Walter Lukken is a runner — has been all his adult life — and that’s probably a good thing, because these days he’s had to dash from one hearing to another on Capitol Hill as acting chairman of the Commodity Futures Trading Commission, the watchdog of the futures and options markets in the U.S. “This new role has much more in common with the hare than the tortoise,” Lukken, 40, told a recent luncheon audience at a conference on federal energy regulation compliance.
The acting CFTC chairman can relate to both, having been a regular short-distance runner in events like the three-mile Capital Challenge before turning to longer distances (in October he was among the top 20 percent of finishers in the Marine Corps Marathon in Washington). Being able to run, of course, isn’t the same as being able to hide, as he was starkly reminded in December during a hearing before the House energy subcommittee on oversight and investigations, where he found himself in hostile territory.
Lukken’s agency, which is overseen by the Agriculture committees in the House and the Senate, is engaged in a fierce turf battle with the Federal Energy Regulatory Commission. The FERC — which is under the purview of the House and Senate Energy committees — and the CFTC are fighting over who gets first crack at penalizing Amaranth Advisors, the Greenwich, Connecticut–based hedge fund that imploded in September 2006 after losing about $6.5 billion that month on bad bets in the natural-gas market. Amaranth is now facing scrutiny over allegations that it tried to manipulate prices, and the argument over jurisdiction will most likely be decided ultimately by a federal appeals court in Washington.
Sitting next to Lukken at the witness table at the December hearing was Joseph Kelliher, the 47-year-old chairman of the FERC. The two adversaries have a lot in common. Both are Republicans, have law degrees and paid their Washington dues working on congressional staffs — Lukken for Senator Richard Lugar, Republican of Indiana, and Kelliher for Texas Representative Joe Barton. Both Lukken and Kelliher are spearheading separate investigations of Amaranth over allegations that it manipulated prices in the March, April and May 2006 natural-gas contracts on the New York Mercantile Exchange.
The FERC’s action in the well-publicized Amaranth case introduces a new regulator into the futures markets, a change that worries many investors, especially hedge fund managers and other noncommercial players. Any enforcement action by any regulator creates a compliance challenge in such markets, and if Kelliher prevails, hedge fund managers will have to begin to factor in possible enforcement by the FERC — on top of regulation by the CFTC — as they plan investment strategies.
The FERC is flexing the relatively new muscle it was granted by the Energy Policy Act of 2005, which was written by the very subcommittee that Lukken and Kelliher faced. That law gives the agency a mandate to go after “any entity” that manipulates energy prices in the FERC’s jurisdiction — and the natural-gas market fits that description. But Lukken’s agency, asserting that its founding legislation, the Commodity Exchange Act of 1974, gives it exclusive jurisdiction over futures trading, is challenging the FERC.
At the heart of the dispute is the CFTC’s goal of retaining exclusive jurisdiction. If Lukken and the CFTC prevail, hedge fund managers will breathe a sigh of relief. Their hope is that they can continue to deal with a single regulator, one they are confident understands the futures markets.
As far as Kelliher and the FERC are concerned, the CFTC is free to continue with its case. Parallel enforcement is hardly unprecedented. In securities cases, state enforcement actions sometimes run simultaneously alongside Securities and Exchange Commission actions, such as crackdowns on fraud against retirees. And the FERC’s new mandate includes punishing traders who manipulate energy prices, in the belief that, as in the case with Amaranth, the FERC can perhaps inflict more harm than the CFTC because it has the power to impose greater penalties and its burden-of-proof hurdles are less stringent.
In December, Lukken had been called before the House panel to account for his agency’s resistance to the FERC’s actions. Almost as soon as the hearing began, he was on the receiving end of tough questioning by Congressman Barton, the ranking Republican member of the Energy Committee.
Barton began his interrogation by reminding the witness that Barton himself had put the language in the Energy Policy Act about the FERC taking action against any entity that manipulates prices when he was chairman of the House Energy Committee and chairman of the House-Senate conference committee that hammered the bill into its final shape.
Barton also took it upon himself to read aloud the entire section of the Energy Policy Act that addresses FERC jurisdiction. Then he looked down from his perch on the committee bench at Lukken and asked, “Do you think that ‘any entity’ doesn’t mean ‘any entity’?”
The acting CFTC chairman gamely replied that his agency supported “the broad grant of jurisdictional authority given to the FERC.” But he added: “Our mandate is to uphold the Commodity Exchange Act, which also has an exclusive jurisdiction provision enacted by Congress in 1974 to protect against duplicative regulation and differing legal standards in those markets. So we have to read those two statutes in context.”
Barton fired back in succinct fashion. “There’s no way you can have exclusive jurisdiction,” he said.
Lukken chose not to argue — at least not in public. But he continues to resist, and the futures industry comes down squarely on the side of Lukken and the CFTC. The Managed Funds Association — the Washington-based lobbying group that represents hedge funds as well as funds of funds and managed futures funds — is joined by the Futures Industry Association, the Chicago Mercantile Exchange and the Nymex in opposing the FERC action against Amaranth.
John Gaine, a special adviser to the MFA who until recently was the organization’s president (Richard Baker, a former Louisiana Republican congressman, became president in early February), dismisses Barton’s claim to authority. “It won’t be the one-off statement of a sitting congressman that decides this,” Gaine says. “This will be decided in a federal court of appeals.”
The issue of regulation jurisdiction has surfaced before. Gaine was at the CFTC during the first assault on its exclusive jurisdiction, in the 1970s, when the SEC sought to block a Chicago Board of Trade plan to trade Ginnie Mae futures. The CFTC thwarted that move and subsequent efforts to pry futures-trading regulation from its grasp, paving the way for innovation and growth in the industry.
“If there were no exclusive jurisdiction, the global derivatives landscape would look a lot different,” Gaine asserts.
“Two federal regulators with differing standards could make it almost impossible for us to function on a day-to-day basis,” says James Newsome, CEO of Nymex Holdings and a past chairman of the CFTC. And other regulators of cash commodity markets, like the U.S. Department of Agriculture, have come to a clear understanding with the CFTC that leaves enforcement in futures trading to that agency.
“There is an effective blueprint in place that has worked for many years,” Newsome says, adding that what the futures industry wants is for the FERC to follow the blueprint.
The turf war between Lukken and Kelliher has an added dimension: Both are lame-duck appointments in a lame-duck administration. Kelliher’s reappointment to the FERC languished for months in the Democratic-controlled Senate before he was approved in December; Lukken is still just acting chairman though the White House nominated him in September for the permanent chairmanship.
Nevertheless, Kelliher has seized on the mandate in the revised Energy Policy Act and beefed up the agency’s surveillance and enforcement capacity. And by taking on the Amaranth case, he has drawn attention to the recent expansion of the FERC’s authority.
“It’s the single biggest grant of regulatory power since the New Deal,” Kelliher says.
Under the 2005 revisions, the FERC can impose penalties of up to $1 million a day — far beyond what the CFTC can levy — which means that it is more likely to order a fund to disgorge profits in a market-manipulation case, holding out the promise to consumers that they can be made whole, Kelliher maintains.
“We do not seek to regulate futures markets,” he insists. “That is the CFTC’s job. But futures prices can and do influence prices in the physical energy markets that we regulate. Our consumer protection mandate therefore requires that we monitor and, where appropriate, sanction manipulative conduct in these instances.”
This is what worries the participants in the futures markets, including hedge fund managers, who argue that the kind of enforcement Kelliher seeks in the Amaranth case constitutes de facto regulation.
“It’s not regulation per se,” the MFA’s Gaine asserts, “but enforcement has the effect of being regulation.” The FERC has evolved immensely since its creation in 1920 by the Federal Water Power Act, the founding legislation that gave it the authority to license hydroelectric projects. It was known for years as the Federal Power Commission after receiving the authority in 1935 to regulate interstate transmission of electricity.
Reorganized in 1977 under its current name, the FERC has jurisdiction over interstate electricity sales, wholesale electricity rates, hydroelectric licensing, natural-gas pricing and oil pipeline rates. It also reviews applications for liquefied-natural-gas terminals, interstate natural-gas pipelines and nonfederal hydropower projects. The agency received its latest expansion of powers — the ones Kelliher insists give it statutory powers over manipulation of energy prices — in the wake of the California energy crisis in the spring of 2001 and the collapse of Enron Corp. later that year.
Natural gas is probably the only major futures market in which the FERC can claim a spillover from its central mission — energy regulation. Though the Nymex has an electricity futures contract, it is not a very robust market and doesn’t benchmark prices in the same way the natural-gas contract does.
Kelliher contends that Amaranth’s spectacular foray into natural-gas futures did spill over, to the detriment of consumers. For the FERC chairman and other witnesses summoned to the energy subcommittee hearing — including a heating oil vendor from Vermont and a representative of municipal gas distribution companies — the impact of Amaranth’s trading was clear: Consumers ended up paying far more for energy than supply and demand would have dictated. (The figure most frequently bandied about was $9 billion for this premium as a result of “excessive speculation” by Amaranth.)
The FERC proceeding against Amaranth — an administrative action that Amaranth is challenging in the U.S. Court of Appeals for the District of Columbia Circuit — is seeking a $291 million fine. To Kelliher, the facts are clear: Amaranth manipulated natural-gas prices in a way that caused harm to consumers, just the sort of infraction the FERC is supposed to prevent — or, at least, punish after the fact.
The argument has a political element, but it does not break down along party lines. In Washington, in fact, it seems like nothing brings partisan rivals together better than a good turf war. While Barton, a Republican, was responsible for getting the Energy Policy Act passed, current energy committee chairman John Dingell, a Michigan Democrat, has been more than willing to take up the cudgel in defense of the FERC. At the December hearing that featured Lukken in the hot seat, Dingell not only expressed disappointment at the CFTC’s resistance but also raised doubts about its vigilance.
“I understand that the FERC has made considerable progress over the past two years in improving its market-surveillance capabilities and exercising its enforcement authorities,” Dingell said. “On the other hand, there are indications that the CFTC may have been more enthusiastic in granting exemptions from regulation than it has been in rooting out possible energy market manipulation.”
The exemptions Dingell seemed to be talking about are allowed under the Commodity Futures Modernization Act of 2000, which puts trading in exempt commercial markets beyond the purview of the CFTC’s surveillance. This loosening of regulation is generally cited as one of the main reasons behind the success of futures trading in recent years: the pace of innovation, the explosive volume of trading and the evolution of futures into an asset class for a wider range of investors.
When Lukken had testified in October before the House agriculture subcommittee that oversees the CFTC, he had praised exempt commercial markets as “incubators for new concepts.” In response to the Amaranth experience, however, he also said in October that changes to the Commodity Exchange Act were necessary for the commission to detect and prevent manipulation in such markets.
Lukken emphasized that the additional oversight should affect only those contracts that mirror the benchmark debt capital market contracts, stressing that “changes should not result in stifling the innovation and other benefits” of exempt commercial markets.
The CFTC complaint against Amaranth Advisors, filed in U.S. District Court in Manhattan last July, alleges that the hedge fund undertook a “manipulative scheme” to drive down the price of the Nymex natural-gas contract during the last half hour of trading before the contracts expired — the “closing range” — by selling contracts it had amassed for just that purpose. The intent of the manipulation, the complaint states, was to benefit short positions in “look-alike swaps” Amaranth had purchased on the IntercontinentalExchange, the Atlanta-based operator of exchanges and trading platforms, which — as an exempt commercial market — is outside the CFTC’s surveillance. The exchange’s contracts mirror the Nymex contracts and use the Nymex settlement price to settle.
Part of what the lawmakers were inveighing against in December was that the CFTC had been completely in the dark about what Amaranth, which denies any wrongdoing, had been up to simply because the agency was not allowed to monitor trading at the IntercontinentalExchange.
Lukken’s most cogent answer — and his biggest concession, perhaps — is contained in his recommendations for amending the Commodity Exchange Act so that his agency has greater authority over certain exempt commercial markets.
Technicalities aside, the fight promises to remain heated, in part because it seems to have such a personal element to it — for the lawmakers, for Kelliher, for Lukken and for their colleagues on the two commissions, as evinced in a recent speech by Bart Chilton, a CFTC commissioner.
“The problem arose when FERC decided to take their new act for a little jurisdictional test-drive in the Amaranth case,” Chilton said during an appearance last year at an industry conference on natural gas. “But they took their act on the road too soon, I think, and it has resulted in a rendition of dueling government banjos. And that is very disappointing. It is the type of government that I have worked in for over 20 years and try to avoid.”
Former MFA president Gaine says he is confident the CFTC will maintain its exclusive jurisdiction, but, of course, it remains an issue for the courts to decide. And though the fight promises to be a long one, Lukken — the runner-turned-marathoner — says he is more than ready to go the distance.
