THE CHICAGO COMMODITIES PROBE : The Regulators : Congress Wants to Know: Were Overseers Lax?

The burgeoning scandal on the Chicago futures exchanges will cause Congress to take an intensive look at the Commodity Futures Trading Commission, the agency that regulates agricultural and financial contracts with a gentle government hand.

By coincidence, this is the year Congress must renew the commission’s charter, and the legislators will press the regulators with questions about combatting fraud.

The fresh attention to the CFTC is likely to renew a debate over whether the agency is lax in its oversight of the nation’s commodity exchanges. The agency has long been criticized for being a lax regulator and too deferential to the wishes of the powerful and fiercely independent Chicago commodity exchanges.

“Congress has a responsibility to the agriculture community, investors and the public to ensure the integrity of the futures trading process,” Rep. E. (Kika) de la Garza (D-Tex.), chairman of the House Agriculture Committee, said Thursday.

He asked for an immediate briefing by the Justice Department and the FBI concerning revelations of a two-year investigation of commodity brokers and traders, with preliminary allegations of widespread fraud against investors.

FBI agents reportedly posed as commodities traders and secretly recorded hundreds of conversations in which brokers and traders discussed cheating their customers. The techniques allegedly included rigged trades, with prices agreed upon before the traders entered the pit where buy and sell orders are shouted out. The false prices could have cheated customers out of millions of dollars because they might have been charged more than the actual market price when buying or received less than the true price when selling.

“We want to do nothing that impedes the investigations of alleged criminal fraud in commodities trading,” De la Garza said, “but it is imperative that committee members have the maximum amount of information available as we begin to consider” the renewal of the CFTC authorization.

CFTC officials would neither confirm nor deny the investigation on Thursday. “We have extensively worked with U.S. attorneys in criminal investigations before, in New York, Chicago, Philadelphia, and Boston,” said a commission spokesman.

Sen. Patrick Leahy (D-Vt.), chairman of the Senate Agriculture Committee, said Thursday he was “very concerned” about the reports of widespread fraud.

“We must ask whether retail customers have been cheated on a large scale; if so, this would raise serious questions about the way our futures markets are operating,” Leahy said.

“It is obviously too early to comment substantively, but we will undertake a careful review to determine what has happened and what changes, if any, might be called for in the regulatory system,” he said.

The current fraud investigation differs from the most publicized controversies over Chicago’s commodities market. While there have always been critics who argued that average investors were easy prey for sharp traders in Chicago and unscrupulous brokers throughout the United States, national debate focused on whether speculation in the futures market could exacerbate swings in the stock market and whether the commodities markets could be manipulated.

Critics seized on two events in this decade as evidence of the futures markets’ failings and regulatory weakness: manipulation of the silver market in 1980 by the Hunt brothers of Texas, which ended in a market collapse and severe losses for major financial firms that financed the billionaire speculators, and the October, 1987, crash in the stock market--in which futures contracts tied to the performance of the stock market were initially blamed for helping to create a market “meltdown.” While some reports in the wake of the crash criticized the futures markets, others found Chicago’s trading pits blameless.

Price Protection

The original mission of CFTC, which is based in Washington, was linked to agriculture because most traditional futures activity dealt with commodities, such as corn, wheat and pork bellies.

The futures markets are used by farmers and food producers seeking to protect themselves against the vagaries of prices caused by unpredictable weather or crop failures.

Contracts covering specific amounts of a commodity for delivery at a specific price at some future date are bought and sold on futures markets. Farmers get a guaranteed price for what they sell and food processors get a guaranteed price for what they buy--leaving commodities traders and average investors to do the speculating on where prices are headed.

Because the activity dealt with agricultural goods, the futures business was regulated first by the Agriculture Department, and since 1975, by the CFTC, which oversees the futures industry with general supervision.

But the day-to-day enforcement of the rules is carried out by the Chicago Board of Trade and the Chicago Mercantile Exchanges themselves. They look for violations of rules and discipline members. The industry depends heavily on self-regulation.

The exchanges’ business, and the potential for scandal, exploded in the past 10 years with the development of new contracts far removed from the farm. Investors can bet on the movement in the price of U.S. Treasury bonds or the fluctuations of the Standard & Poor’s bundle of stocks, as well as other financial indicators.

Wide swings in the futures markets played an important role in the stock market hysteria of October, 1987, which saw the biggest stock market collapse in history. However, Wendy Gramm, chairwoman of the CFTC, said the market system worked well and that she opposed any changes in regulation.

She was supported by both Congressional agriculture committees, which strongly opposed suggestions that the Securities and Exchange Commission be given regulatory authority over the futures exchanges. Members of the agriculture committees didn’t want to cede any jurisdiction to other committees, which regulate the SEC.

SEC Chairman David Ruder said financial futures contracts should be regulated by his agency.

If the current scandal is somehow linked to lax enforcement by the CFTC, or to some regulatory loophole, members of Congress may push again for expanded SEC powers. If the scandal is one of fraud, the result is likely to be a beefed-up CFTC enforcement staff rather than any diminution of the agency’s role.