The World According to Brooksley Born
Less than six months after she became the seventh Chairperson of the
Commodity Futures Trading Commission, Brooksley Born discovered that a number
of powerful congressmen wanted to dramatically limit her power to regulate
the futures markets. The most controversial aspect of the new legislation
sponsored by Senator Richard Lugar and others-and supported by the Chicago
exchanges-is a proposal that would allow the exchanges to create "professional
markets" that would be free of federal regulation.
In the last few weeks, Born has plunged into an active round of lobbying to save her agency and the cause of futures regulation. She is no stranger
to Washington power plays. Before joining the CFTC, Born was a partner at
heavyweight D.C. law firm Arnold & Porter, where she specialized in
representing institutional and corporate clients in futures regulation matters.
She speaks as a woman who knows the power of words and chooses them carefully.
The interview took place in March with Editor Joe Kolman.
We present a number of differing viewpoints on the professional markets
exemption in the Roundtable Section.
Derivatives Strategy: You've said that sophisticated institutional traders don't need the same degree of protection that retail investors do.
But that begs the question: what protections do they need?
Brooksley Born: I do think they need protection against fraud
and manipulation in these markets. Currently the CFTC conducts market surveillance
and oversight over all the futures exchanges. We have people on the floor
of the exchanges watching for trading violations. The exchanges are required
to keep detailed records of trading, and we get reports from the exchanges
and from traders on the markets, showing what the position of large traders
is, for example. None of those things would be available as to professional
markets under the proposed legislation. The federal government would not
have an oversight role at all.
There are standards in the statute and the regulations that deal with
trading practices and that are designed to prevent and deter abuses on the
floor of the market-such as the audit trail requirement that allows us to
see whether floor brokers are trading in front of their customers. There
are standards prohibiting trading in front of the customers, wash sales,
other kinds of illegal transactions-all that would be eliminated.
There are rules about the fitness of people who represent customers on
the floor of the exchanges or act as intermediaries or FCMs (futures commission
merchants). These include prohibitions against convicted felons doing this
work. There are ethics training requirements, net capital requirements and
requirements for segregation of customer funds. All of those requirements
would be eliminated if the professionals restricted their activities to
DS: The exchanges would argue that all these things-audit trails, registration, fitness-would still operate under their own self-regulatory
regimes. Why don't you believe them?
BB: I think it would be likely that some exchanges would do more
than others. We already have difficulties that result in bringing enforcement
actions because of misbehavior on the floor of exchanges. Right now all
the exchanges impose standards on their own markets that were adopted in
the statutory scheme. Under the legislation, those standards would be eliminated.
The exchanges also impose some of their own standards. But that doesn't
mean we don't have a very active enforcement program for abuses or that
we don't work very closely with the exchanges to make sure they're complying
with their self-regulatory responsibility.
DS: So you're saying the current self-regulatory efforts are simply not enough
BB: I believe there is a need for federal oversight to ensure
compliance with those self-regulatory standards, and I think there should
be federal standards for self-regulation. These standards would be totally
eliminated in exempt markets by the proposed legislation.
DS: Under the professional market exemption legislation, exchanges would be able to determine which of their pits would become professional-and
thus exempt from federal regulation. Are you afraid that the exchanges would
turn most of the pits into professional markets?
BB: The exchanges say that more than 90 percent of the volume
of trading on the exchanges today would be eligible for the professional
markets exemption. I am concerned that the reason the exchanges are pushing
so hard for this pro markets exemption is that they want to use it to eliminate
federal oversight of their markets.
Another thing to remember is that trading in futures on U.S. government
securities and foreign currency could be exempt under these bills, not only
under the pro markets exemption but also under the Treasury Amendment's
provisions. If so, they would even be exempt from the federal prohibition
against fraud and manipulation. The Treasury Amendment revisions in the
two bills would allow for the complete elimination of any applicability
of the Commodity Exchange Act to futures markets in government securities
or foreign currency, as long as the participants in those markets were somewhat
more restricted than "the general public." What that means hasn't
really been elaborated on.
DS: What kind of fraud do institutional investors have to fear
if there were no regulatory controls?
BB: Suppose, for example, a floor broker who was assigned to execute an order on the floor of the exchange didn't do so at all, but instead made
a private deal with one of his friends off the floor. We bring cases against
DS: ...despite the best efforts of the exchanges themselves. I
suppose your argument is that exchanges may be trying their best now but
an outside authority is necessary to really do the job properly.
BB: Yes, and also the exchanges, of course, are required by law
to do their best. But under the legislation, they would no longer have that
legal requirement. There would only be self-interest at work in terms of
the motivation of the exchanges to maintain a well-designed and effective
DS: And as a government regulator, you think that really isn't
BB: Historically it certainly has not been enough in the futures
and options markets.
DS: The exchanges argue that under the law, the CFTC would still
be able to demand records and prosecute trading violations after the fact.
BB: We would be able to bring actions for fraud and manipulation, but the provisions relating to other trading abuses that are presently in
our statute would not be applicable.
DS: What kind of trading abuses are we talking about?
BB: Things like wash sales or noncompetitive trading. We would
have to be able to prove that trading actually involved fraud on a customer.
That might be a much heavier burden of proof than we have today in many
cases. But beyond that, there would be no guarantee that we would have the
records available for our enforcement people since there would be no record-keeping
requirements under the act.
Right now, the people who trade on the floor have to keep records, and
the exchanges have to keep records. Under the proposed elimination of federal
oversight, the record-keeping requirements would be gone. So if fraudulent
traders on the floor wanted to, they could decide not to keep records or
destroy their records. And they would not violate any federal law unless
we actually had a subpoena out for them. It would also be harder to detect
these abuses early on. So it would only be likely that we would find out
about them if there either was a tremendous upheaval on the market or a
customer came to us with a complaint. That might be substantially later
than when we typically get involved now.
DS: So if someone wanted to corner the market in silver again
or if they wanted to try it with the S&Ps, under the legislation you
would be relegated to the sidelines, unable to prevent anything from happening.
BB: We would probably not have early warning of it. In the silver cases, for example, the commission did have large trader reports from the
Hunts and other market participants that alerted the commission to the fact
that large positions were being accumulated. We would no longer have that
information until there was such a dramatic impact on the price of silver
that it was clear that some improper behavior was occurring.
DS: But is there any evidence that the exchanges actually have
plans to totally eliminate the record-keeping you need to do your job?
BB: The CBOT wrote me a letter at the end of January saying it
believed it was entitled to the same elimination of federal regulation the
OTC market enjoys. It said that the undue regulation to which it was subjected
under the act included a number of things, and it started the list with
record-keeping and reporting and ended with having to deal with federal
DS: So that leads you to believe that if this bill passes, exchanges will take advantage of the legislation to the fullest.
BB: Usually the reason interest groups press for legislation is
because they want to use it.
DS: Are you as afraid of abuses on existing exchanges as you are
of new exchanges being formed that might become a sort of a lawless Wild
West of trading?
BB: I'm not sure whether under the Senate bill any entity other
than an existing futures exchange would have the advantages of creating
an exchange free of regulation. The Futures Industry Association in its
testimony on the Senate bill in February said that the Senate bill should
be broadened so that anyone, including futures commission merchants, would
be free to create a market in a futures contract and not have any provision
of the act applicable to it.
DS: Some people fear a scenario in which the legislation passes
and there are suddenly all these unregulated trading systems-perhaps on
the Internet-where caveat emptor is the only rule that applies.
BB: If you are going to have unregulated exchanges, it's difficult to justify limiting the unregulated exchanges to a small group of entities.
The futures exchanges seem to be saying that they don't want federal oversight
or regulation but they do want the antitrust exemptions that have allowed
them to have a monopoly on exchange trading. I'm not sure you can justify
that kind of monopoly if there isn't significant regulation.
DS: So if the current regulatory environment ends, it's conceivable that a legal case would challenge certain protections that these exchanges
have right now.
BB: Under the act, they also are protected from certain state
laws. They also have protection from private rights of action that might
DS: So is it conceivable that state gaming laws would become applicable to trading on the CBOT or Merc?
BB: I think that's an issue that probably would be explored.
DS: The exchanges have been vociferous in their complaints about
the competitive edge that they are losing to the OTC market. You don't put
much stock in these complaints. Why?
BB: Largely because the exchanges have experienced such healthy
growth in the last decade. They have more than doubled their trading-an
increase of 130 percent in the last 10 years.
DS: But the OTC market is up 500 percent.
BB: That's because it's gone from nothing to become a very substantial market. The CBOT has just had its best year and is the largest futures exchange
in the world. Its profits were up 26 percent last year over 1995. It is
true that the U.S. futures exchanges are experiencing competition and have
been experiencing it in the last 10 years-probably for the first time in
any significant way-from the OTC market and from exchanges being established
abroad. On the other hand, I think they are doing quite well competitively.
These other markets have grown up because they provide additional services-not
because our futures exchanges are too heavily regulated.
DS: In certain cases-the listed currency markets are most obvious example-the OTC market clearly has advantages that have allowed it to take
over much of the volume from the currency pits.
BB: The OTC cash market in foreign currency has always been much
larger than futures exchange trading in foreign currency. There was an enormous
interbank market in OTC foreign currency transactions in 1974 when the statute
was first extended to foreign currency futures exchange trading. So I'm
not sure that's really a significant change in circumstances.
DS: You said you were surprised by the positions of the FIA and
the exchanges on this legislation. They've always complained about undue
regulation. What was so unexpected?
BB: I didn't say I was surprised by the exchanges' position. It
seems to me the exchanges see a self-interest in having federal regulation
eliminated the way most industries would see some self-interest in that.
I was surprised by the Futures Industry Association because it's essentially
an association of commodities professionals-futures commission merchants
and others who make their profits representing customers on the futures
exchanges. It surprised me that they took the position that they would support
pro markets in their Senate testimony.
I was surprised because these people rely on customers who have confidence in the fairness and safety of these markets in terms of being willing to
commit funds to them. I imagine that there could be a significant diminution
of that confidence if our markets became the least-regulated in the world.
All other countries with established futures markets would have significantly
higher levels of regulation than our pro markets.
DS: A final question about the OTC market: What anti-fraud and
anti-manipulation powers do you think the CFTC should have over the OTC
market, and is there any new role you foresee in this area?
BB: We have traditionally maintained fraud and manipulation prohibitions and enforcement capabilities over those markets to the extent those markets
involve futures and options operations, and we think those powers should