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Adequate oversight of foreign exchange contracts?

Sandwiched between speeches about nutrition needs and arguments over crop insurance, conferees tackled a bothersome marketing issue involving forex contracts during the May 1 farm bill conference.

Short for “foreign exchange,” forex contracts are similar to commodity futures contracts. The two are traded much the same but the highly liquid forex contracts — priced according to current or “spot” exchange rates — typically deal with international currency speculation.

Citing requests and warnings by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA), Sen. Tom Harkin, Senate Agriculture Committee chairman — along with North Dakota Sen. Kent Conrad — introduced an amendment that would expand CFTC jurisdiction over forex contracts. Without proper oversight, said Harkin, such contracts are low-hanging fruit for the criminally inclined.

“In 2004, the 7th Circuit Court made a decision in a case called CFTC vs. Zelener. It adopted a very narrow definition of the term ‘transactions for future delivery.’ What it held is that a three-day contract offered to retail customers for foreign currency that, on its face promised delivery, was not a futures contract and was therefore outside the CFTC’s jurisdiction. This was even though the contracts operated, in practice, as futures contracts.”

The problem with the court’s decision is that “there’s nothing that limits these contracts just to foreign exchange. No court has said ‘we think rolling spot contracts aren’t futures contracts only if they’re for foreign currency.’ They never said that.”

The potential gap in consumer protection has been long known. Harkin pointed to 2005 testimony from NFA officials — “on the front lines of protecting investors and consumers” — warning about the lack of forex oversight.

“The NFA has documented the spread of these contracts to a variety of precious metal products, even oil, marketed on Web sites. (There are) the same old fraudulent pitches but now they have a new way to avoid the CFTC’s jurisdiction.”

Harkin then read from a letter sent by the CFTC just a day earlier. The letter reads, in part, “If not corrected, the Zelener (decision) will likely continue to eat away at … consumer protections. More importantly, however, if Congress doesn’t fully close this loophole, the courts have now provided criminals with a clear roadmap” on how to defraud investors.

Such rolling spot contracts are futures contracts, Harkin said unequivocally. “I don’t think the court was correct. A lot of times, the courts aren’t correct and we need to step in and reassert what we did in the Commodities Exchange Act.”

Harkin admitted there was opposition to the amendment — including the somewhat mysterious President’s Working Group (PWG) on Financial Markets, which tends to speak out during times of market crisis. The PWG keeps no minutes and announces no meetings. Known members include the U.S. Federal Reserve head Ben Bernanke, U.S. Treasury Secretary Hank Paulson and the Securities and Exchange Commission chairman. Interestingly, the CFTC chairman is also part of the PWG.

Even with such a roster allied against his amendment, Harkin asked his fellow conferees to “keep in mind (the PWG) is not elected, is not a statute-created body … The NFA — which is charged with protecting consumers — has begged us to close this loophole.

“Who do we listen to?” asked Harkin. “The CFTC that we statutorily created to do (such oversight)? The NFA, who deals with these matters day in and day out? Or the (PWG), which has not visited this issue in years and has no particular expertise in this?”

The choice was clear for Harkin, who said the amendment would help stave off another Enron-type scandal. “In a year or two, when we find people have been defrauded and had their savings (drained) … people are going to come to us and say ‘What were you doing?’ (The answer will be), ‘we had the Zelener decision and the court decided that these people could do this.’“

Not persuaded by such potential, Rep. Bob Etheridge from North Carolina said he’d prefer not to see forex contracts in commodities. “However, my concern ... is we could open up a can of worms … and do some things we don’t intend to.”

Despite the letter Harkin had just read, Etheridge pointed out that during actual testimony before congressional committees, “the CFTC ... hasn’t asked for it to be addressed … I have confidence in the CFTC when they tell us they can effectively police this activity under their existing authority and that they’d tell us if they needed a change in the law.”

While the NFA may want forex oversight changes, Etheridge pointed to testimony from the agency he believed was contradictory. “While the NFA wants a broader fix, their testimony as of late 2007 indicates they don’t want it to jeopardize the narrower Zelener fix or the broader CFTC reauthorization, which I think is critical. I believe that trying to get a broader look at the Zelener fix would endanger not only reauthorization but to the farm bill it’s attached to by the opposition that would generate in the broader community.”

Harkin asked, “If we extend the broad Zelener fix, who will be harmed?”

“My concern is that we have a very delicate balance put together in this bill,” said Etheridge. “We can (achieve) a narrow fix and deal with (your concerns) in another piece of legislation rather than generate outside issues we don’t need.”

Saying the forex contract fix “is a solution looking for a problem” Georgia Sen. Saxby Chambliss was also against the amendment. “We’ve talked to all the experts who say there isn’t a problem. Some say there could be but there isn’t a problem now.

“On these types of issues, we’ve always deferred to the President’s Working Group who certainly deal with financial markets on a daily basis. They have the expertise because they’re made up of the folks who make decisions relative to the financial markets daily.”

Chambliss then read from a Henry Paulson letter sent earlier that day. “It remains the view of the PWG that this is not necessary to deal with antifraud jurisdiction over products or instruments other than retail foreign currency.’

“I think we’re overreaching, we’re looking at something that isn’t an issue out there. I strongly oppose this amendment.”

In a duel of letters, Harkin produced fresh missives in support of the amendment from the CFTC and the Consumer Federation of America.

“To those who say there’s no problem: do you have to wait until people have been bilked?” asked Harkin.

“I would urge the House conferees to reject what’s been sent from the Senate,” said Virginia Rep. Bob Goodlatte. “I know (Harkin) is concerned about ag commodities. But they can’t be sold at the retail level and, therefore, this type of concern that dealt with a foreign currency doesn’t exist in the ag commodities area.”

Harkin wasn’t dissuaded. “I picked up on what you said — that they can’t do ag commodities. But there’s nothing prohibiting it if it’s a rolling spot contract. I admit we haven’t seen that. But there’s nothing prohibiting it.”

“We haven’t seen that,” Goodlatte agreed. “I think it’s (wrong) to envision something that doesn’t exist and come up with a solution to fix it when it isn’t there.”

After failing several votes, the amendment was withdrawn. Before doing so, however, Harkin had a final statement. “If this thing goes south in the next couple of years, I want to be on record that I stood with consumers, stood with the National Futures Association and the CFTC in trying to give them the jurisdiction to stop it before it started. I hope you’re right. I hope it doesn’t happen.”


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