Mr. MYERS. If you would, please.

Ms. PHILLIPS. I could supplement the record on that or I would be glad to go on and discuss it now, whichever you prefer.

FUTURES MARKETS USES AND THE ROLE OF THE CFTC

Mr. MYERS. I don't think it is necessary now. Provide this for the record. Maybe the rest don't need that, but I do. I ask that so often. I am sure my colleagues experience the same thing. People do ask how are they benefiting from it. I am sure at a loss. My little dabbling in the futures market wasn't very rewarding. I got educated to stay out of it.

Ms. PHILLIPS. We have developed some materials in that area. We are asked the same questions often.

[The information follows:]

I would like to first clarify one point concerning "gamblers" in the futures market. There is a marked distinction between speculation in futures markets and gambling. Gambling involves the creation of risk. In contrast, futures market speculators assume rather than create price risks that are not wanted by comercial interests for periods of time that may range from several seconds to serveral months. In doing so futures speculators provide an additional element of competition in the price formation process.

Most importantly, speculative positions in the futures market facilitate futures trading and are a legitimate adjunct to the hedging needs of producers and other commercials. Hedgers seek to reduce or eliminate the risk of price changes that may occur in the future. In order to transfer this price risk (the primary commercial use of futures markets) there has to be someone willing to assume that risk. It is the speculator who often performs this important function. For example, if a commodity processor wants to take a long (buy) position to hedge his future purchases against an increase in price, someone has to take the opposite position, a short (sell) position. Similarly, when a farmer establishes a short futures position as a hedge against a price decline, he eventually must offset that position by establishing a long position. At that point, someone has to take the opposite short position. Since bids and offers entered by commercial interests are seldom evenly matched, the speculator plays an integal role in price formation and directly facilitates risk transfer by taking the opposite sides of these trades.

This is not to say that the size of an individual trader's position, if unchecked, may not have an adverse impact on price. In order to restrict the potential impact that any one trader may have on price, the Commission has established speculative position limits in a number of commodities including the grains. In addition, the Commission has adopted rules which require exchanges to establish speculative position limits on all commodities that do not have Federal limits. The exchange limits are subject to Commission review and approval, and the Commission has the authority under § 4a of the Commodity Exchange Act to enforce compliance with these limits.

With regard to price manipulation, a major component of the Commission's market surveillance program is addressed to the prevention of this practice. The CFTC operates an extensive daily market surveillance program covering all actively traded commodities. The program is designed to detect and, if possible, prevent disruptions to a market caused by a threatened manipulation or some other major disruptive force. The Commission's staff of surveillance economists review trading in their assigned commodities on a daily basis, monitoring such factors as the activities of large traders, key price relationships, delivery capability and other potential problems, particularly threats of price manipulation. The full Commission meets in closed session each Friday morning to review expiring contracts and discuss any surveillance concerns raised by the staff. The CFTC's surveillance staff will frequently work with the surveillance staff of an exchange to obtain more information about the extent of any potential problem and to encourage voluntary liquidation of any futures positions that are likely to be disruptiuve. These behind the scenes "jawboning" excercises usually are sufficient to deal with the situation.

Mr. MYERS. Thank you.

Mr. TRAXLER. Mr. Smith.

MARKET SENSITIVITY

Mr. SMITH. To follow it up a little bit, I think there is also a growing number of disturbing situations where the market responds to some change in demand or supply worldwide about three days before the farmer finds it out. It seems like other people find it out before farmers do, and then it will come out that there is some change somewhere.

It just seems that whenever there is a change in a trade situation or a big contract-somehow the market seems to know it about two days before the farmers do. That has been pretty regular, too, hasn't it?

Ms. PHILLIPS. I think it is well recognized that the futures markets are anticipatory, so they are very sensitive to new information. Now, whether or not that new information is correct would later be validated.

REPORTING REQUIREMENTS

Mr. SMITH. It just seems that there ought to be some way to make sure the information gets out faster than it does. I know that we depend upon the Big Five grain companies to do most of the trading for us in the world market. They have subsidiaries overseas and their subsidiaries overseas make the contracts, and any time they want to violate the speculative limits, which they do all the time in my judgment, all they have to do is have their overseas subsidiary allege that it made a contract. That gives them an excuse for buying any amount of contracts they want, claiming that they are just hedging an alleged contract made by their subsidiary.

So, for all practical purposes, there is no limit on speculation by the big grain companies on our boards of trade. That leaves a bad taste in farmers' mouths. The more they realize that there is some news this afternoon we will say, and they will say, well, that ought to make the market go up. But the market goes down tomorrow, and it happens time and time again, and then they find out that other people apparently knew this two days ago. They took the market up past the place it should have gone, so it drops then.

It just seems like the information is not getting around fast enough. I don't know of any way to do it better than to require that anybody that has contracts over a certain number, immediately, within 24 hours, reveal who the contract is with. CFTC has over the years-you weren't chairman last year or the year before, but CFTC has not wanted to implement that kind of a rule, but I think that it ought to take another look at that. Have you got anything to say about that?

Ms. PHILLIPS. You have raised really a couple of issues that I would like to respond to. First of all, with respect to the question that you ask, as I understand it, there is a study that is being conducted on whether or not there should be increased reporting requirements for export grain, for example. That area generally has been under the responsibility of USDA. We have not had a mechanism for the reporting of a particular cash grain sale.

Mr. SMITH. For all practical purposes, though, it is of no value. It is just historical by the time they release the information.

Ms. PHILLIPS. Possibly. But they do have in place that kind of reporting requirement. Now, whether or not that needs to be changed, that is something to consider.

SPECULATIVE LIMITS

Mr. SMITH. But really it affects you, because you have the jurisdiction to determine whether or not they are in violation of speculative limits.

Ms. PHILLIPS. Yes.

Mr. SMITH. Not the Department of Agriculture.

Ms. PHILLIPS. Yes.

Mr. SMITH. But you have that jurisdiction, and in determining whether or not they are in violation of the speculative limits, you would need to consider whether or not they had cash contracts to backing up their claimed hedge.

That would let people know, have some way to judge whether or not it is true. I mean, obviously, in some of these big cases we have had in the past, where they claimed they sold a certain number of tons to Rome, Rome couldn't use that amount in 10 years. People will know that they should discount that reported sale.

You wouldn't necessarily get accurate information, you wouldn't necessarily have to be responsible for making them prove the information is correct, but they just ought to file the information so people will know what they are using as the basis for their hedge positions. But I don't think the Department of Agriculture can do that. That is in your jurisdiction.

Ms. PHILLIPS. We certainly do oversee the administration of the speculative limits, and have been working with the exchanges to tighten up that process. One of the areas that is at issue with the exchanges, in fact, is the hedging limits. We are trying to get speculative limits in place at the present time, so that is a project that we are currently working on.

EXCHANGE SELF-REGULATION

Mr. SMITH. You see, USDA says, and it is true, that they don't have any way to enforce it against a foreign country or a foreign purchaser, but you do. If they are in violation of speculative limits, you can do something about it. It doesn't make any difference if their contract involves Canadian wheat, our wheat or whose wheat it is. You can do something about it. You are the one agency that could enforce the reporting of this kind of information and make it available to the public.

Another question. Last year I was told that all of the exchanges have established good systems to meet their self-regulatory responsibilities. You weren't chairman then, but what do you have to say about that now?

Ms. PHILLIPS. That is certainly an ongoing process. We have a regular oversight auditing program through which we review all of the capabilities of the exchanges, and certainly with improving technology. One year an exchange may be doing quite well, and then in a few years if there is a breakthrough in technology, we might urge them to put new systems in place.

The exchanges vary. Some exchanges have very good programs. In the case of other exchanges, we ask them and push them to make some improvements, so I can't really make a blanket statement on that, because it varies from one exchange to another.

Mr. SMITH. You did say in your statement that you are going to rely increasingly in this budget on self-regulation? Is that right? Ms. PHILLIPS. Yes, sir.

NATIONAL FUTURES ASSOCIATION

Mr. SMITH. That is my question really. Can you rely on self-regulation, in view of the record?

Ms. PHILLIPS. Certainly it is not just the exchanges but it is also NFA, when we are talking about reliance on self-regulation. We can only rely on self-regulation to the extent that the exchanges and NFA are doing a good job. One of our jobs is to oversee them, and to force them to make changes.

CHICAGO BOARD OF TRADE RULE ENFORCEMENT REVIEW

Mr. SMITH. Do you have severe differences of opinion on the Chicago Board of Trade about whether or not they are doing the job? Ms. PHILLIPS. We did have a rule review last fall that urged them to make some changes, and they had a period of 60 days in which to respond to us on those changes. Their response did indicate that changes were being made and are in process. Again, we are going to have to monitor to see how well they actually carry it out. Plans are one thing, but actually doing it is another thing, so I would have to reemphasize that it is an ongoing process.

Mr. SMITH. Don't you already know that they haven't been carrying it out?

Ms. PHILLIPS. No.

Mr. SMITH. You don't?

Ms. PHILLIPS. No. At present we feel that they have made some improvements that they had to submit to us, for example, some rule changes to effect these changes. But I am not sure that I could give a full report card for another six or eight months, until we have had a chance to see how those new procedures are working

out.

CBOT LEGAL ACTION AGAINST THE CFTC

Mr. SMITH. What is the basis of the Chicago Board of Trade's legal action against the Commission? What is their claim, let's put it that way.

Ms. PHILLIPS. The Chicago Board of Trade has brought suit against us with respect to a joint interpretative policy statement that the SEC and the CFTC issued with respect to the interpretation of the Jurisdictional Accord that is contained in the statute. That is the basis of their suit.

Mr. SMITH. What is the status of that suit?

Ms. PHILLIPS. We have filed our papers, and as I understand it, the Board of Trade has filed their papers. We understand that there may be a decision by the judges as early as either the end of this month or the beginning of next month, so it is still in court.

33-494 0-84--2

Mr. SMITH. The chairman of the SEC appeared before my other subcommittee a couple or three days ago. We had a conversation about your differences and your accord with regard to jurisdiction. Have you got that pretty well worked out now or not?

Ms. PHILLIPS. With the SEC?

Mr. SMITH. Yes.

Ms. PHILLIPS. Yes, we believe we do. It is the Chicago Board of Trade that disagrees.

Mr. SMITH. Have you, and the SEC pretty well agreed on jurisdiction over options?

Ms. PHILLIPS. Yes, sir.

INSIDER TRADING STUDY

Mr. SMITH. The SEC now has an insider rule, and you don't, especially with regard to these options. That gives substantially more protection to the customer if SEC handles the jurisdiction instead of you. Have you considered or are you considering an insider trading rule?

Ms. PHILLIPS. As a matter of fact, that is one of the four studies that we have been mandated to undertake. We certainly are looking into the question of whether or not there are either trading abuses or whether or not we should make either regulatory changes or recommendations for additional legislation in that area. That report is due to be submitted by the end of this year.

Mr. SMITH. Can you at this time tell whether or not the fact that you don't have an inside trade rule encourages exchanges to fashion contracts so that you would have jurisdiction over them instead of the SEC?

Ms. PHILLIPS. One of the concerns that the SEC consistently has had, and we recognize this concern, is about the development of either options or futures contracts on certain individual securities or very narrow based securities that might trade as a surrogate for individual stock.

It is because of some of those concerns that the SEC had, and that we recognized, that the two agencies reached the interpretative guidelines. We have no experience in the trading of these new indexes, and so the idea was to try to have some of these products trade under a situation that had adequate safeguards, and get some experience, and if we are satisfied in a year or so, we can review whether or not we need to readdress our interpretation.

CONCEPT OF INSIDER TRADING

Mr. SMITH. You don't have a proposed rule now?

Ms. PHILLIPS. On insider trading?

Mr. SMITH. Right.

Ms. PHILLIPS. No, sir.

Mr. SMITH. If you were to approve an insider trading rule, would it be broad enough to prohibit officers or packing companies from trading in live cattle.

Ms. PHILLIPS. We are looking actually at a broad variety of what possible insider trading there might be, and that is one of the areas, yes, that we are specifically looking into. The securities' insider trading concept has to do with a fiduciary relationship be