responsibility.

You talked about the gap in enforcement for investment banks. I don't know what the most current figure is, but I heard at one time that we have opened our discount window to the tune of about $200 billion in borrowing by these investment banks.

The obvious question is, the entities that are borrowing the money now from the federal taxpayers through the discount window, what kind of oversight and supervision do we have of these entities? And I think what I heard in your opening statement is a suggestion that the SEC may play a role in that or could or should play a role in that.

Reconcile these two things: reducing the number of staffers in your budget and expanding your responsibilities to include investment banks to make sure that at the end of the day the taxpayers of America don't end up holding the bag as investment banks use the discount window.

MR. COX: Well, Mr. Chairman you're absolutely right about the importance of that function of overseeing, supervising investment banks. And in addition I would add to that the SEC also has been given very recently a significant new function related to subprime and that is oversight and regulatory authority over credit rating agencies. Both of these functions are prioritized within the SEC's budget. But something has to give. It has to come from someplace. And so if the SEC's budget were to be frozen on a continued basis, we would run out of potential savings.

The largest area of potential savings I have been able to find thus far is the agency's historical function of maintaining a filing and information service that was essentially related to the 1930s-era idea of having paper forms. We had people walk into the SEC and inspect documents. With the Internet, we didn't need that any longer and so we were able to free up about 100 positions within the agency and put those slots to better use. But the opportunity to find efficiencies like that is a very steep decline curve.

SEN. DURBIN: Now, historically the SEC has relied on fees and collections to defer their costs of operation to some extent. Is that not the case?

MR. COX: Well, it is partly true but, in a way that concerns me some days, not entirely true, because while we do collect a good deal in the way of fees, all of our funds are appropriated, so --

SEN. DURBIN: All of your funds are -- fees are what?

MR. COX: Appropriated. We cannot live off of the fees we collect.

SEN. DURBIN: Well, I understand that part. But what I'm driving at is -- I'm trying to reconcile the earlier question. Where will you find, or some future SEC chairman, where will they find the resources to now keep a close eye on investment banks using the discount window, borrowing from American taxpayers? It seems that there should be -- and it may not exist today -- some fee collection that would fund that government responsibility. Has that been proposed by the administration or anyone, to your knowledge?

MR. COX: Well, indeed, were this committee willing to do so, taking the existing stream of fees that the SEC already collects and dedicating it to SEC operations would provide a good deal of consistency to the --

SEN. DURBIN: But those fees are not collected from investment banks currently, are they?

MR. COX: Well, no they are not. And we could, I suppose -- I should say Congress could fashion a new kind of fee. But in any case, the difference between the fees that the SEC's responsible for collecting and our appropriation is already significant. There's a big delta there.

SEN. DURBIN: But it would seem in fairness that if this branch of our economy is going to be reviewed -- there's oversight, that the cost of that oversight shouldn't be borne by another sector of the economy, collection of fees from some other entity. That doesn't seem to track. At least, I don't know if -- this in detail, but it would seem collecting a fee from the supervised entity is more reasonable.

MR. COX: Well, I think, at least in the SEC's experience, we have subsisted entirely on the basis of appropriated funds and so there has been no effort, with respect to any of the agencies' programs, to match some form of fee collection with our function.

SEN. DURBIN: Thank you.

Senator Brownback.

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SEN. DURBIN: Mr. Chairman, on March 19th, 2007, the SEC published a proposed rule on amendments to financial responsibility rules for broker-dealers. In the notice, the SEC asked for comments on changes to the rules on net capital, customer protection books and records and notification rules.

I understand that some of these proposed amendments have been sought by the financial services community for a number of years. Among the changes proposed are reduction in capital charges or a haircut for money market mutual funds and the inclusion of certain money market mutual funds as qualified securities, eligible for deposit in a special reserve account.

It's my understanding the comment period closed last June. And since it will soon be a full year since the comment period on the proposed rule elapsed, what is the current status of this rulemaking?

MR. COX: Mr. Chairman, we are very interested in this subject. We have taken a fresh look at it in light of all of the market turmoil to make sure that this is the right time to be embarking on these kinds of changes. But the comment that we have received has included much favorable comment, and so this is very much on the rulemaking agenda of the commission at this time.

SEN. DURBIN: Since it's been a year, what is the anticipated release date for your final rule?

MR. COX: We don't have a calendar date right now for further action on this proposal, but I would be happy, Mr. Chairman, to report back to you in real time about what the prognosis is.

SEN. DURBIN: If you would, please. Are you soliciting additional comments --

MR. COX: No, I believe the comment period has closed. I'm going to check and make sure that's the case.

SEN. DURBIN: Okay, and is there any --

MR. COX: Yes, that is the case.

SEN. DURBIN: Is there plan to reissue a new proposal, or are you going to stick with the original proposal?

MR. COX: Well, I think that the opportunity to fashion a final rule based not only on the proposal but the questions that were asked and the comment that was received should be sufficient so that it would not be required that we re-propose it.

SEN. DURBIN: Okay, if you'd kind of let me know just in general terms when that might happen.

Last August a group of law professors asked you to convene -- asked your agency to convene a series of roundtables on the topic of securities litigation reform, and The Wall Street Journal reported that the forums would occur "early next year," implying this year, 2008. Can you tell me if such roundtables are planned or under way?

MR. COX: Mr. Chairman, this was a suggestion in chief from academics led by, among others, Professor Langevoort at Georgetown. It is one that I think for a variety of reasons many people agree the commission should act upon. There are a variety of reasons across the ideological spectrum and across the markets that people have interest and concerns with this general topic.

My own interest in this topic and experience with it suggests to me that it is best taken up in a bipartisan way. We have currently a shorthanded commission, comprised only of Republican commissioners. And so I have wanted to wait before we had any such roundtable -- even though, of course, we could always have a balanced panel -- to make sure we also had a balanced commission that would give the public confidence that we were handling this very important issue with great care and not in any political way.

SEN. DURBIN: Last question I have: Two weeks ago the SEC adopted rules requiring a registered investment company to disclose when it divests from securities of issuers that the fund determines conduct or have direct investments in certain business operations in Sudan. These rules were mandated in the Sudan Accountability Investment Act, signed into law in December 31st of last year. How will the SEC track these particular divestment disclosures?

MR. COX: Mr. Chairman, as you know, we acted with great alacrity to do what was required by the statute and we are energetically going to implement it as well through the Division of Corporation Finance and our Office of Risk Assessment.

SEN. DURBIN: So how would an investor be able to quickly determine that a particular company has made such a disclosure, for example?

MR. COX: I'm sorry?

SEN. DURBIN: How would an individual investor be able to determine that a particular company has made such a disclosure?

MR. COX: Well, all of these filings will be made public. And we have taken some very recent measures to provide for full text search capability of filings that are available on our EDGAR online disclosure system.

SEN. DURBIN: Good. Thank you.

Senator Brownback, any further questions?

SEN. BROWNBACK: No further questions.

SEN. DURBIN: Chairman Cox, thanks. I appreciate your coming by. Glad you're working with the CFTC on a memorandum of understanding and hope that you'll continue that cooperative arrangement. I had asked when they formed this subcommittee to bring these two agencies together. There are so many things that you do have in common, at least in terms of the integrity of the marketplace, that I hope that that conversation continues outside this room.

Thanks for being here today.

MR. COX: Thank very much, Mr. Chairman.

SEN. DURBIN: This meeting of the subcommittee will stand adjourned. Any questions for the record will be submitted to those who have testified in the hopes that there will be prompt reply so we can do our work. Thank you. (Sounds gavel.)

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