Last week the Senate passed the financial “reform” legislation, which now goes to a conference committee that will produce a bill that combines the Senate bill with that passed by the House months ago. (Ironically, the vote came when I was at a very nice conference on financial regulation hosted by Notre Dame.)
The Senate bill is best measured in pounds rather than pages. (Pounds of what I’ll leave to your imagination.) It is comprehensive, and from what I can tell, it is comprehensively wretched. Stephen Bainbridge, whose opinion I respect a good deal, strenuously objects to the nationalization of corporate governance embedded in some of the bill’s language. The infamous Lincoln swaps provision, which I’ve written about, is a horror. It is some kind of sick joke to remake the entire derivatives market–and the banking sector–with a transparently populist ploy heaved up by a rather undistinguished senator (but I repeat myself) from Arkansas in a desperate attempt to stave off a primary challenge. (Said ploy being incompletely successful, with Blanche Lincoln facing a runoff against her more lefty opponent. Which probably gives the provision continued life when it should be put out of our misery with all dispatch. The joke is even sicker when one considers that if current polls are at all accurate, Lincoln will be demolished in the general election.) The clearing mandate is also a disaster in waiting.
Rather than deconstruct the whole abortion, I’ll focus on a couple of (relatively minor, in the scheme of things) features that illustrate its intellectual incoherence.
The first relates to market manipulation. Here is a place where Congress could do some good by rewriting the existing law. As I’ve written extensively over the past 15 plus years, US manipulation law could use a serious overhaul. I’ve made concrete recommendations, including in a recent article in the Energy Law Journal.
But instead of doing something reasonable, the Senate passed an amendment proposed by the aptly named Senator Cantwell that does the exact opposite of what I recommend in the ELJ piece. Specifically, apparently lacking the ability to form an original thought, Cantwell and the Senate fire up the copy machine and essentially Xerox the anti-manipulation language in the Securities and Exchange Act. The amendment (S3348) outlaws “any manipulative device or contrivance.”
Boy, that’s such a big help. Makes things crystal clear, no?
Look, a major problem with US commodity manipulation law is its complete failure to define what is manipulative, and to provide courts and commissions with any guidance as to just what kinds of conduct are manipulative, and what tests should be applied to make that determination. In its attempt to ensure that the law is sufficiently broad to catch everything that could be construed as manipulative, Congress has instead passed language that is so vague that the law can hardly catch anything. The amendment’s language does nothing to correct that.
Moreover, Cantwell sings paeans to the securities law’s anti-manipulation provisions and precedents, and the effects of previous utilization of similar language in other commodity manipulation laws:
This language in this amendment is patterned after the law that the SEC uses to go after fraud and manipulation; that there can be no manipulative devices or contrivances.
It is a strong and clear [not!] legal standard that allows regulators to successfully go after reckless and manipulative behavior.
This legislation tracks the Securities Act in part because Federal case law is clear that when the Congress uses language identical to that used in another statute, Congress intended for the courts and the Commission to interpret the new authority in a similar manner, and Congress has made sure that its intention is clear.
In the 75 years since the enactment of the Securities and Exchange Act of 1934, a substantial body of case law has developed around the words “manipulative or deceptive devices or contrivances.”
The Supreme Court has compared this body of law to “a judicial oak which has grown from little more than a legislative acorn.” It is worth noting that the courts have held that the SEC’s manipulation authority is not intended to catch sellers who take advantage of the natural market forces of supply and demand, only those who attempt to affect the market or prices by artificial means unrelated to the natural forces of supply and demand.
Mr. President, Congress granted the same antimanipulation authority to the Federal Energy Regulatory Commission in 2005 in the Energy Policy Act. We did this as a result of the Enron market manipulation. I am very proud of this legislation and its ban on manipulation in electricity and natural gas markets. I say that because there was a similar issue of deregulation of energy markets that led to the Federal regulators not doing their job.
Since we have implemented this language in the electricity markets, the Federal Energy Regulatory Commission, since 2005, has used its authority to conduct 135 investigations. Of those 135 investigations, 41 have resulted in settlements involving civil penalties or other monetary remedies totaling over $49 million.
Two investigations brought about enforcement actions against manipulation, one against Amaranth for $291 million—-
The PRESIDING OFFICER (Mr. Udall of Colorado). The Senator has used 5 minutes.
Ms. CANTWELL. Mr. President, I ask unanimous consent for an additional 1 minute.
The PRESIDING OFFICER. Without objection, it is so ordered.
Ms. CANTWELL. The alleged market manipulation brought enforcement action against Amaranth for $291 million in civil penalties and Energy Trading Partners for $167 million in civil penalties. That is just an example of what a statute with teeth and a regulatory entity can do to actually stop manipulation when given that authority.
Sigh. There are so many things completely wrong with this it isn’t even funny. Most importantly, the relevance of SEC precedent to commodity market manipulation is a cross between (a) completely non-existent, and (b) actively counterproductive. Most importantly, as I point out in the ELJ piece, whereas the most important kinds of commodity manipulations are market power manipulations (e.g., corners) most securities manipulations are information/fraud driven. The canonical securities manipulation is the pump-and-dump, which has nothing whatsoever to do with market power manipulation that should be the first order target of any commodity anti-manipulation measure. So, the vaunted SEC precedents are worth exactly bupkus. No, that’s too generous. They will be actually counterproductive as enforcement attorneys and judges try to pound a market power manipulation peg into a fraud hole.
The ETP case that Cantwell mentions is a perfect example of this. I was an expert for ETP in this case, and know it intimately; as an aside, Cantwell is less than accurate in her characterization of the outcome of that case, because the government settled for a lot less ($5 million to the government, plus a set aside of $25 million to pay potential settlements in third party lawsuits) than the $167 million figure she cites, and that was a let’s-get-this-behind-us-gift to FERC, which brought the case. Substantively, the FERC had to twist itself into knots to try to characterize the conduct it found offensive into the “deceptive device or contrivance” category. FERC’s theories, uhm, evolved, to put it mildly; actually “devolved” would be a better characterization. At every iteration, I was reminded of Maxwell Smart: “Would you believe?” (No, actually.) Rather than being the shining example that Cantwell paints it to be, the ETP case was a perfect example of the fundamental idiocy of trying to export securities law manipulation concepts and precedents to the commodity markets.
Instead of improving manipulation law, the Cantwell amendment will make it worse, as hard as that is to believe. I don’t know if I’ve ever written a more depressing sentence.
Cantwell focuses on intent. But that isn’t the only problem with existing commodity manipulation law. Artificial price and causation have also posed problems too. But all are eminently fixable through an application of solid economics, as I discuss in more detail in the ELJ piece, and which I demonstrated in my book on manipulation in the mid-90s and my piece on the Ferruzzi squeeze from 2004.
Another poster child for the intellectual bankruptcy of the Senate bill is its provision to empower the CFTC to extend position limits to OTC energy derivatives. I have pieces forthcoming in Regulation and the Swiss Derivatives Review analyzing speculation and position limits in commodity markets. The title of the Regulation piece suffices to convey the conclusions: “No Theory? No Evidence? No Problem!” That is, the CFTC’s current proposal to impose position limits is not grounded in an understanding of the economics of commodity markets, and is completely unsupported by empirical evidence. The same, obviously, is true of the provision in the just passed legislation. But we’ll get limits nonetheless.
The Senate provision is particularly troubling because it will likely have effects on the Commission’s futures position limits as well as on OTC limits. Fear of driving trading to the OTC markets restrained the Commission in its setting of the proposed limits, and led some Commissioners to express reservations about the entire effort. With OTC position limit authority, those constraints and reservations evaporate. Now the only competitive constraint on the CFTC is the threat of trading moving overseas. But that threat is less severe than the competitive threat to the domestic OTC market, so it is quite possible that the Commission will impose more onerous restrictions on both exchange-traded and OTC-traded positions now that it has the OTC authority.
At the Notre Dame conference Chester Spatt warned of the unintended consequences of regulation. Quite so. And the Senate bill, and whatever comes out of conference, will spawn myriad unintended–but not unpredictable–consequences, most of them quite pernicious. When the Insane Clown Posse (AKA the United States Congress) is done “reforming” our financial markets we’ll learn to our regret that however flawed our existing system is, it is a far, far better thing than the product of the constructivist irrationality of Dodd, Lincoln, Cantwell, and Frank et al.