Unafraid of sounding like a technological reactionary, the Chicago Mercantile Exchange has lately devoted a lot of firepower to potshots at the Internet. One recent salvo was launched specifically at "boiler rooms filled with salesmen soliciting the unwary public to trade dollars against foreign currencies without supervision, regulatory mandates and rules," according to congressional testimony in June by CME chairman John F. Sander. "They operate in darkness," he thundered, complaining about "the resulting loss of liquidity from our carefully regulated markets to these no-holds-barred back office dealing rooms." His remedy? "Put this market under a "regulatory roof before this bucketshop subculture grows into a national disaster."

Any of God's children, it seems, can set out an electronic shingle to trade FX on the net. Clearly some of these outfits are weird and marginal. See, for example, www.entrepreneurs.net/adventure/networktools/cur-rency.asp, which promises a 50 percent return in 12 months where traders "watch the market 24 hours a day and have cots in their offices, and sometimes do not leave for three to four days." Minimum investment: $100. But other sites are less absurd and some do seem to offer research and education in FX.

The CME's vitriol is not backed up by any data on the magnitude of the alleged menace, nor by proof of malfeasance by these net fry, nor by realistic expectations of what Washington might do, since many of them operate offshore. What's more, regulators say there have been as yet no cases of Internet trading fraud. "I think it would be remiss to say fraud is rampant," says a spokesman for the Commodity Futures Trading Commission.

Which is why some cynics wonder if whipping the Internet isn't just a new variant of the CME's attack on any over-the-counter challenge to its markets. The Internet operators certainly bear a strong resemblance to the top-of-the-line broker-dealers in that they don't charge commissions. Also, the CME's accusations of prearranged trading, trading against the customer and front-running have been used frequently against the OTC markets.

The CME's saber-rattling, however, has scared some of the net small fry. "We are very worried about these developments with the CME," says a trader at First Money Garden Corp., one object of the exchange's anger. "We're not doing anything wrong, but they send undercover agents to collect little pieces of information about things done incorrectly," he adds. "Then they take it to court."

Options touting is another growing net phenomenon that has the Establishment anxious. The Committee on Options Proposals (COOP) has dubbed Wade Cook the "worst malefactor" in this field. Cook generates trading recommendations off a bulletin board, which has promised returns of 30 percent per month from covered call writing. A check with www.wadecook.com shows a photo of Wade, who looks like a well-heeled lawyer, boasting that this is the only site on the Internet "teaching you ways to double your money every 2.5 to 4 months." A review of one of Cook's trades by a COOP member found that the best possible outcome was not a profit but a $3.00 loss. This is bad for "options credibility, because those who follow Cook's recommendations are generally those who do not otherwise trade options," COOP opined. "As a result, potential customers are burned and they never return." The COOP is also worked up about newsgroup sites that offer instruction and free advice and/or simple software for options.

Regulators and the NASD regularly conduct surveillance forays of the net. Geoffrey Aronow, the CFTC's director of the Division of Enforcement, has said that his staff periodically drop in on web sites, bulletin boards and chat rooms. This monitoring has already produced "dozens of initial referrals to the investigative staff," he says-most of them corrected as soon as the CFTC pointed out, as it did in a formal directive of August 8, that commodity pool operators (CPOs) and commodity trading advisors (CTAs) using the Internet must comply with all the provisions of the Commodity Exchange Act. This means in practice that electronic communication "may constitute solicitation activity, which gives rise to both registration and disclosure duties." In early September the CFTC made its first ever policing act on the Internet, by ordering two individuals with questionable backgrounds to stop providing advise in the form of electronic newsletters. The CFTC has amended its web page (www.cftc.gov) to allow the public "to report suspected commodities-related wrongdoing." But few experts think a rush of complaint is imminent. "The small bucketshops will blow over, though of course some fraud with occur with the avalanche of growth on the net," says Paul Farrell, author of Investor's Guide to the Net.

Ho-Hum Derivatives Study by GAO

Just about everyone in the know about derivatives in Washington has heard that some modification of the Treasury amendment to the Commodity Exchange Act (CEA) is long overdue, and that the CFTC and the Treasury Department have for several months been working on just such a project. Everyone except, seemingly, the U.S. General Accounting Office (GAO), which in mid-August circulated for comment a draft of a report highly critical of the legal framework for derivatives. Entitled the "CEA's Contribution to the Legal and Regulatory Uncertainty in the Derivatives Markets," it analyzed the troubling disconnect between the broad jurisdiction of the CEA and the narrow and inadequate regulatory structure that exists in OTC markets.

The report's conclusion, from a copy of the draft seen by Derivatives Strategy, contained language guaranteed to alarm the broker-dealer community: "The act continues to embrace the principle of functional regulation without providing a regulatory structure necessarily based on the same principle. As a result the legal and regulatory uncertainties will likely persist as regulators, the courts and others are tasked with determining whether OTC derivatives are futures and, if so, whether they are appropriately regulated under the CEA."

The very mention of swaps being futures is perceived by broker-dealers as a full karate kick to the head. Swap dealers don't take kindly to attacks on the 1974 Treasury Amendment, which the GAO report alleged was difficult to interpret because of contradictory language that has resulted in inconsistent interpretations by the federal courts.

Washington pundits immediately speculated whether the report and its timing was GAO's way of trying to influence the dialogue between Treasury and the CFTC. Another possible interpretation: the GAO was hoping to influence the legislative proposals of Senators Lugar and Leahy, who plan to introduce a bill to update the CEA later this year. None of these possibilities were in the money, however. Whatever its analytic merits, this document demonstrates that bureaucracy moves at glacial speed and often wastes taxpayers' money. Why? Because it is a response to a research project requested by the House Agricultural Committee three years ago!

A study that might have been influential had it been timely has languished on the bureaucratic back burner. In a fit of housecleaning, the GAO decided to complete and release it, even though the membership of the committee (and their staffers) has been greatly altered by the last round of Congressional elections. After the comment period, the full GAO report will be released in about early December. Says a GAO staffer, "By the time it does come out, because it has been leaked to the press, I'm not sure there will be much excitement."

Perhaps the GAO will get more bang from its nearly finished study on OTC derivatives sales practices.

Early Xmas Present from Feds

Regulators who de-regulate get brownie points in today's Washington. Knowing this, Fed chairman Alan Greenspan last month applauded the Fed's new amendments to Regulation Y, which unravel 20 years of regulations that are "utterly irrelevant today" Those irrelevancies include restrictions and constraints on banks in derivatives trading and investment. Under the new rules, which are subject to a 60-day comment period, banks would not have to seek individual exemptions for particular types of nonbanking activities. Instead they'd get blanket one-time approval.

According to Fed governor Susan Phillips, the Fed has "gained confidence in the industry's ability to handle derivatives. As they are gaining experience, they may want to offer specialized new types of products and not have to come back [to us] for every little change in the contract and come up with a new application [each time]," she says. Phillips also seems to think that the Fed's liberality will be an advantage to commercial banks competing with Wall Street, making it easier for banks to offer new arrays of credit products.

Maybe so. But a check by Derivatives Strategy with several banks' legal departments found nobody very excited about new freedoms in the 110-page document. Says one banker, "The Fed is making a lot out of small procedural changes."