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 U.S. futures and options markets. “This new role has much more in common with the hare than the tortoise,” Lukken, 40, told a luncheon audience at a recent conference on energy regulatory compliance.
The acting chairman can relate to both, having been a regular 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. 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.
Sitting next to Lukken at the witness table at the December hearing was Joseph Kelliher, the 47-year-old FERC chairman. The two have much 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 Representative Joe Barton, a Texas Republican. 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.
FERC’s action in the Amaranth case introduces a new regulator into the futures markets, a change that worries many investors, especially hedge fund managers and other noncommercial players. If Kelliher prevails, hedge fund managers will have to begin to factor in possible enforcement by FERC — on top of regulation by the CFTC — as they plan investment strategies.
FERC is flexing the 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 FERC’s jurisdiction — and the natural-gas market fits that description. But Lukken’s agency asserts that its founding in 1974 under the Commodity Exchange Act gives it exclusive jurisdiction over futures trading. 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 FERC are concerned, the CFTC is free to continue with its case. Parallel enforcement is hardly unprecedented; in securities, state enforcement actions sometimes run alongside those of the Securities and Exchange Commission. In the Amaranth case 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 was called before the House panel to account for his agency’s resistance to 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 on the Energy Committee.
Barton began by reminding the witness that Barton himself, as then–Energy Committee chairman, had put the language in the Energy Policy Act about FERC taking action against any entity that manipulates prices. Barton also read aloud the entire section of the Energy Policy Act that addresses FERC jurisdiction. Then he peered down at Lukken from the committee bench and asked, “Do you think that ‘any entity’ doesn’t mean ‘any entity’?”
The acting CFTC chief gamely replied that his agency supported “the broad grant of jurisdictional authority given to 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, “There’s no way you can have exclusive jurisdiction.”
Lukken chose not to argue — at least not in public. But the futures industry comes down squarely on his side. The Managed Funds Association — the Washington-based lobbying group that represents hedge funds, funds of funds and managed futures funds — joins the Futures Industry Association, the Chicago Mercantile Exchange and Nymex Holdings in opposing the FERC action against Amaranth.
John Gaine, a special adviser to the MFA who until recently was the organization’s president (former Louisiana Republican congressman Richard Baker became president in 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.”
Gaine was at the CFTC during an earlier 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. “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 and a former CFTC chairman. And other commodity market regulators, 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 the futures industry just wants FERC to follow the blueprint.
The turf battle has an added dimension: Both Lukken and Kelliher are lame-duck appointments in a lame-duck administration. Kelliher’s reappointment to FERC languished for months in the Democratic-controlled Senate before he was approved in December; Lukken is still acting chairman though the White House nominated him in September for permanent status.
Nevertheless, Kelliher has seized on the mandate in the revised Energy Policy Act and beefed up the agency’s surveillance and enforcement capacity. By taking on the Amaranth case, he has drawn attention to the recent expansion of FERC’s authority. “It’s the single biggest grant of regulatory power since the New Deal,” Kelliher says.
Under the 2005 revisions 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.”
Hedge fund advocates worry 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 explains, “but enforcement has the effect of being regulation.”
FERC has evolved immensely since its creation in 1920 by the Federal Water Power Act, which 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 and renamed in 1977, FERC’s areas of jurisdiction now include interstate electricity sales, wholesale electricity rates, hydroelectric licensing, natural-gas pricing and oil pipeline rates. The latest powers — the ones Kelliher insists give it statutory authority over energy price manipulation — came in the wake of the California energy crisis in spring 2001 and the collapse of Enron Corp. later that year.
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 dictated. (A figure frequently bandied about is $9 billion for this premium as a result of “excessive speculation” by Amaranth.)
FERC’s administrative proceeding against Amaranth, which is challenging it in the U.S. Court of Appeals for the District of Columbia Circuit, is seeking a $291 million fine.
The argument has a political element, but it does not break down along party lines. In Washington, it seems that nothing brings partisan rivals together better than a good turf war. Although Republican Barton 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 FERC. At the December hearing, Dingell not only expressed disappointment at the CFTC’s resistance but also raised doubts about its vigilance. “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,” he said. Dingell seemed to be talking about allowances under the Commodity Futures Modernization Act of 2000 that put trading in exempt commercial markets beyond the purview of the CFTC.
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 view of Amaranth, 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. But he stressed that “changes should not result in stifling the innovation and other benefits” of exempt commercial markets.
The fight promises to remain heated, in part because of the strong personal element. Bart Chilton, a CFTC commissioner, said in a recent speech: “The problem arose when FERC decided to take their new act for a little jurisdictional test-drive in the Amaranth case. 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.”
The MFA’s Gaine says he is confident the CFTC will maintain its exclusive jurisdiction. Meanwhile, Lukken — the runner-turned-marathoner — says he is more than ready to go the distance.
