A. Requirements for a Legislative Framework

1. General Principles for Markets that are Competitive, Fair, and Free From Fraud and Manipulation

The process of working through important issues with the CFTC led the Commission staff to identify requirements for legislation to permit the trading of single stock futures. Contrary to what some have suggested, this is not at base a turf battle between the futures and options markets and the agencies that regulate them. There are fundamental issues of market integrity and investor protection at stake. For this reason, we should move forward in a reasoned and principled manner, as we consider how to permit an entirely new product to trade. If legislation is crafted correctly, markets will compete and regulators will cooperate. I think it would be useful to review the components we believe are critical for an appropriate legislative framework.

Shared Jurisdiction

First, single stock futures are undeniably a substitute for stocks and stock options, and are fully expected to be a retail product. Thus, the framework must recognize the legitimate interests of both the SEC and the CFTC in regulating these products. Single stock futures possess attributes of both securities and futures contracts. The nature of single stock futures makes joint regulation appropriate, and exclusive jurisdiction ill-advised. Shared jurisdiction and joint regulation entail both recognizing each agency as best qualified to apply the key components of the laws it administers, and coordinating the agencies' efforts to ensure efficient market regulation that is not duplicative or overly burdensome.

At the practical level, this means ensuring that both agencies have the authority to carry out core functions, and that both encounter no jurisdictional barriers in the suppression of fraud and manipulation. Yet, at the same time, mechanisms should be devised to coordinate on certain costly issues so that the traditional regulator takes the lead.

Encourage Fair Competition

Second, the framework must encourage fair competition among markets. We do not want a framework that lets differences in regulation determine winners and losers. Any legislation should allow both securities and futures markets to enter the competitive fray, but should not give any type of market an artificial competitive advantage. This involves not only stating that some specific regulations should be harmonized, but providing a mechanism for the CFTC and SEC to do so on an ongoing basis as the markets evolve.

For example, mechanisms must be put in place so that both the SEC and the CFTC can act to harmonize the margin requirements across markets on an ongoing basis. Otherwise, the market with the more lenient margin requirements will have an artificial competitive edge. Markets should not compete for customers based on how much leverage they are allowed to provide those investors. Competition should be based on better products, services, and prices - not on regulatory differences.

The legislation also should require coordinated clearing of single stock futures so that a future purchased on one exchange could be offset on another exchange that trades the same type of future. This would allow the multiple listing of the same single stock future product on multiple exchanges and promote price competition in ways that we have recently seen narrow spreads in the options markets. Coordinated clearing also makes it more viable for new markets to enter the competitive arena over time. Without coordinated clearing, new markets will not be able easily to offer the same products as competitors.

Protect Investors

Third, the framework must acknowledge that single stock futures will be retail products. While extremely complex derivative products might not attract retail customers, a simple future on a share of a blue chip stock is the type of product that is sure to do so. Accordingly, legislation must maintain the SEC's ability to protect investors and to maintain integrity of the markets on which they trade. For this reason, the SEC should have clear and direct authority over the markets and market participants that trade single stock futures.

I think it is important to explore a few examples of what might happen, if the SEC does not have such authority.

In the securities markets, recommendations that brokers make to investors are governed by the suitability rules of self-regulatory organizations subject to SEC oversight. If the securities law principle of suitability is not applied to single stock futures, a broker could recommend such a product to a retiree with no liability under the securities laws. The customer protection regime is quite different under the futures laws. Investors receive a one-time disclosure document informing them that they can lose money on futures. What are the implications of these differences? I believe they are quite significant. Consider that in the vast majority of cases the same broker who sells the retiree securities will also be licensed to sell single stock futures. Does anyone believe that investors will understand that the protections they enjoy when they purchase one product from their broker will not also apply to the other? And worse yet, could brokers have an incentive to offer the riskier single stock futures to investors if they could do so without the suitability responsibilities that attach to the sale of securities? I see no public policy reason to create a framework with such an inexplicable disparity in investor protections.

Next, consider a corporate insider who learns that his company is about to receive an unsolicited bid to be taken over. The insider buys a substantial amount of single stock futures on a futures exchange and earns huge profits on the transaction, which he plans to send to an offshore bank. This case involves insider trading that takes money out of the pockets of investors who did not have this information. This is exactly the type of situation that the Commission needs its full authority to address. Without direct authority over the futures exchange or a requirement for insider reporting, the SEC may have difficulty ever learning of the futures purchase by the insider. Even if the SEC were notified of the suspicious futures transactions, if we have to seek CFTC permission to proceed with an investigation or enforcement action, the SEC loses precious time and could likely lose the ability to freeze the insider's U.S. assets. Such activities could destroy years of Commission efforts to protect investors from insider trading abuses. Indeed, I think back to some of our most celebrated insider trading cases. Would we want a system that would risk the successful prosecution of such cases merely because they involved single stock futures?

Investors also currently rely on the Commission to protect them from unscrupulous, or even just sloppy, practices by investment advisers and mutual fund managers. A bill should not introduce single stock futures into the mix of investment opportunities that an investment adviser may recommend to his or her clients or that a portfolio manager may purchase for the mutual fund he or she manages without regulation by the SEC. This would leave investors in funds consisting of single stock futures without the same protections that investors in mutual funds have enjoyed since 1940.

These are only a few examples, but I hope they illustrate why the investor protections contained in the securities laws should be extended to single stock and narrow-based stock index futures. Please recognize that the SEC's instruments for investor protection are interlinked. Enforcement actions coupled with inspections and the ability to promulgate new regulations, when necessary, are essential ingredients of ensuring the integrity of America's markets. Direct access to audit trails, coordinated market surveillance, inspection authority, as well as suitability and customer protection regulation, are all necessary to the SEC's ability to effectively regulate and protect investors. Although the SEC actively pursues those who violate the securities laws, much of our success results from preventing problems before a single investor is harmed.

The SEC should not be required to seek the permission of any other entity to protect investors. The SEC has many decades of experience and legal precedent in protecting the public - expertise that should be carried over to equity substitutes such as single stock futures. Our securities markets are second to none because of the investor confidence that has flourished under this regulatory framework. It would be extremely unwise to move ahead with legislation that lacks the elements necessary to ensure the market integrity, suitability, and customer protections that investors have come to expect under the securities laws.

Do Not Harm Existing Markets

Fourth, the framework must avoid any harm to existing capital markets. In lifting the ban on single stock futures and reopening jurisdictional issues, legislative changes should not take away existing SEC authority over financial products. For instance, the Shad-Johnson Accord clarified the SEC's jurisdiction over security options, and that jurisdiction should not be diminished in any way. Nor should legislation eliminate the SEC's existing role in evaluating stock indexes for susceptibility to manipulation and compliance with appropriate standards that assure they will not become a surrogate for single stocks. Given the CFTC's exclusive jurisdiction over such futures, the standard put forward in any bill and the SEC's role in applying it must be sufficient to deter insider trading through index futures. Investors have strong expectations about the integrity of markets that the SEC regulates, and the resultant investor confidence fuels the success of those markets. Accordingly, legislation should not eliminate any existing SEC oversight of securities and related markets.

Moreover, we cannot allow market integrity issues in new markets to migrate to existing capital markets. Because problems in one market, at times, may be identified and understood only by reference to another market, legislation must provide for coordinated surveillance of all markets.

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Adherence to these principles will leave U.S. markets for these products better positioned to compete against their foreign counterparts. When U.S. markets are forced to compete against each other for investors' business and to maintain the integrity that promotes investor confidence and attracts additional business, those markets should be leaders in the international arena. As markets around the world compete for customers and capital, one overriding principle will serve as our competitive advantage: the quality of our markets.

2.Discussion Draft

The Commission staff prepared a discussion draft that incorporates these legislative goals into amendments to the federal securities laws and the Commodity Exchange Act. Unfortunately, given the pendency of this bill as well as bills in the House, the CFTC has not apparently had a chance to review or comment on our draft in detail. In addition to the extension of securities law protections to covered products, much of the proposal is devoted to ensuring that those laws do not unnecessarily burden the markets and intermediaries that trade those products. We continue to look forward to comments from the CFTC and to having a dialogue with your Committees on our suggested approach. We are setting out below a brief summary of the principal elements of that plan - a plan that presumes shared SEC and CFTC jurisdiction over these products.

First, this draft framework defines single and narrow-based stock index futures as securities. This triggers SEC oversight and the application of the securities laws. Then, having brought the markets and intermediaries that trade these products under the securities laws, we next focus on detailed regulatory relief for some of these intermediaries and markets as a means to avoid unnecessary or duplicative regulation.

For example, we exempt from registration those floor brokers on designated contract markets already registered with the CFTC. We also create a simple process of notice registration with the Commission for certain markets and intermediaries already registered with the CFTC. And, such markets and intermediaries would have to comply only with securities law provisions that are considered "core." We clearly exempt these markets and intermediaries from the numerous non-core provisions of the securities laws, where the CEA and CFTC regulation sufficiently addresses the same public policy concerns.

For the core provisions of the securities laws that would still apply to these entities, we provide innovative ways to relieve their regulatory burdens and to coordinate our regulatory efforts with the CFTC. For example, for many of the proposed rule changes that CFTC-regulated markets would submit to the SEC, we provided for immediate effectiveness of such changes and a limited scope of review. Where appropriate, in areas such as examinations, we recognize that the CFTC should be the lead regulator for such CFTC-regulated entities and limit our activities accordingly.

In addition to the detailed regulatory relief and coordination provisions, we provide minimum requirements to be incorporated into listing standards for these products. Such requirements, along with provisions related to coordinated clearing, are aimed at promoting market integrity and intermarket competition.

Finally, we incorporate these products into other relevant securities laws, such as the Securities Act of 1933, the Investment Company Act, and the Investment Advisers Act. In doing so, we avoid unnecessarily burdensome regulation under these acts as well.

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This discussion draft shows that the protections of the securities laws can be extended to single stock and narrow-based stock index futures while still permitting the efficient operation of our markets. Our discussion draft would achieve the goals of creating a new market for single stock and stock index futures that is competitive, fair, and free from fraud and manipulation. U.S. investors deserve nothing less. U.S. capital markets provide the lifeblood of American business and are the place where American families invest their hard-earned dollars with hopes of earning returns that will provide for everything from their children's educations to their retirements. We cannot afford to put these markets at risk.

B. Comparison to S. 2697

Crafting our plan was not easy. Therefore, I appreciate your efforts in drafting the bill. Moreover, I am heartened by the bill's attempt to recognize some of the principles that the Commission feels are so important in this area. Unfortunately, as written, the bill ultimately does not vindicate those principles and achieve the goals of the legislative framework previously outlined. The bill does not sufficiently extend the protections of the securities laws to single stock and narrow-based stock index futures. The Commission therefore could not support the legislation in its current form.

As you continue to revise your legislation, I would hope your bill ultimately can answer questions, such as the following, in the affirmative:

Does the bill clarify in both the CEA and the securities laws that the SEC has full authority over single stock and narrow-based stock index futures and that the securities laws protections apply to these products?

Does the bill provide for expedited registration of the intermediaries and exchanges that trade these products with both the SEC and the CFTC?

Does the bill provide real mechanisms for both the SEC and the CFTC to ensure that the relevant securities and futures regulations, such as those related to margin, remain harmonized on an ongoing basis?

Are there provisions for coordinated clearing of these products?

Are there provisions that enable the CFTC and SEC to work together to foster competition in the markets for these products?

Will both the CFTC and SEC be able to effectively prosecute frauds involving these products?

The staff and I look forward to providing additional technical assistance to help you reach the right answers for our markets.

III. Conclusion

Once again, the Commission appreciates the efforts that the Committees have made in bringing derivatives issues to the forefront. We believe the regulatory provisions that we have set forth can support the work of the Committees in their efforts to repeal the ban on single stock futures and eliminate uncertainty for the OTC derivatives markets in a way that fosters competition, bolsters market integrity, and ensures that no harm befalls America's capital markets or investors. Only then can the promise of these products to American investors be fulfilled. And only then will U.S. markets, tested under the rigors of true competition, be ready to vie effectively with foreign markets.

The Commission appreciates the Committees' efforts with respect to derivatives issues. Just as derivatives products themselves can be complex, so too are the issues that surround these products. Having regulated securities derivative products for decades, the Commission welcomes the opportunity to actively participate in the dialogue about derivative products that your bill will engender. We look forward to sharing our views with your Committees, the Working Group, market participants, and other legislators as changes continue to be considered.

Thank you.