CFTC rule requires further scrutiny

Jan 13, 2013 @ 12:01 am

Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, speaks at SIFMA's annual meeting in New York on Oct. 23.
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Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, speaks at SIFMA's annual meeting in New York on Oct. 23. (Bloomberg)

Whatever is in the best interests of investors is best for the financial services industry. For that reason, a new Commodity Futures Trading Commission rule to harmonize certain CFTC and SEC mandates that apply to mutual funds investing in commodities requires further scrutiny.

The rule requires mutual funds and their investment advisers to register with the CFTC if they trade commodities — including futures, swaps and options — above certain thresholds. The rule triggers record-keeping requirements, disclosure obligations and other responsibilities.

Industry experts and several industry trade groups have argued that the rule is redundant because the Securities and Exchange Commission already oversees mutual funds. What's more, concerns have been raised that the rule eventually will lead to higher costs for investors.

Some have argued that the CFTC failed to weigh the costs and benefits of the rules properly before finalizing them.

To that point, two industry trade groups, the Investment Company Institute and the U.S. Chamber of Commerce, last month filed an appeal with the U.S. Court of Appeals for the District of Columbia Circuit after a U.S. District Court upheld the registration rule, known as Rule 4.5. On Jan. 3, the two organizations filed an emergency motion to expedite their appeal.

“The District Court's decision fell far short of well-established D.C. Circuit precedent requiring agencies to adequately measure the costs imposed by capital markets regulations on businesses, investors and the economy as a whole, and to weigh them against the desired benefits,” said David Hirschmann, president and chief executive of the chamber's Center for Capital Markets Competitiveness. “Nothing in the district court's decision changes the fact that the CFTC did not adequately consider alternative approaches to its flawed and overly broad approach, which will only inject more confusion into our capital markets without offering any clear benefits to investors.”

CFTC officials declined to comment on the appeal.

“We brought this challenge because the CFTC failed to justify the regulatory excess and added costs of its amendments to Rule 4.5, which would impose that agency's regulatory regime atop the comprehensive regulation already applied to registered funds by the Securities and Exchange Commission,” said ICI president and chief executive Paul Schott Stevens. “We believe the District Court decision is deeply flawed and will clearly harm the many shareholders of registered funds that will bear the costs of overlapping regulation by two agencies.”

We respect the CFTC's authority in the regulation of commodities futures and swaps, and know that the regulator looks to uphold its mission to protect market users and the public from fraud, manipulation and abusive practices. However, Rule 4.5 appears to be an overreach by the agency into the regulation of mutual funds, which already are overseen by the SEC.

The CFTC approved the rule last February by a 4-1 vote. At that time, Jill E. Sommers, one of the regulator's commissioners, dissented, saying that the CFTC failed to show that the benefits of the rule outweighed the cost to the industry.

Ms. Sommers said in her dissenting statement that the CFTC failed to explain why the extensive information reporting it will now require of mutual funds is justified for systemic-risk purposes. She added that the rule's cost-benefit analysis was “sorely lacking.”

The CFTC rule undoubtedly will impose significant compliance costs on investment advisers, and those added costs will be passed along to the investor. And it has been argued that the additional disclosure requirements that will be imposed by the rule will result in lengthy and confusing prospectus disclosures for fund shareholders.

This flies in the face of the SEC's focus in recent years on making a mutual fund prospectus easier — not harder — to read.

Finally, this additional regulation likely will result in fewer choices for mutual fund investors. As a result, advisers may be forced to limit their commodities investments for their clients or look to gain exposure to various commodities for a diversified investment portfolio through more costly, and potentially more risky, means.

None of these choices is in the best interests of the investor.

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