Fueled by a rash of disclosures about questionable energy trading practices, Sen. Dianne Feinstein (D-CA) last week offered modified stand-alone legislation that seeks to bring over-the-counter (OTC) energy and metals derivatives traded over private electronic exchanges under the oversight umbrella of the Commodity Futures Exchange Commission (CFTC).

This is the senator’s second attempt to bolster the oversight powers of the CFTC, having lost a skirmish in April to include her proposal in the Senate’s omnibus energy bill. But Feinstein and her allies think her measure has a much better chance now, given the change in landscape since April — namely, the release of the Enron Corp. memos that revealed strategies for manipulating energy prices in the West, and corporate disclosures of natural gas and power round-trip, or “wash,” trading transactions to artificially inflate trading volumes and revenue.

The fact that Sen. Tom Harkin (D-IA), chairman of the Agriculture Committee, and Sen. Richard Lugar (R-IN), the ranking Republican on the panel, “have signed on [as co-sponsors] demonstrates that there’s a renewed desire for this bill,” said Feinstein spokesman Scott Gerber. Other co-sponsors include Sens. Peter Fitzgerald (R-IL), Maria Cantwell (D-WA), Ron Wyden (D-OR), Barbara Boxer (D-CA), Richard Durbin (D-IL), Patrick Leahy (D-VT) and John Corzine (D-NJ).

Feinstein is hoping the Agriculture Committee, which heard testimony on her measure last week, will mark up and vote on her legislation before Congress leaves for the August recess, he said. “We’d certainly like to do it before [ the recess].” When lawmakers return in September, her bill could then be offered on the Senate floor as either an amendment to another bill, or on a stand-alone basis, Gerber noted.

Feinstein last week had reportedly considered attaching her measure to an accounting reform bill on the Senate floor, sponsored by Sen. Paul Sarbanes of Maryland. But there was “some concern that would slow down the [Sarbanes] bill that’s gaining a lot of momentum” in the Senate, Gerber said.

She is seeking to repeal the Commodity Futures Modernization Act of 2000 (CFMA), which she says exempts from CFTC oversight energy/metals derivatives traded over private electronic exchanges. Specifically, Feinstein’s new bill would give the CFTC the authority to investigate allegations of fraud and manipulation in the energy and metals derivatives markets; subject all electronic trading platforms (except those executing financial derivatives’ transactions) to registration, transparency, disclosure and reporting requirements; require all electronic trading exchanges to maintain sufficient capital to carry out their operations; and would require the Federal Energy Regulatory Commission and the CFTC to meet quarterly to discuss the energy derivatives markets.

The initiative also calls for all energy transactions not regulated by the CFTC and FERC to be referred to an appropriate agency. “This was a catch-all [provision]…in case there’s something we haven’t thought of,” Gerber noted.

At the Senate Agriculture Committee’s hearing, CFTC Chairman James Newsome questioned the need for the Feinstein bill, saying his agency retained full authority to pursue fraud and manipulation of energy/metals derivatives under the CFMA. In fact, he reported his agency currently was “deep into a comprehensive investigation” of allegations of market manipulation by Enron and other energy traders, including the use of round-trip trades, and planned to “aggressively prosecute” companies that are found to have violated the Commodity Exchange Act.

“I’m not here to say that absolutely nothing should be done,” Newsome said to the committee, suggesting that perhaps Congress should simply clarify and confirm the CFTC’s anti-fraud and manipulation authority in order to end the confusion over the scope of its oversight powers.

Newsome called on the committee to wait until the CFTC’s investigation of energy traders is completed before it takes legislative action. If it becomes clear that changes to the CFMA are needed “after or during our investigation,” he assured the senators he would “immediately relay those needs to the [congressional] committees” that have jurisdiction over the commission.

CFTC Commissioner Thomas J. Erickson said he supported the Feinstein bill, which he called a “pragmatic and modest approach,” and disagreed with Newsome that current law provides the CFTC with sufficient oversight power. Under the CFMA, “We have a hole in the regulatory regime that allows for manipulation” of energy and metals swap transactions, he noted.

The two men also were at odds over whether the CFTC had the power under the CFMA to investigate energy companies for round-trip, or “wash,” trading activities.

The controversy over the extent of the CFTC authority under the CFMA arises from the fact that the law created two categories of commodities — “excluded” and “exempted” commodities, Erickson told the committee. Under “excluded” commodities (financial derivatives), the CFTC has no jurisdictional power. But under “exempted” commodities (energy/metals derivatives), the CFTC “retains a jurisdictional interest, but that law limits its application.”

While the CFMA basically allowed the CFTC to keep its anti-fraud and manipulation jurisdiction over the “exempted” energy/metals transactions, Erickson said other provisions in the law watered this down. “Thus, we have a gap in the oversight of exempt commodity transactions…The gap creates a conundrum. On the one hand, the act expects full prosecution of manipulations of exempt commodities in regulated exchange markets,” such as the New York Mercantile Exchange. But “on the other hand, the regulatory regime in place today turns a blind eye to the manipulation of these very same commodities,” if transacted over a private electronic trading platform.

Harkin and Lugar, both of whom were involved in the drafting of the CFMA, couldn’t even remember why energy and metals derivatives were given an exemption. They said that when the CFMA bill passed out of the Agriculture Committee, there wasn’t any exemption. The committee leaders noted that it was added in conference for some reason.

“It was very hard to get that act [CFMA] passed,” Lugar recalled, adding that he saw Feinstein’s proposal as a “modest attempt” to address the derivatives loophole. “I still think it [CFMA] is a good bill,” added Harkin, but he conceded there was a need to review the exemption for energy and metals derivatives.

Lugar challenged the CFTC’s Newsome to come up with an alternative to the Feinstein bill. In the absence of a “better alternative,” he said he intended to join the growing list of co-sponsors to the bill.

Both Newsome and Erickson agreed that it was unlikely that Enron would have been prevented, had the Feinstein bill been enacted into law. “At the end of the day, when we look at what created the Enron situation, the majority of their problems had to do with accounting fraud,” Newsome said. “I can’t give any guarantees that Enron…would not have occurred,” noted Erickson, but he believes the Feinstein proposal “would have given us a better chance at detecting any over-exposure” on the part of Enron.

In addition to enhancing CFTC’s authority, Erickson noted Feinstein’s measure was needed to restore confidence in energy trading, a market that he says is “fading away.” Most of the electronic energy platforms that were sanctioned under the CFMA are no longer in operation now, he told the committee.

Both Dynegy and Aquila Energy have halted electronic trading over the past month, and Williams is on the verge of doing the same, said Sen. Feinstein. Twelve of the largest energy traders have lost $188 billion of capital, or 71% of their market value, over the past year, she noted, yet they continue to fight CFTC oversight of the markets.

CMS Energy has admitted to participating in about $3 billion in round-trip trades, Reliant Resources reported $6.4 billion in similar trades between 1999 and 2001, while Duke Energy has posted $2 billion in “wash” trades, of which $650 million were executed on IntercontinentalExchange, an electronic platform exempt from CFTC regulation, Feinstein said.

These bogus trades are “flim flam…[they] create an illusion of activity to raise stock prices,” she testified. Feinstein said her legislation would subject the phony trades to CFTC purview.

Randall Dodd of Washington, DC-based Derivatives Study Center, a supporter of greater CFTC oversight, said the industry needed legislation that would promote derivatives, but would prohibit the “unproductive, downright nefarious” use of them. If it were up to him, he would propose stiff registration and reporting requirements for OTC derivatives traders, background checks, capital and collateral requirements, and would require derivatives dealers to post bid and ask prices throughout the day.

Aquila Energy Chairman Richard Green said the company favored the Feinstein bill, although it did not believe that the CFMA law was responsible for the ongoing crisis in the energy industry. Her legislation will provide the “necessary safety net to restore public trust while not impeding the dynamics of the marketplace.”

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