WASHINGTON -- The Commodity Futures Trading Commission's plans to ease some of its rules to allow more exchange-traded derivatives transactions may trigger even more risks for state and local governments, a commission administrative law judge says.
In a letter submitted to the agency last week, George Painter criticized commission proposals that would lift a requirement that brokers identify the account for which trades are being made before the trades are executed.
"I think it's a disaster," Painter said yesterday in an interview. "We may as well close up the shop if we're going to wipe out audit trails."
The administrative law judge said lifting the requirement would put even the most sophisticated clients in jeopardy because brokers could easily misallocate trades.
"If other public treasurers, pension fund managers, and insurance fund managers are persuaded to increase their derivative trading in reliance on CFTC regulation, the commission's failure to insist on account identification on all orders prior to execution may indeed be a costly one," Painter said.
"It does not take a great deal of imagination to see how such a system would be abused," Painter said.
His comments came 10 days after Orange County, Calif., officials said that they had lost $1.5 billion from the county's investment fund by trading in derivatives. The county now estimates the losses at $2.02 billion.
Painter pointed to the actions of convicted investment adviser Steven Wymer as an example of the types of abuses that could take place if account identification rules were eased.
Wymer pleaded guilty in 1992 to defrauding towns nationwide and agreed to pay more than $209 million to settle civil and criminal charges against him. Wymer told Congress he had allocated trades to customers after the trades were conducted.
Painter maintained that the commission's proposals could set the stage for the same types of abuses.
Without account identification, "a broker could order a large number of trades and wait until the end of the day to assign the trades to various accounts," Painter said. He added that, like Wymer, a broker could be tempted to put the good trades into his own account or the accounts of family members or friends and lay the bad trades off on other customers.
Painter questioned why the agency would consider a plan to ease audit trail requirements when as recently as November, the commission reported to Congress that three U.S. futures exchanges were unable to reconstruct trades to a 90% accuracy level.
Earlier this fall, the futures trading agency opened for public comment its proposals to establish a professional trading market. The agency's proposals were a toned-down version of requests from the Chicago Board of Trade and the New York Mercantile Exchange for eased regulation to better compete with the over-the-counter derivatives market.
The exchanges had asked for regulatory relief for a special trading market that would be limited to professionals and institutional investors.
Meanwhile, the commission isn't only proposing eased regulation. It is also considering proposing possible safeguards for state and local governments. Specifically, the agency is considering whether all state and local governments should be considered qualified swaps participants.
The Office of the Comptroller of the Currency, in its comments to the commission, voiced concerns about the agency's proposals to change the swaps exemption language, fearing it would restrict municipalities from using swaps.
"The OCC recommends retaining this language, rather than limiting the access of municipalities to the swaps market," said Douglas Harris, senior deputy comptroller for capital markets, in the comment letter.
"Limiting market access to participants such as municipalities would be damaging to the market and its participants, including national bank participants, and is not currently justified," Harris said.
The OCC official said in his comments that swaps and other over-the-counter derivative products haven't been a source of problems for municipalities.
"Most of the direct derivatives losses suffered by municipalities, including the recently publicized losses suffered by Orange County, Calif., and Charles County, Md., have involved investments in mortgage derivatives and structured notes, including government securities," Harris said.
