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entitled 'Financial Regulation: Clearer Goals and Reporting
Requirements Could Enhance Efforts by CFTC and SEC to Harmonize Their
Regulatory Approaches' which was released on April 22, 2010.
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
April 2010:
Financial Regulation:
Clearer Goals and Reporting Requirements Could Enhance Efforts by CFTC
and SEC to Harmonize Their Regulatory Approaches:
GAO-10-410:
GAO Highlights:
Highlights of GAO-10-410, a report to congressional committees.
Why GAO Did This Study:
The conference report accompanying the Consolidated Appropriations Act
of 2010 directed GAO to assess the joint report of the Securities and
Exchange Commission (SEC) and the Commodity Futures Trading Commission
(CFTC) on harmonization of their regulatory approaches. In October
2009, CFTC and SEC issued this report in response to the Department of
the Treasury’s recommendation that the two agencies assess conflicts
in their rules and statutes with respect to similar financial
instruments. GAO’s objectives were to review (1) how CFTC and SEC
identified and assessed harmonization opportunities, (2) the agencies’
progress toward implementing the joint report’s recommendations, and
(3) additional steps the agencies could take to reduce inconsistencies
and overlap in their oversight.
To meet these objectives, GAO reviewed the joint report and related
documentation, interviewed agency officials, and obtained and analyzed
written comments on the report from market participants.
What GAO Found:
CFTC and SEC conducted joint analyses and sought public input to
inform their efforts to identify and assess significant differences in
their rules and statutes and develop recommendations to address such
differences. The agencies obtained public input through joint public
meetings and a public comment period and worked together to analyze
this input. In drafting the joint report on harmonization of their
regulatory approaches, CFTC and SEC focused their analysis on eight
potential areas for harmonization and made at least one recommendation
in all but one of these areas. The joint report also includes several
recommendations to enhance coordination between the agencies. For
example, the report recommended the creation of a Joint Advisory
Committee to be tasked with considering and developing solutions to
issues of common interest in the futures and securities markets. The
joint report did not cover gaps in the agencies’ authorities to
oversee over-the-counter derivatives, which were the subject of
congressional deliberation at the time of their study.
The joint report’s recommendations for statutory changes have yet to
be enacted, and the recommendations for agency action remain in the
planning stages. According to agency staff, since issuing the joint
report in October 2009, the agencies have been focused on working with
Congress on drafting legislation to address recommended statutory
changes. Congress authorized CFTC and SEC to fund the Joint Advisory
Committee, as requested in the joint report, and proposed legislation
includes provisions that would partially address recommended statutory
changes in areas including oversight of exchange rules and
enforcement. CFTC and SEC have drafted a charter for the Joint
Advisory Committee and expect to have this committee functioning by
early summer 2010. Agency staff said the agencies have not set firm
timelines for the implementation of the other recommendations for
agency action.
Additional harmonization opportunities exist beyond those addressed by
the joint report’s recommendations, and future efforts by CFTC and SEC
to assess these opportunities could benefit from clearer goals and
accountability requirements. With only a few months to complete their
report, agency staff said the agencies could not address all
differences in their rules and statutes through the joint report’s
recommendations. Market participants identified several areas they
believe could benefit from additional harmonization efforts, including
portfolio margining and investor definitions and categories. The
agencies plan to coordinate future harmonization efforts through the
Joint Advisory Committee, but they have not yet developed clear goals
for harmonization or developed requirements for the agencies to
evaluate and report their progress toward meeting such goals. Without
a clearer vision to guide future harmonization efforts and mechanisms
to ensure accountability for these efforts, CFTC and SEC may not be
strategically positioned to implement the joint report’s
recommendations and address remaining harmonization opportunities.
What GAO Recommends:
GAO recommends that CFTC and SEC establish clearer goals for
harmonization, including time frames for implementing the joint
report’s recommendations, and develop requirements for reporting and
evaluating progress toward these goals. CFTC and SEC generally agreed
with our conclusions and concurred with our recommendation.
View [hyperlink, http://www.gao.gov/products/GAO-10-410] or key
components. For more information, contact Orice Williams Brown at
(202) 512-8678 or williamso@gao.gov.
[End of section]
Contents:
Letter:
Background:
CFTC and SEC Obtained Public Input and Conducted Joint Analyses to
Identify and Assess Significant Differences in Their Statutes and
Rules:
Most of the Joint Report's Recommendations Have Yet to Be Enacted or
Remain in the Planning Stages:
Additional Harmonization Opportunities Exist, and the Agencies' Future
Harmonization Efforts Could Benefit from Clearer Goals and
Accountability Requirements:
Conclusions:
Recommendation for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Briefing to Congressional Staff:
Appendix III: Comments from the Commodity Futures Trading Commission:
Appendix IV: Comments from the Securities and Exchange Commission:
Appendix V: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: Summary of Joint Report's Recommendations for Statutory
Change and Agency Action:
Table 2: Summary of H.R. 4173 Provisions That Would Address Certain
Recommended Statutory Changes:
Abbreviations:
CBOE: Chicago Board Options Exchange:
CEA: Commodity Exchange Act:
CFMA: Commodity Futures Modernization Act of 2000:
CFTC: Commodity Futures Trading Commission:
FCM: futures commission merchant:
SEA: Securities Exchange Act of 1934:
SEC: Securities and Exchange Commission:
SIPA: Securities Investor Protection Act:
SPAN: Standard Portfolio Analysis of Risk:
SRO: self-regulatory organization:
TIMS: Theoretical Intermarket Margin System:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
April 22, 2010:
The Honorable Richard Durbin:
Chairman:
The Honorable Susan Collins:
Ranking Member:
Subcommittee on Financial Services and General Government:
Committee on Appropriations:
United States Senate:
The Honorable José E. Serrano:
Chairman:
The Honorable Jo Ann Emerson:
Ranking Member:
Subcommittee on Financial Services and General Government:
Committee on Appropriations:
House of Representatives:
When Congress created the Commodity Futures Trading Commission (CFTC)
in 1974 to oversee the commodity futures markets, the futures markets
were relatively distinct from the securities markets overseen by the
Securities and Exchange Commission (SEC).[Footnote 1] As early as the
1970s, however, the emergence of derivative products with
characteristics of both futures and securities led to periodic
disputes concerning which agency should have regulatory jurisdiction
over certain new products.[Footnote 2] These jurisdictional disputes
have at times consumed significant agency resources and resulted in
lengthy delays in introducing product innovations to the markets.
Moreover, the futures and securities markets have increasingly
overlapped in terms of market participants, raising concerns about
duplicative or inconsistent regulation of entities that engage in
similar activities. Despite efforts by CFTC and SEC in recent decades
to resolve these issues, concerns about remaining overlaps, gaps, and
inconsistencies in their oversight have led to calls for a merger of
the two agencies, or absent a merger, greater harmonization of their
regulatory approaches.
In its June 2009 white paper on financial regulatory reform, the
Department of the Treasury (Treasury) recommended that CFTC and SEC
report to Congress by September 30, 2009, on existing conflicts in
their rules and statutes with respect to similar types of financial
instruments.[Footnote 3] Treasury recommended that the agencies either
explain why such differences are essential to achieving underlying
policy objectives or make recommendations for changes to statutes and
rules that would eliminate the differences. In October 2009, CFTC and
SEC responded to Treasury's recommendation by issuing a joint report
in which the agencies examined harmonization opportunities and made
recommendations to reduce inconsistencies in their oversight and
enhance cooperation between them.[Footnote 4]
The conference report accompanying the Consolidated Appropriations Act
of 2010 mandated that GAO review the joint report of CFTC and SEC on
harmonization of their rules and statutes. Accordingly, in this
report, we examine (1) how CFTC and SEC identified and assessed
significant differences in their rules and statutes and developed
recommendations to address such differences, (2) what progress CFTC
and SEC have made toward implementation of the joint report's
recommendations, and (3) what additional steps CFTC and SEC could take
to eliminate or reduce inconsistencies in regulatory oversight and to
enhance regulatory efficiency and effectiveness, as well as market
transparency.
To satisfy our responsibility under the mandate to report the results
of this work by March 1, 2010, we provided an interim report in the
form of a briefing to the subcommittees' staffs on February 26, 2010.
Appendix II contains the full briefing slides. This letter represents
the final report.
To address our objectives, we reviewed and analyzed the joint report
of CFTC and SEC on harmonization (joint report), documentation of
public input collected by CFTC and SEC through joint public meetings
and a public comment period, CFTC and SEC analyses of relevant
differences in their statutes and regulations, and provisions of
proposed legislation that address statutory changes recommended in the
joint report. We interviewed CFTC and SEC staff about steps taken by
the agencies to identify and assess harmonization opportunities,
progress the two agencies have made toward implementing the joint
report's recommendations, and additional harmonization opportunities
that may exist. In addition, to identify additional steps the agencies
could take to harmonize their rules and statutes, we obtained and
analyzed written comments on the joint report from representatives of
securities and futures market participants, the investor community,
and other experts who participated in the joint public meetings hosted
by the agencies to discuss harmonization opportunities. Finally, we
reviewed prior GAO work on futures and securities markets regulation,
financial regulatory reform, and practices that can enhance and
sustain collaboration among federal agencies.[Footnote 5]
We conducted this performance audit from January 2010 to April 2010 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives. A more
extensive discussion of our scope and methodology appears in appendix
I.
Background:
Prior to the 1930s, securities markets were overseen by various state
securities regulatory bodies and the securities exchanges themselves.
In the aftermath of the stock market crash of 1929, the Securities
Exchange Act of 1934 (SEA) created SEC as a new federal agency and
gave it authority to register and oversee securities broker-dealers,
as well as securities exchanges, to strengthen securities oversight
and address inconsistent state securities rules. SEC's mission is to
protect investors; maintain fair, orderly and efficient markets; and
facilitate capital formation. In addition to regulation by SEC and
state agencies, securities markets and the broker-dealers that accept
and execute customer orders in these markets continue to be regulated
by self-regulatory organizations (SRO), including the Financial
Industry Regulatory Authority, that are funded by the participants in
the industry. Among other things, these SROs establish rules and
conduct examinations related to market integrity and investor
protection. SEC also registers and oversees investment companies and
advisers, approves rules for the industry, and conducts examinations
of broker-dealers and mutual funds. State securities regulators are
generally responsible for registering certain securities products and,
along with SEC, investigating securities fraud. SEC is also
responsible for overseeing the financial reporting and disclosures
that companies issuing securities must make under U.S. securities laws.
Oversight of the trading of futures contracts has changed over the
years in response to changes in the marketplace. Under the Grain
Futures Act of 1922, the trading of futures contracts was overseen by
the Grain Futures Administration, an office within the Department of
Agriculture, reflecting the nature of the products for which futures
contracts were traded. However, futures contracts were later created
for nonagricultural commodities, such as energy products like oil and
natural gas, metals such as gold and silver, and financial products
such as Treasury bonds and foreign currencies. In 1974, as a result of
the Commodity Exchange Act (CEA), CFTC was created as a new
independent federal agency to oversee the trading of futures
contracts. CFTC's mission is to protect market users and the public
from fraud, manipulation, and abusive practices related to the sale of
commodity and financial futures and options, and to foster open,
competitive, and financially sound futures markets. Like SEC, CFTC
oversees the registration of intermediaries, including futures
commission merchants (FCM), and relies on SROs, including the futures
exchanges and the National Futures Association, to establish and
enforce rules governing member behavior.[Footnote 6] The Commodity
Futures Modernization Act of 2000 (CFMA) established a principles-
based structure for the regulation of futures exchanges and
derivatives clearing organizations, and clarified that some off-
exchange derivatives trading--and in particular trading on facilities
accessible only to large, sophisticated traders--was permitted and
would be largely unregulated or exempt from regulation.[Footnote 7]
In recent decades, CFTC and SEC have sought ways to resolve
jurisdictional disputes and address other emerging areas of overlap in
their respective oversight of futures and securities markets. For
example, in 1981, CFTC and SEC reached an agreement, called the Shad-
Johnson Jurisdictional Accord, to clarify their respective
jurisdictions over securities-based options and futures. The accord
was enacted into law in January 1983 and, among other things,
confirmed SEC's jurisdiction over securities-based options, including
stocks and stock indexes; provided CFTC with jurisdiction over futures
(and options thereon) on certain securities and securities indexes;
and prohibited futures trading on single stocks, as well as on
securities indexes that did not meet specific requirements.[Footnote
8] In 2000, CFMA lifted the ban on futures on single stocks and narrow-
based securities indexes, allowing them to be traded on securities or
futures exchanges but subject to joint regulation of CFTC and SEC.
Pursuant to the CFMA, the two agencies worked together to jointly
create margin requirements for single stock futures. Exchanges that
list and trade security futures are subject to the jurisdiction of
both CFTC and SEC; this is one example of how the securities and
futures markets have overlapped in terms of regulated entities. In
addition, financial intermediaries must register with both CFTC and
SEC if they serve investors trading in instruments subject to the
jurisdiction of the two agencies. According to the joint report,
approximately 45 percent of futures commission merchants are also
registered with SEC as broker-dealers. The joint report provides
additional examples of the agencies' efforts to collaborate in various
areas. For example, in March 2008, the two agencies entered into a
memorandum of understanding with the goal of creating a closer
relationship between the agencies on a broad range of issues affecting
their jurisdictions.[Footnote 9] The agreement identified points of
contact for coordination, outlined a protocol for addressing novel
derivative products, and generally contemplated enhanced information
sharing between the two agencies on areas of mutual concern and
interest.
Despite efforts by the agencies to define their respective regulatory
jurisdictions, jurisdictional disputes have periodically delayed the
introduction of novel derivative products to the marketplace. The
joint report notes that the governing statutes do not definitively
address the fundamental question of whether certain derivative
instruments qualified as futures contracts or options. In one recent
example, in January 2005 the Chicago Board Options Exchange (CBOE)
filed a proposal with SEC to list and trade a new option on an
exchange-traded fund holding investments involving gold, but
introduction of this product was delayed by over 3 years as CFTC and
SEC could not reach agreement on jurisdiction. In another instance,
according to the Chief Executive Officer of CBOE, an option on a
credit default product was placed on hold for 7 months, while a
European derivatives exchange introduced a similar product within
weeks of the announcement of the proposal to list this similar
product. These examples illustrate the potential for such delays to
create domestic and international competitive disadvantages for U.S.
exchanges and clearinghouses attempting to introduce novel products.
In its June 2009 white paper on financial regulatory reform, Treasury
noted that the broad public policy objectives of futures and
securities regulation are the same and that many of the differences in
the regulation of the markets are no longer justified. Specifically,
Treasury expressed the following concerns:
* Economically equivalent instruments may be regulated in different
manners, depending on which agency has jurisdiction. For example, many
futures products and financial options regulated as securities are
similar, and the returns to one can often be replicated with the other.
* Jurisdictional disputes consume significant agency resources, and
uncertainty about the outcome of such disputes may impede innovation.
* Jurisdictional distinctions may have unnecessarily limited
competition between markets and exchanges. Under existing law,
financial instruments with similar characteristics may be forced to
trade on different exchanges that are subject to different regulatory
regimes.
* The agencies follow different approaches to the regulation of
exchanges, clearing organizations, and intermediaries. Pursuant to the
CEA, CFTC employs a more principles-based approach to regulation,
under which market participants can have greater flexibility in
complying with regulatory requirements than under a more rules-based
approach. Treasury suggested that the two agencies seek agreement on
principles of regulation that are significantly more precise than the
CEA's current "core principles."
As noted earlier, Treasury recommended that the agencies make
recommendations to address differences in statutes and regulations
that are not justified by the agencies' policy objectives. In the
joint report, the agencies note that broad differences in futures and
securities regulation reflect, in part, fundamental differences in the
roles played by the two markets. Because of the role of certain
securities markets in capital formation, for example, securities
regulation is more concerned with disclosure than commodities
regulation is. For example, securities with returns that depend on the
issuer's financial performance--such as stocks issued by institutions
to raise capital--require more detailed disclosure to protect
investors than futures products with returns that depend on changes in
the price of a physical commodity. The primary purpose of the futures
markets is to facilitate the management and transfer of risk, and
certain securities markets, such as securities options and other
securities derivatives markets, also facilitate the management and
transfer of risk. As noted above, Treasury expressed concern that
certain securities options and futures products are subject to
different regulatory requirements although they serve similar purposes.
CFTC and SEC Obtained Public Input and Conducted Joint Analyses to
Identify and Assess Significant Differences in Their Statutes and
Rules:
To respond to Treasury's recommendation, CFTC and SEC obtained public
input and conducted independent and joint analyses to identify and
assess significant differences in their statutes and rules. In July
and August 2009, the agencies collaborated to prioritize and
categorize issues on which to solicit public input. Through joint
public meetings held in early September 2009 and a request for public
comments, CFTC and SEC collected views on harmonization opportunities
from a range of market participants and experts. The agencies worked
together to analyze the information collected, develop
recommendations, and draft the joint report. On the basis of their
analysis of the public input, CFTC and SEC grouped issues of
regulatory conflict into eight areas, and in the joint report made at
least one recommendation in all but one of these categories. The
agencies also made five recommendations intended to enhance
operational coordination between them. The joint report focuses on
differences in the agencies' existing authorities and does not cover
issues related to gaps in the agencies' authorities to oversee over-
the-counter derivatives, which were the subject of congressional
deliberation at the time of their analysis.
The Agencies Analyzed Differences in Statutes and Rules and Obtained
Public Input to Help Identify Potential Areas for Harmonization:
Given the tight time frame--Treasury recommended in June 2009 that the
agencies report to Congress by the end of September 2009--agency staff
said they focused on significant areas of difference and relied to a
large extent on public input to help identify significant regulatory
differences and, in turn, harmonization opportunities. As a first
step, the agencies worked separately and together in July and August
2009 to analyze differences between them regarding their statutes and
regulations. For example, CFTC and SEC staff completed a side-by-side
analysis of the agencies' respective statutes and rules in nine areas:
(1) exchanges and markets, (2) clearance and settlement, (3) trading
practices, (4) intermediaries, (5) Securities Act of 1933 and
applicable provisions of the Exchange Act, (6) financial
responsibility rules, (7) enforcement, (8) investment companies, and
(9) investment advisers. According to CFTC and SEC staff, the agencies
used this analysis to identify significant statutory and regulatory
differences and to prioritize and categorize issues on which to
solicit public input.
Following these independent and joint analyses, CFTC and SEC sought
input from the public in two ways. First, the agencies jointly
arranged and hosted public meetings on September 2 and 3, 2009. For
the joint public meetings, CFTC and SEC invited members of the
investor community, academics, industry experts, and futures and
securities market participants to participate in a series of panel
discussions and provide their views on regulatory differences and
harmonization opportunities. The agencies organized the meetings into
five panel discussions, with each panel focused on one of five broad
categories: (1) exchanges and markets, (2) intermediaries, (3)
clearance and settlement, (4) enforcement, and (5) investment funds.
Including the participation of all nine CFTC and SEC Commissioners and
30 panelists, these joint public meetings were unprecedented in the
history of the two agencies, according to the joint report. Second,
CFTC and SEC provided an opportunity for public comment from August 19
to September 14, 2009, on the issues to be discussed at the joint
public meetings. In addition to the statements submitted by
individuals who participated as panelists, the agencies received over
a dozen statements offering the views of individuals or organizations
not represented on the panels.[Footnote 10]
CFTC and SEC Staff Said the Two Agencies Collaborated to Assess
Harmonization Opportunities and Develop Recommendations:
According to CFTC and SEC staff, the agencies worked together to
analyze the collected information, develop their findings and
recommendations, and draft the joint report. On the basis of their
analysis of comments obtained from the joint public meetings and
public comment request, the agencies focused the joint report's
analysis on eight subject areas covering issues the agencies believe
emerged as the most relevant to harmonizing their statutory and
regulatory regimes: (1) product listing and approval, (2)
exchange/clearinghouse rule changes, (3) risk-based portfolio
margining and bankruptcy/insolvency regimes, (4) market structure, (5)
price manipulation and insider trading, (6) customer protection
standards applicable to financial advisers, (7) regulatory compliance
by dual registrants, and (8) cross-border regulatory matters.[Footnote
11] For each of the eight areas, the joint report includes discussion
of statutes and regulations relevant to SEC oversight, followed by
discussion of statutes and regulations relevant to CFTC oversight. For
each area, the joint report also includes an analysis section in which
the two agencies analyze the differences between their regulatory
approaches. Each agency took responsibility for drafting the sections
on its regulations and the statutes relevant to its authority. The
agencies divided initial drafting responsibility for the analysis and
recommendation sections, and CFTC and SEC staff said that the agencies
shared their drafts with each other and incorporated each other's
comments. In the analysis sections, the agencies also incorporated
public input obtained through the joint public meetings and the public
comment period.
CFTC and SEC jointly issued their report in October 2009 and made 15
recommendations that cover harmonization opportunities in all but one
of the eight areas--market structure. Table 1 summarizes the joint
report's recommendations for statutory change and agency action in
these seven areas. The recommendations for statutory change cover
changes CFTC and SEC believe require legislative action to amend one
or both of the agencies' statutes, while the recommendations for
agency action cover changes the agencies believe they can implement
without action from Congress. In the joint report, the agencies note
that market participants and other experts offered mixed views about
whether differences in the futures and securities market structures
are justified by the agencies' policy objectives. Later in this
report, we discuss opposing views on whether Congress should legislate
changes to the structure of the futures industry to introduce features
of the securities market structure.[Footnote 12]
Table 1: Summary of Joint Report's Recommendations for Statutory
Change and Agency Action:
Areas of difference in statutes and rules: 1. Oversight of new
products;
Recommendations for statutory change:
* Provide a process for expedited judicial review of jurisdictional
matters regarding new products. Specifically, establish and clarify
(1) legal certainty with respect to the agencies' authority over
products exempted by the other agency, and (2) a review process to
ensure that any jurisdictional dispute is resolved by the commissions
against a firm timeline;
Recommendations for agency action: N/A.
Areas of difference in statutes and rules: 2. Exchange and
clearinghouse rules;
Recommendations for statutory change:
* Enhance CFTC authority over exchange and clearinghouse compliance
with CEA;
Recommendations for agency action: N/A.
Areas of difference in statutes and rules: 3. Segregation, insolvency,
and margin;
Recommendations for statutory change:
* Facilitate the holding of (1) futures products in a securities
portfolio margin account and (2) securities options, securities
futures products, and certain other securities derivatives in a
futures portfolio margin account;
Recommendations for agency action: As part of the recommendation to
facilitate portfolio margining, CFTC and SEC should undertake a review
of additional changes that may be needed to achieve the benefits of
risk-based portfolio margining and a review of whether further
modifications to portfolio margining would be in the public interest.
Areas of difference in statutes and rules: 4. Market structure;
Recommendations for statutory change: N/A;
Recommendations for agency action: N/A.
Areas of difference in statutes and rules: 5. Manipulation, insider
trading, and fraud enforcement;
Recommendations for statutory change:
* Expand CFTC's conflict-of-interest prevention authority;
* Enhance whistleblower protections;
* Clarify CEA's restitution remedy;
* Enhance CFTC's authority over disruptive trading practices;
* Expand the scope of insider trading provisions under CEA, and;
* Expand SEC's statutory authority for aiding and abetting;
Recommendations for agency action: N/A.
Areas of difference in statutes and rules: 6. Customer protection
standards;
Recommendations for statutory change:
* Impose a uniform fiduciary duty on intermediaries who provide
similar investment advisory services regarding futures and securities;
Recommendations for agency action: N/A.
Areas of difference in statutes and rules: 7. Regulatory compliance by
dual registrants;
Recommendations for statutory change: N/A;
Recommendations for agency action:
* Align record retention requirements for intermediaries by
harmonizing the length of time records are required to be maintained;
* align customer risk disclosure documents, and;
* align specific private fund reporting requirements.
Areas of difference in statutes and rules: 8. Cross-border access;
Recommendations for statutory change:
* Empower CFTC to require certain foreign boards of trade to register
with CFTC;
Recommendations for agency action:
* SEC review of its approach to cross-border access to determine
whether greater efficiencies could be achieved with respect to cross-
border transactions consistent with the protection of investors and
the public interest.
Source: GAO analysis of A Joint Report of the SEC and the CFTC on
Harmonization of Regulation, October 2009.
Note: N/A = Not applicable.
[End of table]
In addition, the agencies made five recommendations to enhance
operational coordination between them:
* create a Joint Advisory Committee to be tasked with considering and
developing solutions to emerging and ongoing issues of common interest
in the futures and securities markets;
* create a Joint Agency Enforcement Task Force to share market
surveillance data, improve market oversight, enhance enforcement, and
relieve duplicative regulatory burdens;
* establish a joint cross-agency training program for staff;
* develop a program for the regular sharing of staff through detail
assignments; and:
* create a Joint Information Technology Task Force to pursue linking
information on CFTC-and SEC-regulated persons and other information
the agencies jointly find useful.
The joint report's recommendation for the creation of a Joint Advisory
Committee included a request that Congress authorize CFTC and SEC to
form, fund, and operate this committee. The other four recommendations
for operational coordination did not identify a need for legislative
action prior to implementation.
The joint report does not cover issues related to gaps in the
agencies' regulatory authority with respect to over-the-counter
derivatives. The executive summary of the joint report notes that
these gaps were discussed in the Treasury white paper and were the
subject of deliberation before Congress at the time of the agencies'
harmonization study. Consistent with Treasury's request that the
agencies identify existing conflicts in their rules and statutes, CFTC
and SEC staff said that they chose to focus on their existing
authorities in the report.
Most of the Joint Report's Recommendations Have Yet to Be Enacted or
Remain in the Planning Stages:
The joint report's recommendations for statutory changes have yet to
be enacted, and the recommendations for agency action remain in the
planning stages. Congress authorized funding for the Joint Advisory
Committee, as requested in the joint report, and has proposed
legislation including provisions that would address several
recommended statutory changes. CFTC and SEC staff told us they expect
to have the Joint Advisory Committee functioning by early summer 2010.
The agencies have not yet established time frames for implementing the
joint report's other recommendations that do not require legislative
action.
One Requested Legislative Action Has Been Taken, and Proposed
Legislation Includes Provisions That Would Address Some Recommended
Statutory Changes:
According to CFTC and SEC staff, since issuing the joint report in
October 2009, the agencies have been focused on working with Congress
on drafting legislation to address statutory changes recommended in
the joint report. To date, Congress has acted on a request in one of
the agencies' recommendations to enhance operational coordination: The
Consolidated Appropriations Act of 2010 authorized CFTC and SEC to
fund the Joint Advisory Committee. The joint report's recommendations
for changes to one or both of the agencies' statutes have yet to be
enacted.
H.R. 4173, as passed by the House of Representatives, would address
statutory changes recommended by the report in five areas, if enacted
(see table 2).[Footnote 13] First, H.R. 4173 includes provisions that
would enhance CFTC's authority over exchange and clearinghouse
compliance with the CEA, as recommended by the joint report. Second,
by amending the Securities Investor Protection Act (SIPA) to extend
SIPA protection to margin related to futures positions held in a
securities portfolio margining account, H.R. 4173 would address one of
the statutory changes recommended to facilitate portfolio margining.
H.R. 4173 also includes provisions that address recommended
enhancements to a specific enforcement authority for either CFTC or
SEC. For example, Sections 7207 and 7208 would grant SEC specific
statutory authority for aiding and abetting under the Securities Act
and the Investment Company Act.[Footnote 14] As noted in table 2,
several of the H.R. 4173 provisions would represent only partial
implementation of the joint report's recommendations. For example,
with respect to enhancing CFTC's authority over exchange and
clearinghouse rules, H.R. 4173 would not amend the CEA to allow CFTC
to reject proposed rule changes if it cannot make a finding that the
change is consistent with the CEA and regulations.[Footnote 15] In
addition, H.R. 4173 provisions regarding fiduciary duty and
whistleblower protections would implement recommended statutory
changes with respect to securities market participants, but not
futures market participants. Finally, the H.R. 4173 provision related
to cross-border access would not empower CFTC to require certain
foreign boards of trade to register with CFTC, as recommended in the
joint report.
Table 2: Summary of H.R. 4173 Provisions That Would Address Certain
Recommended Statutory Changes:
Area of difference: Exchange and clearinghouse rules;
SEC/CFTC recommendation: Enhance CFTC authority over exchange and
clearinghouse compliance with the CEA;
Provision in H.R. 4173: Section 3114 would partially implement this
recommendation by expanding the time period allowed for CFTC review of
new rules and by repealing certain procedural requirements for CFTC to
file an enforcement action for violation of core principles. Sections
3103 and 3111 include amended core principles for clearinghouses and
contract markets, respectively, clarifying the CFTC's rule-making
authority to determine the appropriate manner of compliance with the
CEA.
Area of difference: Segregation, insolvency, and margin;
SEC/CFTC recommendation: Facilitate the holding of (1) futures
products in a securities portfolio margin account and (2) securities
options, securities futures products, and certain other securities
derivatives in a futures portfolio margin account;
Provision in H.R. 4173: Section 7509 would partially implement this
recommendation by amending SIPA to extend SIPA protection to margin
related to futures positions held in a securities portfolio margin
account.
Area of difference: Customer protection standards;
SEC/CFTC recommendation: Impose a uniform fiduciary duty on
intermediaries who provide similar investment advisory services
regarding futures and securities;
Provision in H.R. 4173: Section 7103 would partially implement this
recommendation by amending the SEA and the Investment Advisors Act to
create a fiduciary duty for brokers, dealers, and investment advisers.
Area of difference: Manipulation, insider trading, and fraud
enforcement;
SEC/CFTC recommendation: Expand CFTC's conflict-of-interest prevention
authority; Enhance whistleblower protections; Enhance CFTC's authority
over disruptive trading practices; Grant SEC specific statutory
authority for aiding and abetting under the Securities Act and the
Investment Company Act;
Provision in H.R. 4173: Section 3108 would authorize CFTC to require
futures commission merchants and introducing brokers to implement
conflict-of-interest procedures separating research and analysis from
trading and clearing activities; Section 7203 would partially
implement this recommendation by amending the SEA to enhance
whistleblower protections; Section 3118 would amend the CEA to expand
CFTC's authority over certain disruptive trading practices; Sections
7207 and 7208 would grant SEC specific statutory authority for aiding
and abetting under the Securities Act and the Investment Company Act.
Area of difference: Cross-border access;
SEC/CFTC recommendation: Empower CFTC to require certain foreign
boards of trade to register with the CFTC;
Provision in H.R. 4173: Section 3115 would amend the CEA to authorize
CFTC to require foreign boards of trade seeking to provide direct
access to persons in the United States to meet certain standards for
transparency and market integrity with respect to contracts where the
price is linked to a contract trading on a U.S. exchange but does not
require registration in the United States.
Source: GAO analysis of H.R.4173.
[End of table]
Recommendations for Agency Action Remain in the Planning Stages:
According to CFTC and SEC staff, the joint report's recommendations
for action by one or both agencies generally are in the initiation or
planning stage. As noted above, only one of the recommendations for
enhanced interagency coordination included a request for legislative
action, and Congress acted on this request to authorize funding for
the Joint Advisory Committee. The agencies have drafted a charter for
the Joint Advisory Committee, and CFTC and SEC staff told us they were
working together to finalize the charter and consider selection of
individuals to sit on the committee. The report's other
recommendations requiring agency action include the other operational
coordination recommendations and recommendations for the agencies to
align certain requirements and study certain issues, such as portfolio
margining and SEC's approach to cross-border access. Agency staff said
they expect to have the Joint Advisory Committee functioning by late
spring or early summer 2010 but have not set firm time frames for
implementing the joint report's other recommendations requiring agency
action.
Additional Harmonization Opportunities Exist, and the Agencies' Future
Harmonization Efforts Could Benefit from Clearer Goals and
Accountability Requirements:
While the joint report's recommendations would reduce or eliminate
certain inconsistencies in the two agencies' regulatory approaches,
additional harmonization opportunities exist and the agencies' future
harmonization efforts could benefit from clearer goals and
accountability requirements. The agencies acknowledge that the
recommendations do not address all differences that may not be
justified by their policy objectives, and market participants and
other experts identified areas they believe could benefit from
additional harmonization efforts. Importantly, some remaining
differences in the agencies' regulatory approaches could create
opportunities for regulatory arbitrage. CFTC and SEC staff told us
they may use the Joint Advisory Committee to further Treasury's
recommendation on harmonization, but the agencies have not established
clear goals for harmonization or requirements to report and evaluate
progress toward such goals. Without a clear vision for future
harmonization efforts, the agencies may not be strategically
positioned to implement the joint report's recommendations and assess
remaining opportunities for harmonization.
Joint Report's Recommendations Do Not Address All Differences in
Statutes and Rules with Respect to Similar Products and Entities:
Given time and resource constraints, agency staff said they could not
address all differences through the joint report's recommendations. As
noted earlier, CFTC and SEC relied heavily on public input to identify
areas of focus for the joint report. Although public input generally
indicated support for harmonization in several areas, on some issues,
significant disagreement existed at the joint public meetings as to
whether or how to achieve harmonization, presenting challenges to
reaching agreement in a short time. The joint report's recommendations
acknowledge a need for further study in certain areas, including risk-
based portfolio margining and SEC's approach to cross-border access.
However, with respect to certain other issues where disagreement
existed, such as the structure of the U.S. futures markets and SEC's
process for reviewing and approving exchange and clearinghouse rules,
the agencies did not make any recommendations. Moreover, CFTC and SEC
acknowledge that some potential harmonization opportunities not
covered in the report, such as harmonizing the agencies' investor
definitions, merit consideration by the agencies.
At the joint public meetings, the CFTC and SEC Chairmen both cited
reducing regulatory arbitrage as an objective of the harmonization
effort. Importantly, some remaining statutory and regulatory
differences may create opportunities for regulatory arbitrage--that
is, the potential for market participants to use a particular market
or product instead of a competing market or product to exploit
regulatory differences. In its white paper, Treasury expressed concern
that economically equivalent instruments may be regulated in different
manners, depending on which agency has jurisdiction, and consistent
with this concern, we have endorsed the goal of consistent regulation
of similar products and institutions to help minimize negative
competitive outcomes.[Footnote 16] However, the joint report's
recommendations do not address all inconsistencies in oversight of
similar products and institutions. For example, the joint report's
recommendations do not explicitly address the potential for different
margin requirements for certain economically equivalent instruments
when used for similar purposes. In a joint comment letter submitted to
the agencies following the joint public meetings, several securities
options exchanges and the Options Clearing Corporation said that
differences between the agencies' approaches to regulating margin can
result in significantly different margin requirements for comparable
securities options and futures products, creating a competitive
disadvantage for certain options regulated as securities.[Footnote 17]
The joint report notes that CFTC, unlike SEC, generally does not have
authority to set margin levels for futures contracts or options on
futures, but does not recommend a statutory change to harmonize the
agencies' authority over margin requirements.[Footnote 18] In
addition, SEC staff noted that all securities transactions are subject
to a small fee under the SEA and that there is no comparable fee for
futures transactions. The joint report did not include a discussion of
this difference, and according to SEC staff, a statutory change would
be required to achieve harmonization on this matter. As discussed
below, market participants identified other areas where remaining
differences could create the potential for regulatory arbitrage,
including differences in market structure and investor definitions.
CFTC staff said that recognizing that issues related to regulatory
arbitrage are often complicated is important because many factors,
including statutory goals, can drive differences in the rules
applicable to similar products and activities and because judgments
about which regulatory approach is more appropriate can be difficult.
Moreover, regulatory differences with respect to similar products or
institutions do not necessarily indicate that either futures or
securities market requirements provide insufficient investor
protection or impose excessive burdens on market participants.
Nevertheless, when such differences exist, it is important to consider
whether they can create incentives for market participants to engage
in economically costly activities in order to take advantage of more
favorable regulations.
As part of our review, we contacted the 30 panelists who participated
in the joint public meetings to ask them about their views on the
joint report and its recommendations. We also requested input from
four other individuals, based on suggestions from CFTC and SEC. In
their written comments, respondents identified areas they believe
could benefit from additional harmonization efforts. These areas
include (1) legal certainty for new products, (2) oversight of
exchange and clearinghouse rules, (3) portfolio margining, (4) market
structure, and (5) investor definitions. Respondents provided other
comments on the joint report and its recommendations, but we focused
on remaining areas for harmonization most emphasized by respondents.
* Greater legal certainty for new products: Many respondents supported
the joint report's recommendation for having the U.S. Court of Appeals
expeditiously resolve a dispute between CFTC and SEC over their
jurisdiction over a new product in cases where the agencies do not
reach agreement within a prescribed time frame. However, several
expressed concern that implementation of this recommendation would not
fully resolve concerns related to establishing greater legal certainty
for new products. First, a few securities market participants favored
an administrative dispute resolution mechanism rather than the
expedited judicial review mechanism. According to these respondents,
in cases where the agencies fail to reach agreement within the
prescribed time frame, directing agency appeals to an administrative
body, such as Treasury or a regulatory council, could further expedite
the dispute resolution process. One respondent expressed concern that
referring product disputes to the courts, even under expedited time
frames, could still result in delays of over a year and could entail
time-consuming and expensive litigation. In support of the joint
report's recommendation, CFTC and SEC staff cited precedents and
pending legislation in which courts serve as venues for deciding
questions concerning the legal definitions of securities and futures.
SEC staff also noted that the potential for delays could be limited by
the time limits suggested in the joint report's recommendation. SEC
staff expressed concern that an administrative body, depending on its
composition, could be subject to political influence. Second, two
futures market participants supported changes that would allow
exchanges to choose whether to list a product as a future or a
security, but CFTC and SEC staff said that agency review is needed to
ensure that new products fit within the legal definitions of the
regime--futures or securities--under which they are regulated.
[Side bar:
Recent Example of the Resolution Process for Jurisdictional Conflict:
On January 25, 2005, CBOE filed a proposed rule change with SEC to
list and trade options on shares in a trust holding investments in
gold. In 2004, SEC had approved a securities exchange’s proposal to
list and trade the gold trust shares underlying the proposed option
product, but CFTC staff took the view that the gold trust shares
should be viewed as commodity transactions (rather than securities)
and that, as such, CFTC should have exclusive jurisdiction over the
options on the gold trust shares. As a result of this difference in
views, SEC deferred action on the proposed listing of the options on
gold trust shares for over three years. In the interim, CBOE submitted
amendments to its proposed rule change, and four other exchanges
submitted proposals to list and trade options on gold trust shares.
In addition, in October 2007, OneChicago, a security futures exchange,
submitted a proposal to CFTC to list and trade futures on gold trust
shares. In March 2008, pursuant to a memorandum of understanding
between the agencies and discussions between CFTC and SEC staffs, SEC
published the amended CBOE proposal for comment in the Federal
Register. In March and April 2008, CFTC published a notice seeking
public comment on exemptions from CFTC’s exclusive jurisdiction for
the OneChicago product and the CBOE product. The finalization of these
exemptions permitted the OneChicago product to be traded and cleared
as a security future subject to the joint jurisdiction of CFTC and SEC
and the gold trust options to be traded and cleared as securities
options subject to exclusive SEC jurisdiction. On May 29, 2008, SEC
granted approval to CBOE to list and trade the gold trust options.
End of sidebar]
Oversight of exchange and clearinghouse rules: Although the joint
report recommends legislation to enhance CFTC's authority over
exchange and clearinghouse compliance with the CEA, it does not
include a recommendation for SEC in this area. Echoing views expressed
at the joint public meetings and discussed in the joint report, some
respondents recommended that SEC adopt or consider adopting a process
similar to CFTC's more rapid process for reviewing and approving
exchange and clearinghouse rules, under which most proposed rules are
immediately effective upon self-certification by the exchange or
clearinghouse that the rule complies with the CEA. Exchanges noted
that the self-certification process is competitively important because
it allows them to implement rule changes quickly. A few respondents
also urged the two agencies to reach agreement on an overarching set
of principles to govern their oversight of exchange and clearinghouse
rules. This view also was reflected in the joint public meetings and
the joint report. As noted in the joint report, SEC recently approved
a new process for streamlining review of rule changes, and SEC staff
noted that about two-thirds of rule changes proposed by securities
exchanges are effective immediately upon filing. SEC staff
acknowledged that despite the recent streamlining, differences remain
between the two agencies' rule approval processes. Under the SEA, for
example, rule changes that are not effective under self-certification,
in contrast to the approach under the CEA, must be approved by SEC
before they are effective. In addition, all proposed rule changes on
the securities side are published for comment. SEC staff noted that
differences in the agencies' rule approval processes in part reflect
differences in the structures of the futures and securities markets.
For example, in the securities markets, multiple exchanges compete to
provide a trading venue for products that are fungible across the
exchanges; thus proposed securities exchange rules can have
implications for competition among the exchanges.
* Portfolio margining and insolvency regimes: The joint report's
recommendation to facilitate portfolio margining neither explicitly
addresses differences in the portfolio margining methods used for
futures and securities portfolio margining accounts nor fully
addresses issues related to the insolvency of an intermediary that is
dually registered as a broker-dealer and a futures commission
merchant. Two respondents suggested that the agencies adopt a uniform
portfolio margining regime. Currently, the portfolio margining method
approved by SEC for securities portfolio margining accounts is
different from the method for futures portfolio margining
accounts.[Footnote 19] Agency staff said these differences could
result in different margin requirements for similar, or economically
equivalent, instruments when used for similar purposes. SEC staff said
they are aware of the potential for regulatory arbitrage as a result
of these different methods. CFTC and SEC staff agreed that there are
issues related to portfolio margining that merit further
consideration. In addition, a few market participants recommended that
CFTC and SEC work with Congress to harmonize the bankruptcy and
customer protection rules applicable to joint broker-dealer/FCMs.
[Footnote 20] These respondents noted that harmonization of these
rules is needed to help ensure the orderly unwinding of customer
positions in the event of a joint broker-dealer/FCM bankruptcy.
[Footnote 21] One respondent observed that while addressing these
insolvency issues cannot be characterized as a "quick win," CFTC and
SEC should begin the process soon considering its importance and the
volatility of today's markets.
* Market structure: At the joint public meetings, panelists presented
mixed views on the need to resolve differences in the futures and
securities market structures, and the joint report discusses these
views. Noting the absence of a joint report recommendation, a few
respondents recommended actions to promote greater competition in the
U.S. futures markets. Two respondents told us that Congress and CFTC
should take steps to introduce features of the securities market
structure to the futures markets to improve competition and lower
costs for investors in these markets. For example, one securities
market participant recommended that CFTC encourage listing of fungible
products to allow trading of products on multiple exchanges and
mandate interoperability of clearing organizations to permit market
participants to clear trades at a clearinghouse regardless of the
facility on which the trade was executed. Another respondent suggested
that regulators take a more aggressive stance in using their antitrust
authorities to ensure that futures exchanges and clearinghouses and
their rules are not anticompetitive. In written comments provided in
response to our questions, one futures market participant opposed
mandated interoperability among futures clearinghouses, citing the
potential for interoperability to inhibit innovation, eliminate
competition among clearinghouses, and contribute to greater systemic
risk by linking and exposing futures clearinghouses to one anothers'
risks. The joint report states that securities options exchanges have
been both competitive and innovative in developing new products,
notwithstanding the use of central clearing. Although the joint report
did not include a recommendation related to market structure, it noted
that the agencies have supported provisions for nondiscriminatory
access to clearing organizations for the over-the-counter derivatives
market.[Footnote 22] Moreover, in 2007, in response to Treasury's
request for comments on the regulatory structure associated with
financial institutions, the Department of Justice expressed support
for a review of exchange-controlled clearing of financial futures, the
regulatory structure that underlies it, and its alternatives.[Footnote
23] The joint report notes that the Futures Industry Association, in
its comment letter to the agencies, stated that it would welcome a
comprehensive study of how best to improve competition in the market
structures for both futures and listed options markets.
* Investor definitions: Some market participants recommended that CFTC
and SEC harmonize their respective customer categories and definitions
with respect to oversight of intermediaries to help ensure greater
consistency in the application of customer protection rules. One
dually registered broker-dealer/FCM said that because essentially the
same entities transact business across asset classes, the agencies
could simplify definitions to include fewer categories based on net
worth (rather than financial assets) and investment experience. For
example, this respondent suggested that the agencies agree on the
definition of "retail" investor. SEC and CFTC staff said the agencies
did not cover this issue for the purposes of the joint report and that
it merits further consideration by the agencies.
Clearer Goals and Reporting Requirements Could Enhance CFTC and SEC's
Future Harmonization Efforts:
CFTC and SEC staff told us that the agencies may use the Joint
Advisory Committee to coordinate their efforts to address
harmonization issues involving differences between the two agencies'
approaches to regulation. In prior work, we have identified practices
that can help enhance and sustain collaboration among federal
agencies.[Footnote 24] These practices include defining and
articulating a common outcome; developing mechanisms to monitor,
evaluate, and report on results; and reinforcing agency accountability
for collaborative efforts through agency plans and reports. Although
the draft charter for the Joint Advisory Committee includes
furtherance of Treasury's recommendation on harmonization as one
possible activity of the committee, the agencies have not established
clear goals for harmonization or requirements for the agencies to
report and evaluate progress toward such goals. For example, the
agencies have not created a plan for implementing the joint report's
recommendations or established clearly defined objectives for
addressing remaining harmonization opportunities. Consistent financial
oversight of similar products and institutions--one of nine principles
we have identified for financial regulatory reform--could be used to
guide the agencies' efforts to define objectives that would allow them
to readily determine which issues fall within or outside the scope of
harmonization.[Footnote 25] Without clear goals and accountability
requirements to guide future coordination efforts, the agencies may
not be strategically positioned to implement the joint report's
recommendations and address remaining harmonization opportunities.
Conclusions:
The October 2009 joint report of CFTC and SEC on harmonization
represents a substantial positive step toward reducing and eliminating
inconsistencies in the agencies' regulatory approaches. The two
agencies' efforts to identify and assess harmonization opportunities
are notable for the unprecedented dialogue held at the joint public
meetings and the agencies' development of 20 recommendations in just
over 3 months. However, the agencies could not address all
harmonization opportunities through this time-constrained study, and
additional areas for harmonization may emerge as the markets continue
to evolve. With the joint report completed, sustained coordination
between CFTC and SEC is crucial as the agencies work to implement the
report's recommendations and to assess remaining harmonization
opportunities. Indeed, several of the report's recommendations direct
the agencies to create a joint body or program to facilitate
operational coordination.
Although agency staff told us that they plan to use the Joint Advisory
Committee to coordinate future harmonization efforts, CFTC and SEC
have not yet established goals with respect to harmonization or
developed requirements to report and evaluate their progress toward
these goals. With regard to the status of the joint report's
recommendations, the agencies expect to have the Joint Advisory
Committee functioning within months, but have not yet set time frames
for implementing the report's other recommendations for agency action,
which generally remain in the planning stages. We recognize that
relatively little time has passed since the joint report was issued
and that other agency priorities, such as working with Congress on
drafting legislation, may delay action toward implementing these
recommendations. As the agencies continue to work toward
implementation, setting appropriate goals, including time frames, and
reporting progress toward these goals could help to ensure that the
agencies take timely actions to address these recommendations.
Moreover, the agencies have not established a formal plan for
identifying and assessing remaining harmonization opportunities as
well as additional areas for harmonization that may emerge as a result
of regulatory reform and market developments. Such a plan could
establish clear objectives for assessing remaining harmonization
opportunities, such as eliminating inconsistencies and gaps in
oversight of similar products and entities. Without such a plan,
ongoing harmonization efforts may become stalled and the agencies may
not continue the process of determining which issues fall within or
outside the scope of harmonization and what actions are needed to
address them.
Recommendation for Executive Action:
To help ensure that CFTC and SEC are strategically positioned to
implement the joint report's recommendations and address remaining
harmonization opportunities, we recommend that as CFTC and SEC
continue to develop the charter for the Joint Advisory Committee, the
Chairmen of CFTC and SEC take steps to establish, with associated time
frames, clearer goals for future harmonization efforts and
requirements for reporting and evaluating progress toward these goals.
Specifically, the agencies could benefit from formalizing a plan to
assess implementation of the joint report's recommendations and
harmonization opportunities that may not have been fully addressed by
the joint report, such as differences in market structure and investor
definitions. Such a plan could include goals for future harmonization
efforts, such as time frames for implementing the recommendations;
assessment of whether remaining differences in statutes and
regulations result in inconsistent regulation of similar products and
entities that could lead to opportunities for regulatory arbitrage;
and periodic reports to Congress on their progress, including the
implementation and impact of the recommendations.
Agency Comments and Our Evaluation:
We provided the Chairmen of CFTC and SEC with a draft of this report
for their review and comment. CFTC and SEC provided us with written
comments, which appear in appendixes III and IV. In their comments,
both agencies agreed to take steps to implement our recommendation.
CFTC stated that, consistent with this recommendation, the charter for
the Joint Advisory Committee now provides that "[t]he committee shall
work to develop clear and specific goals toward identifying and
addressing emerging regulatory risks, protecting investors and
customers, and furthering regulatory harmonization, and to recommend
processes and procedures for achieving and reporting on those goals."
SEC agreed that the agencies should work to define specific goals for
harmonization, including setting time frames for implementing the
joint report's recommendations and developing periodic reports to
evaluate their progress in this area. SEC also agreed that developing
a formal plan for identifying and assessing remaining and emerging
harmonization opportunities would be beneficial to furthering the
agencies' efforts. Both agencies noted their appreciation of our
recognition of the joint report as a substantial positive step and
commented that they are continuing to work toward implementing the
joint report's recommendations. Finally, we received technical
comments from CFTC and SEC that we have incorporated into the report,
as appropriate.
We are sending a copy of this report to the Chairman and the Ranking
Member of the Subcommittee on Agriculture, Rural Development, Food and
Drug Administration, and Related Agencies of the House Committee on
Appropriations. We are also sending copies to the Chairman of the
Commodity Futures Trading Commission, the Chairman of the Securities
and Exchange Commission, and other interested parties. In addition,
the report will be available at no charge on GAO's Web site at
[hyperlink, http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 or williamso@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major
contributions to this report are listed in Appendix V.
Signed by:
Orice Williams Brown:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: Scope and Methodology:
To describe how the Commodity Futures Trading Commission (CFTC) and
the Securities and Exchange Commission (SEC) identified and assessed
significant differences in their statutes and rules, we reviewed and
analyzed the joint report of CFTC and SEC on harmonization (joint
report); transcripts of the panel discussions held at the joint public
meetings hosted by the agencies on September 2 and 3, 2009; statements
submitted to CFTC and SEC in response to the agencies' request for
public comment on opportunities for harmonization; CFTC and SEC
analyses of relevant differences in their statutes and regulations;
and other agency documentation related to the joint report. We also
interviewed CFTC and SEC staff who participated in the agencies'
efforts to collect public input and draft the joint report.
To describe the status of the agencies' efforts to implement the joint
report's recommendations, we reviewed and analyzed relevant provisions
of proposed and enacted legislation that address legislative actions,
including statutory changes, recommended in the joint report.
Specifically, we analyzed and summarized provisions of H.R. 4173, as
passed by the House of Representatives, that would address, at least
in part, recommendations in the joint report. We reviewed the
provision of the Consolidated Appropriations Act, 2010, that
authorized funding for the Joint Advisory Committee as well as the
agencies' draft charter for this committee. Finally, we spoke with
CFTC and SEC staff about the status of statutory changes and agency
actions recommended in the joint report.
To identify additional steps CFTC and SEC could take to harmonize
their regulatory approaches, we interviewed CFTC and SEC staff and
obtained and analyzed written comments on the joint report from
representatives of securities and futures market participants, the
investor community, and other experts who participated in the joint
public meetings. Specifically, in January and February 2010, we
developed and implemented a brief e-mail questionnaire to collect
feedback on the joint report and its recommendations from market
participants and other experts. On the basis of our review of the list
of panelists who participated in the joint public meetings and our
discussions with CFTC and SEC about how these panelists were selected,
we determined that the 30 individuals who served as panelists were an
appropriate group of respondents for this questionnaire. We also e-
mailed this questionnaire to four other individuals, based on
suggestions from CFTC and SEC. These individuals included former CFTC
Commissioners and a representative of the Securities Industry and
Future Markets Association who did not participate in the joint public
meetings but submitted comments to the agencies on harmonization. In
January 2010, we e-mailed our questionnaire to the 34 individuals and
requested written comments by early February 2010. We received 22
responses and analyzed these responses to identify areas that
respondents believed could benefit from additional harmonization.
Finally, we reviewed our prior work on futures and securities markets
regulation, financial regulatory reform, and practices that can
enhance and sustain collaboration among federal agencies.[Footnote 26]
We conducted this performance audit from January 2010 to April 2010 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Briefing to Congressional Staff:
Briefing to Subcommittees on Financial Services and General Government,
House and Senate Appropriations Committees:
Mandated Review of the Joint Report of SEC and CFTC on Harmonization
of Regulation Preliminary Findings:
February 26, 2010:
Briefing Outline:
* Objectives;
* Scope and Methodology;
* Background;
* Summary;
* CFTC and SEC Conducted Joint Analyses and Considered Public Input in
Identifying and Assessing Significant Conflicts in Their Rules and
Statutes;
* The Agencies Have Worked with Congress on Several Recommended
Statutory Changes, While Most Recommendations for Agency Actions
Remain in Planning Stages;
* Additional Harmonization Opportunities Exist, and Efforts to Assess
These Opportunities Could Benefit from Clearer Goals and
Accountability Requirements.
Objectives:
1. How did the Commodity Futures Trading Commission (CFTC) and the
Securities and Exchange Commission (SEC) identify and assess conflicts
between their laws and regulations and develop recommendations to
address such conflicts?
2. What progress have CFTC and SEC made towards implementation of the
joint report's recommendations?
3. What additional steps, if any, could CFTC and SEC take to eliminate
or reduce inconsistencies in oversight, and enhance regulatory
efficiency and effectiveness, as well as market transparency?
Scope and Methodology:
To accomplish our objectives, we:
* reviewed and analyzed the SEC/CFTC harmonization report,
documentation of public input obtained by CFTC and SEC through joint
public meetings and a public comment period, and preliminary analyses
conducted by CFTC and SEC on relevant differences in their statutes
and regulations;
* interviewed CFTC and SEC officials about how they identified and
assessed harmonization opportunities and developed recommendations;
progress made on the report's recommendations; and additional
harmonization opportunities that may exist;
* reviewed provisions in proposed legislation that may address
SEC/CFTC recommendations for statutory changes;
* obtained the views of market participants and other experts on the
report's recommendations and additional opportunities for
harmonization; and;
* reviewed prior GAO work and other relevant studies.
Background:
CFTC was created in 1974 with the mandate to regulate commodity
futures and commodity options markets.
* CFTC's mission is to protect market users and the public from fraud,
manipulation, and abusive practices related to the sale of commodity
and financial futures and options, and to foster open, competitive and
financially sound futures and options markets.
* Futures markets serve to provide a means for risk management and
price discovery.
SEC was created in 1934 to oversee the securities markets.
* SEC's mission is to protect investors, maintain fair, orderly, and
efficient markets, and facilitate capital formation.
* While both CFTC and SEC seek to promote market integrity and
transparency, securities markets are concerned with capital formation.
Certain securities markets, such as securities options and other
securities derivatives markets, also facilitate the transfer of risk.
Although CFTC and SEC generally oversee separate markets, their
jurisdiction has overlapped in several areas. These areas have
included:
* Futures on single stocks and the Shad-Johnson Accord;
* Innovative products that have features of both futures and
securities; and;
* Dually registered broker-dealers and futures commission merchants.
In its June 2009 White Paper on financial regulatory reform, the
Department of the Treasury (Treasury) noted that the broad public
policy objectives of futures and securities regulation are the same,
and that many differences in regulation exist between the markets that
are no longer justified.
Treasury expressed the following concerns:
* Economically equivalent instruments may be regulated in a different
manner, depending on which agency has jurisdiction;
* Jurisdictional disputes consume significant agency resources, and
uncertainty about the outcome of such disputes may impede innovation;
and;
* The agencies follow different approaches to regulation of
exchanges, clearing organizations, and intermediaries.
In the White Paper, Treasury recommended that CFTC and SEC issue a
report to Congress by September 30, 2009 on all existing conflicts in
statutes and regulations with respect to similar types of financial
instruments. The report was either to explain why those differences
are essential to achieving underlying policy objectives or to make
recommendations for changes to statutes and regulations that would
eliminate the differences.
In October 2009, CFTC and SEC responded to this request with a joint
report on harmonization of their regulatory approaches.
Summary:
CFTC and SEC conducted joint analyses and sought public input to
inform their efforts to identify and assess significant conflicts in
their rules and statutes. The agencies obtained public input through
joint public meetings and a public comment period and worked together
to analyze this input. In drafting the report, CFTC and SEC grouped
issues into eight potential areas for harmonization and made at least
one recommendation in all but one of these areas. The joint report
also includes several recommendations to enhance coordination between
the agencies.
Most of the joint report's recommendations for statutory changes have
yet to be enacted, and the recommendations for agency action are in
the planning stages. According to agency officials, since October
2009, CFTC and SEC have focused on working with Congress on drafting
legislation to address recommended statutory changes. Proposed
legislation includes provisions that may address the joint report's
recommendations to expand the authority of one or both of the agencies
in areas including exchange rules, enforcement, and cross-border
access.
Additional harmonization opportunities exist, and future efforts by
CFTC and SEC to assess these opportunities could benefit from clearer
goals and accountability requirements. Given time constraints, agency
officials said that the agencies could not address all conflicts
through the joint report's recommendations. Market participants
identified several areas they believe could benefit from additional
harmonization efforts, including portfolio margining and investor
definitions. The agencies plan to coordinate future harmonization
efforts through a joint committee, but the draft charter for this
committee does not include clear goals for harmonization and
requirements for the agencies to report and evaluate their progress
towards meeting such goals. Without a clearer vision to guide future
harmonization efforts and mechanisms to ensure accountability for
these efforts, CFTC and SEC may not be strategically positioned to
address remaining opportunities for harmonization.
Agencies Conducted Joint Analyses and Sought Public Input to Inform
Report:
CFTC and SEC conducted joint analyses and obtained public input to
identify significant conflicts in statutes and regulations.
* In July and August 2009, CFTC and SEC worked together on a
preliminary side-by-side analysis of their statutes and regulations.
* The agencies sought input from market participants and other experts
by hosting joint public meetings in early September 2009 and providing
an opportunity for public comment from August 19 to September 14, 2009.
* At the joint public meetings, CFTC and SEC held panel discussions to
address differences in five broad categories: (1) regulation of
exchanges and markets; (2) regulation of intermediaries; (3)
regulation of clearance and settlement; (4) enforcement; and (5)
regulation of investment funds.
* CFTC and SEC officials said that given the short timeline, they
focused on identifying significant areas of difference and developing
actionable recommendations.
Agencies Conducted Joint Analyses and Sought Public Input to Inform
Report:
CFTC and SEC worked together to analyze the public input and to
develop the report's recommendations.
In drafting the joint report, the agencies grouped issues into eight
potential areas for harmonization and made at least one recommendation
in all but one of these areas.
The agencies also made several recommendations to enhance coordination
between them:
* Create a Joint Advisory Committee to be tasked with considering and
developing solutions to emerging and ongoing issues of common interest
in the futures and securities markets;
* Create a Joint Agency Enforcement Task Force;
* Establish a cross-agency training program;
* Develop a program for sharing staff through detail assignments; and;
* Create a Joint Information Technology Task Force.
Table: Overview of Recommendations:
Area of Difference: 1. New products;
Recommendations for statutory change: Facilitate product approval
process and provide legal certainty;
Recommendations for agency action: N/A.
Area of Difference: 2. Exchange rules;
Recommendations for statutory change: Enhance CFTC authority over
exchange compliance with CEA[A];
Recommendations for agency action: N/A.
Area of Difference: 3. Margin/insolvency;
Recommendations for statutory change: Facilitate portfolio margining;
Recommendations for agency action: Study effects of portfolio
margining changes.
Area of Difference: 4. Market structure;
Recommendations for statutory change: N/A;
Recommendations for agency action: N/A.
Area of Difference: 5. Trading practices;
Recommendations for statutory change: Expand CFTC's conflict of
interest prevention authority; enhance whistleblower protections;
clarify CEA's restitution remedy; enhance CFTC's authority over
disruptive trading practices; expand the scope of insider trading
provisions under the CEA; and expand SEC's statutory authority for
aiding and abetting;
Recommendations for agency action: N/A.
Area of Difference: 6. Customer protection standards;
Recommendations for statutory change: Establish a uniform fiduciary
standard for those providing investment advisory services;
Recommendations for agency action: N/A.
Area of Difference: 7. Dual registrants;
Recommendations for statutory change: N/A;
Recommendations for agency action: Align record retention requirements
for intermediaries; align customer risk disclosure documents; and
align specific private fund reporting requirements.
Area of Difference: 8. Cross-border access;
Recommendations for statutory change: Empower CFTC to require foreign
boards of trade to register with CFTC;
Recommendations for agency action: Review approach to cross-border
access (SEC).
Source: SEC and CFTC, Joint Report of the SEC and the CFTC on
Harmonization of Regulation, October 2009.
N/A = Not applicable.
[A] Commodity Exchange Act.
[End of table]
Most Recommendations Have Yet to Be Enacted or Remain in Planning
Stages:
Status of recommendations for statutory changes:
* SEC and CFTC officials said that since the report issued in October
2009, they have focused on assisting Congress with drafting language
for statutory changes.
* Congress has authorized funding for the Joint Advisory Committee,
but other recommended statutory changes have not been enacted.
* Provisions in H.R. 4173, as passed by the House of Representatives,
would address some of these recommendations.
Table: Summary of H.R. 4173 provisions that would address recommended
changes:
Area of Difference: Exchange Rules;
SEC/CFTC Recommendation: Enhance CFTC authority over exchange and
clearinghouse compliance with the CEA;
Provision in H.R. 4173: Section 3114 would partially implement this
recommendation by expanding the time period allowed for CFTC review of
new rules and by repealing certain procedural requirements for CFTC to
file an enforcement action for violation of core principles. Sections
3103 and 3111 include amended core principles for clearinghouses and
contract markets, respectively, clarifying the CFTC's rulemaking
authority to determine the appropriate manner of compliance with the
CEA. H.R. 4173 would not amend the CEA to provide for agency approval
of proposed rule changes based on a finding that the change is
consistent with the CEA and regulations.
Area of Difference: Margin/Insolvency;
SEC/CFTC Recommendation: Facilitate portfolio margining;
Provision in H.R. 4173: Section 7509 would partially implement this
recommendation by amending the Securities Investor Protection Act to
extend insurance protection to futures held in a securities portfolio
margin account.
Area of Difference: Customer;
SEC/CFTC Recommendation: Establish a uniform fiduciary duty standard
for those providing investment advisory services;
Provision in H.R. 4173: Section 7103 would partially implement this
recommendation by amending the Securities Exchange Act (SEA) and the
Investment Advisors Act to create a fiduciary duty for brokers,
dealers, and investment advisors.
Area of Difference: Trading Practices;
SEC/CFTC Recommendation: Expand CFTC's conflict of interest prevention
authority;
Provision in H.R. 4173: Section 3108 would authorize CFTC to require
futures commission merchants and introducing brokers to implement
conflict of interest procedures separating research and analysis from
trading and clearing activities.
SEC/CFTC Recommendation: Enhance whistleblower protections;
Provision in H.R. 4173: Section 7203 would partially implement this
recommendation by amending the SEA to enhance whistleblower
protections.
SEC/CFTC Recommendation: Enhance CFTC authority over disruptive
trading practices;
Provision in H.R. 4173: Section 3118 would amend the CEA to expand
CFTC's authority over certain disruptive trading practices.
SEC/CFTC Recommendation: Grant SEC specific statutory authority for
aiding and abetting under the Securities Act and the Investment
Company Act;
Provision in H.R. 4173: Sections 7207 & 7208 would grant SEC specific
statutory authority for aiding and abetting under the Securities Act
and the Investment Company Act.
Area of Difference: Cross-border access;
SEC/CFTC Recommendation: Empower CFTC to require certain foreign
boards of trade to register with CFTC and to meet certain standards
that enhance transparency and market integrity;
Provision in H.R. 4173: Section 3115 would amend the CEA to authorize
CFTC to require foreign boards of trade seeking to provide direct
access to persons in the U.S. to meet certain standards for
transparency and market integrity with respect to contracts where the
price is linked to a contract trading on a U.S. exchange, but does not
require registration in the U.S.
[End of table]
Status of recommendations for agency action:
* CFTC and SEC have drafted a charter for the Joint Advisory Committee.
* The report's other recommendations for agency action generally are
in the planning or initiation stages.
* The agencies plan to have the Joint Advisory Committee functioning
by late spring or early summer 2010, but have not set timelines for
implementing the other recommendations that do not require statutory
changes.
Additional Opportunities for Harmonization Exist:
Given time and resource constraints, agency officials said that they
could not address all areas of difference through the joint report's
recommendations.
CFTC and SEC officials said they did not explicitly define the term
"harmonization" and focused on jurisdictional disputes and broad
differences in regulation, which agency officials viewed as
encompassing differences in the regulation of economically equivalent
products.
The report does not recommend changes to address some differences that
may create incentives for regulatory arbitrage—that is, some remaining
differences in rules and statutes may influence market participants'
incentives to invest in a particular product or have a product
regulated as a security or future.
In written comments provided to GAO, market participants and other
experts identified areas they believe could benefit from additional
harmonization efforts.
* Greater legal certainty for new products: Some market participants
called for an administrative body to resolve disputes, but agency
officials cited precedents and pending legislation in which courts
serve as venues for deciding questions concerning the legal
definitions of securities and futures.
* Oversight of exchange and clearinghouse rules: Some market
participants recommended that SEC move towards greater self-
certification of new exchange rules. SEC officials noted that recent
changes streamlined SEC's process, but acknowledged that differences
remain.
* Portfolio margining: Agency officials agreed that there are issues
related to portfolio margining that merit further consideration.
* Market structure: Market participants had mixed views on the need to
resolve differences in market structure.
* Harmonizing investor definitions: Agency officials agreed that this
is an area for potential harmonization.
Clearer Goals and Accountability Requirements Could Enhance Future
Harmonization Efforts:
CFTC and SEC officials told us that the agencies may use the Joint
Advisory Committee to identify and address harmonization issues
involving conflicts between the two agencies' approaches to regulation.
However, the draft charter for the Joint Advisory Committee does not
establish clear goals for harmonization and requirements for reporting
and evaluating progress towards such goals.
GAO has identified practices that can help enhance and sustain
coordination among federal agencies. These practices include:
* defining and articulating a common outcome;
* developing mechanisms to monitor, evaluate, and report on results;
and;
* reinforcing agency accountability for collaborative efforts through
agency plans and reports. (GAO-06-15)
Consistent financial oversight of similar products and institutions —
one of GAO's nine principles for financial regulatory reform — could
be used to guide CFTC/SEC efforts to define and articulate a common
outcome. (GAO-09-216)
Without clear goals and accountability requirements to guide future
coordination efforts, the agencies may not be strategically positioned
to address remaining harmonization opportunities. Furthermore, without
clearly defined objectives for harmonization, CFTC and SEC cannot
readily determine which issues fall within or outside the scope of
harmonization.
Recommendation:
To ensure that CFTC and SEC are strategically positioned to implement
the joint report's recommendations and address remaining harmonization
opportunities, we recommend that as CFTC and SEC continue to develop
the charter for the Joint Advisory Committee, they take steps to
establish clearer goals for future harmonization efforts and
requirements for reporting and evaluating progress towards these
goals. Specifically, the agencies could benefit from formalizing a
plan to assess implementation of the joint report's recommendations
and harmonization opportunities that may not have been fully addressed
by the joint report, such as differences in market structure and
investor definitions. Such a plan could include assessment of whether
remaining differences in statutes and regulations result in
inconsistent regulation of similar products and entities that could
lead to opportunities for regulatory arbitrage, and periodic reports
to Congress on their progress, including the implementation and impact
of the recommendations.
[End of section]
Appendix III: Comments from the Commodity Futures Trading Commission:
U.S. Commodity Futures Trading Commission:
Three Lafayette Centre:
1155 21st Street, NW:
Washington, DC 20581:
Telephone: (202) 418-5000:
Facsimile: (202) 418-5521:
[www.citc.gov]
April 16, 2010:
Orice Williams Brown:
Director:
Financial Markets and Community Investment:
U.S. Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Ms. Brown:
We have received and reviewed the Government Accountability Office's
("GAO's") draft report entitled "Clearer Goals and Reporting
Requirements Could Enhance Efforts by CFTC and SEC to Harmonize Their
Regulatory Approaches" ("Report"). We commend you for the time and
effort that the GAO has devoted to preparing this Report.
We appreciate the GAO's conclusion that the joint report on
harmonization of CFTC and SEC regulation ("joint report") represented
"a substantial positive step towards reducing and eliminating
inconsistencies in the agencies' regulatory approaches." The joint
report was made possible by unprecedented dialogue and cooperation
between the two agencies.
We note the Report's observation that many of the joint report's
recommendations are either currently under consideration by Congress
or in the planning stages. Congress is making great progress on
legislation to reform financial regulation. As the Report states, a
number of the legislative recommendations are included in the
financial regulatory reform bill recently passed by the House of
Representatives, H.R. 4173. Additionally, the CFTC and the SEC are
moving forward with plans to establish a joint advisory committee. In
this regard, and consistent with the Report's recommendation, the
joint advisory committee charter now provides that "[t]he committee
shall work to develop clear and specific goals toward identifying and
addressing emerging regulatory risks, protecting investors and
customers, and furthering regulatory harmonization, and to recommend
processes and procedures for achieving and reporting on those goals."
The agencies continue to work on the other recommendations included in
the joint report.
Once again, we thank you and your staff for their work on this project.
Sincerely,
Signed by:
Gary Gensler:
Chairman:
[End of section]
Appendix IV: Comments from the Securities and Exchange Commission:
United States Securities And Exchange Commission:
The Chairman:
Washington, D.C. 20549:
April 15, 2010:
Ms. Orice Williams Brown:
Director, Financial Markets and Community Investment:
United States Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Ms. Brown:
This letter responds to your request, dated April 1, 2010. to review
and comment on the draft report entitled Financial Regulation: Clearer
Goals and Reporting Requirements Could Enhance Efforts by CFTC and SEC
to Harmonize Their Regulatory Approaches (GAO-I 0-410) ("GAO Report").
Thank you for providing us with the opportunity to comment on the
draft GAO Report. We appreciate the GAO Report's recognition that the
Joint Report of the SEC and the CFTC on Harmonization of Regulation
("Joint Report") represents a substantial positive step towards
reducing and eliminating inconsistencies in the agencies' regulatory
approaches. Specifically, the GAO Report acknowledges the
unprecedented dialogue that resulted from the first ever public joint
meetings held by the two agencies and the agencies' development of 20
recommendations in just over three months.
The issuance of the Joint Report represents a significant step forward
that will help is to achieve the many benefits of greater coordination
and harmonization between the SEC and the CFTC. As the GAO noted, the
focus of the Joint Report was on a number of significant issues that
emerged from the agencies' public deliberations as the matters most
relevant to a reconciliation of the two agencies' statutory and
regulatory schemes. The 20 recommendations offered in the Joint Report
will help to fill regulatory gaps, eliminate inconsistent oversight,
and promote greater collaboration.
The agencies are working together and are committed to ensuring that
progress is being made towards the implementation of the Joint
Report's recommendations. As noted in the GAO Report, several of the
substantive recommendations in the Joint Report require action by
Congress. The Commission staff has been working with the CFTC staff on
providing recommendations for legislation. Further, the establishment
of the Joint Advisory Committee will be an important resource as the
SEC and CFTC fulfill their respective missions and further the
initiative on harmonization.
At the same time, we agree with the GAO that the Commission and the
CFTC should continue to evaluate and consider areas where there may be
opportunities for additional harmonization. Accordingly, the GAO's
suggestion of developing a formal plan for identifying and assessing
remaining and emerging harmonization opportunities would be beneficial
to furthering the agencies' efforts.
In addition, to ensure that the Joint Report's recommendations are
implemented and to continue to move forward with our harmonization
efforts, we agree with the GAO that the agencies should work to define
specific goals for harmonization, including setting time frames for
implementing the Joint Report's recommendations and developing
periodic reports to evaluate our progress in this area.
Thank you again for the consideration that you and your staff have
shown to our staff and the opportunity to comment on this draft
report. If you have any questions or would like to further discuss
this letter, please feel free to contact Robert Cook, Director of the
Division of Trading and Markets, at (202)551-5500, or Jamie
Brigagliana, Deputy Director, at (202)551-5700.
Sincerely,
Signed by:
Mary L. Schapiro:
Chairman:
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice Williams Brown (202) 512-8678 or williamso@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Karen Tremba (Assistant
Director), John Fisher, Matt McDonald, Omyra Ramsingh, Jennifer
Schwartz, Andrew Stavisky, and Richard Tsuhara made significant
contributions to this report.
[End of section]
Related GAO Products:
Financial Regulation: A Framework for Crafting and Assessing Proposals
to Modernize the Outdated U.S. Financial Regulatory System.
[hyperlink, http://www.gao.gov/products/GAO-09-216]. Washington, D.C.:
January 8, 2009.
Commodity Futures Trading Commission: Trends in Energy Derivatives
Markets Raise Questions about CFTC's Oversight. [hyperlink,
http://www.gao.gov/products/GAO-08-25]. Washington, D.C.: October 19,
2007.
Financial Regulation: Industry Trends Continue to Challenge the
Federal Regulatory Structure. [hyperlink,
http://www.gao.gov/products/GAO-08-32]. Washington, D.C.: October 12,
2007.
Results-Oriented Government: Practices That Can Help Enhance and
Sustain Collaboration among Federal Agencies. [hyperlink,
http://www.gao.gov/products/GAO-06-15]. Washington, D.C.: October 21,
2005.
Financial Regulation: Industry Changes Prompt Need to Reconsider U.S.
Regulatory Structure. [hyperlink,
http://www.gao.gov/products/GAO-05-61]. Washington, D.C.: October 6,
2004.
CFTC and SEC: Issues Related to the Shad-Johnson Jurisdictional
Accord. [hyperlink, http://www.gao.gov/products/GAO/GGD-00-89].
Washington, D.C. April 6, 2000.
The Commodity Exchange Act: Issues Related to the Commodity Futures
Trading Commission's Reauthorization. [hyperlink,
http://www.gao.gov/products/GAO/GGD-99-74]. Washington, D.C.: May 5,
1999.
The Commodity Exchange Act: Legal and Regulatory Issues Remain.
[hyperlink, http://www.gao.gov/products/GAO/GGD-97-50]. Washington,
D.C.: April 7, 1997.
Financial Market Regulation: Benefits and Risks of Merging SEC and
CFTC. [hyperlink, http://www.gao.gov/products/GAO/T-GGD-95-153].
Washington, D.C.: May 3, 1995.
[End of section]
Footnotes:
[1] Futures are agreements that obligate the holder to buy or sell a
specific amount or value of an underlying asset, reference rate, or
index at a specified price on a specified date. These contracts may be
satisfied by delivery or by offset with another contract.
[2] Derivatives are contracts that have a market value determined by
the price of an underlying asset, reference rate, or index (called the
underlying). Underlyings include stocks, bonds, agricultural and other
physical commodities, interest rates, foreign currency rates, and
stock indexes.
[3] Treasury, Financial Regulatory Reform, A New Foundation:
Rebuilding Financial Supervision and Regulation, Washington, D.C.,
June 2009.
[4] SEC and CFTC, A Joint Report of the SEC and the CFTC on
Harmonization of Regulation, Washington, D.C., October 2009.
[5] For example, see GAO, CFTC and SEC: Issues Related to the Shad-
Johnson Jurisdictional Accord, [hyperlink,
http://www.gao.gov/products/GAO/GGD-00-89] (Washington, D.C.: Apr. 6,
2000); Financial Regulation: A Framework for Crafting and Assessing
Proposals to Modernize the Outdated U.S. Financial Regulatory System,
[hyperlink, http://www.gao.gov/products/GAO-09-216] (Washington, D.C.:
Jan. 8, 2009); and Results-Oriented Government: Practices That Can
Help Enhance and Sustain Collaboration among Federal Agencies,
[hyperlink, http://www.gao.gov/products/GAO-06-15] (Washington, D.C.:
Oct. 21, 2005). See the Related GAO Products section for additional
reports.
[6] Futures commission merchants are individuals, associations,
partnerships, corporations, and trusts that solicit or accept orders
for the purchase or sale of any commodity for future delivery on or
subject to the rules of any exchange and that accept payment from or
extend credit to those whose orders are accepted. Firms and
individuals who trade futures with the public or give advice about
futures trading must be registered with the National Futures
Association, the industrywide SRO for the U.S. futures industry.
[7] A derivatives clearing organization is a clearinghouse or similar
organization that enables each party to a transaction to substitute
the credit of the clearinghouse for the credit of the parties,
provides for the settlement or netting of obligations from the
transaction, or otherwise provides services mutualizing or
transferring the credit risk from the transaction.
[8] This agreement was codified in the Securities Acts Amendments of
1982, which amended the federal securities laws, and in the Futures
Trading Practices Act of 1982, which amended the CEA. The accord
allowed CFTC to approve a stock index futures contract for trading if
CFTC found that the contract was (1) settled in cash; (2) not readily
susceptible to manipulation; and (3) based on an index that was a
widely published measure of and reflected the market as a whole or a
substantial segment of the market, or else was comparable to such a
measure. According to SEC and CFTC, these three standards were
intended to ensure that stock index futures would not be readily
susceptible to manipulation, be used to manipulate the underlying
securities or related options markets, or serve as a surrogate for a
single stock futures contract. For more information about the Shad-
Johnson Jurisdictional Accord, see [hyperlink,
http://www.gao.gov/products/GAO/GGD-00-89].
[9] SEC and CFTC, Memorandum of Understanding Between the U.S.
Securities and Exchange Commission and the U.S. Commodity Futures
Trading Commission Regarding Coordination in Areas of Common
Regulatory Interest, Washington, D.C.: March 11, 2008.
[10] An electronic futures exchange, securities option exchanges, and
a securities industry association were among those who submitted
statements but were not represented by individual panelists at the
joint public meetings.
[11] The joint report defines risk-based portfolio margining as a
margin methodology that sets a minimum level of required margin by
analyzing the risk of each component position in an account and then
recognizing any risk-offsets in the overall portfolio of positions.
The joint report discusses barriers that exist to the holding of
futures in a securities portfolio margining account and vice versa.
Panelists at the joint public meetings cited potential advantages of
facilitating greater risk-based portfolio margining by allowing the
recognition of risk offsets between certain securities and certain
futures products. These advantages include enhancing capital
efficiency by freeing customer capital for other purposes and
increasing the international competitiveness of the U.S. financial
markets.
[12] In the securities markets, identical, fungible securities are
traded on multiple markets as part of the "national market system."
This system was mandated by Congress in 1975 through amendments to the
federal securities laws. Under this market structure, exchanges
compete for trading and execution services for fungible securities,
and clearing is done through one central clearinghouse for each
product type. In contrast, in the futures markets, although products
can be similar in terms and function, they are not fungible across
markets and clearing organizations. Futures exchanges direct trades
for clearing to a clearinghouse, and common ownership of the exchange
and the clearinghouses to which it directs clearing is common.
According to the joint report, this same structure generally holds in
other areas of the world, including Europe and Asia.
[13] The Wall Street Reform and Consumer Protection Act of 2009, H.R.
4173, 111th Cong. (2009) (passed by the House of Representatives on
Dec. 11, 2009). The bill does not address the joint report's
recommendation for statutory changes in the area of new product
oversight.
[14] SEC has specific statutory authority for aiding and abetting
under the SEA and the Investment Advisers Act.
[15] In order to reject a proposed exchange rule, under existing
authority CFTC must find that the rule violates the CEA. The joint
report concluded that the requirement for CFTC to make such a finding
may limit its ability to reject new rules that may not be in the
public's interest.
[16] See [hyperlink, http://www.gao.gov/products/GAO-09-216].
[17] See comment letter submitted jointly by the Boston Options
Exchange, CBOE, International Securities Exchange, NASDAQ Options
Market, NASDAQ OMX PHLX, and the Options Clearing Corporation,
September 19, 2009.
[18] According to CFTC staff, Section 3112 of H.R. 4173 eliminates the
restriction on the CFTC's authority over margin, allowing the CFTC to
address changes to rules governing margin requirements, so long as
they are limited to protecting the financial integrity of a
derivatives clearing organization, are designed for risk management
purposes, and do not set specific margin levels.
[19] SEC has approved use of the Option Clearing Corporation's
Theoretical Intermarket Margin System model (TIMS) for calculating
margin requirements based on the net market risk of all positions in a
securities portfolio margining account. TIMS is a theoretical pricing
model which allows offsets among instruments referencing the same
underlying asset and also recognizes offsets between certain broad-
based indexes. In calculating margin for a portfolio, TIMS computes
potential profits and losses on all instruments according to defined
percentage increases and decreases in their prices (e.g., stocks are
moved 15 percent up and 15 percent down from the current price). The
method used for futures portfolio margin accounts, Standard Portfolio
Analysis of Risk (SPAN), assesses the net market risk of all positions
in a portfolio using a probability-based approach. Under this
approach, offsets may be recognized among instruments that do not
reference the same underlying asset, but have offsetting risk
characteristics due to historic or expected correlations in their
price movements. SPAN calculates margin based on expected price
changes within an established level of statistical confidence
(generally 95-99 percent).
[20] H.R. 4173, Section 3006 would require CFTC, SEC and the
prudential regulators to make recommendations to Congress regarding
changes to insolvency law, including to clarify and harmonize
insolvency law applicable to dually registered entities (broker-
dealer/FCMs) and portfolio margining.
[21] According to one respondent, the failure of Lehman Brothers in
September 2008 illustrated the difficulties that can arise when trying
to unwind a joint broker-dealer/FCM's customer relationships when
there are numerous and complex transactions, including exchange-traded
derivatives, securities positions being financed, and over-the-counter
derivatives.
[22] With respect to nondiscriminatory access to clearing
organizations for over-the-counter derivatives, Sections 3103 and 3203
of H.R. 4173 would prohibit derivatives clearing organizations and
clearing agencies from discriminating against unaffiliated trading
venues.
[23] Comments of the U.S. Department of Justice to Review by the
Treasury Department of the Regulatory Structure Associated With
Financial Institutions, 72 Fed. Reg. 58939 (October 17, 2007)(notice
and request for comments).
[24] See [hyperlink, http://www.gao.gov/products/GAO-06-15].
[25] See [hyperlink, http://www.gao.gov/products/GAO-09-216].
[26] For example, see [hyperlink,
http://www.gao.gov/products/GAO/GGD-00-89], [hyperlink,
http://www.gao.gov/products/GAO-09-216], and [hyperlink,
http://www.gao.gov/products/GAO-06-15].
[End of section]
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