Sept. 3 (Bloomberg) -- The heads of the Securities and Exchange Commission and Commodity Futures Trading Commission agreed to sharpen margin requirements, insider-trading rules and approvals for financial instruments to fight manipulation in the $592 trillion over-the-counter derivatives market. The agencies will seek to close gaps in oversight, eliminate duplicative rules that allow for “regulatory arbitrage” and bring consistency to the supervision of similar products, firms and markets, CFTC Chairman Gary Gensler said today at a joint meeting of the two agencies in Washington. “It’s important that we at the CFTC and SEC all check turf at the door and think of what’s best for the American public, what’s best for the markets,” Gensler said. The agencies are hosting the second of two hearings examining ways to combine or coordinate some SEC and CFTC regulations governing derivatives that either overlap or leave gaps in oversight. The disparities in oversight have been exploited by foreign exchange scam artists, National Futures Association Chief Executive Officer Daniel Roth said. “We are aware of dozens of completely unregulated firms hawking these products to retail customers, and we have received complaints from customers who have lost their life savings to these fraudsters,” Roth said in prepared testimony. “I am not concerned when multiple regulators have jurisdiction, I am much more concerned when no regulator has clear jurisdiction” as is the case with foreign-exchange futures contracts where the CFTC’s authority is unclear, Roth said. The Best System Gensler also said there is a need to create uniform bankruptcy regimes and to deal with market structure and surveillance. He and SEC Chairman Mary Schapiro have been given until Sept. 30 by President Barack Obama to resolve differences, a deadline Gensler said may slip. The SEC uses a rules-based approach to regulate equities and equity-linked products, including stock options used by both small and large investors. The CFTC, using a principles-based approach, oversees commodity futures, which is dominated by institutional investors. Futures contracts and stock options are two of many different types of derivatives contracts used to hedge risk. “Public input will help inform the SEC and CFTC on where harmonization may be needed and how it may be achieved, where potential gaps exist and how they should be addressed, and where there may be potential overlap,” Schapiro said today. Insider Trading Fraud in the derivatives market may be lessened if the CFTC had SEC-like powers to enforce insider trading and market manipulation cases, Columbia University securities law professor John Coffee said in prepared remarks to be delivered today. The CFTC “needs legislation prohibiting insider trading on commodities and transactions within its jurisdiction” and should be able to impose financial penalties in cases of violations. The SEC “is armed with a greater enforcement club” and can impose penalties without going to court, Coffee said. “The bottom line here is that it would make sense to harmonize these penalty levels so that both agencies had equivalent powers,” he said. Mark Young, testifying for the Futures Industry Association yesterday, said applying insider trading laws to the futures markets may prevent corporations from using nonpublic information to hedge investments in commodities like oil or grains, which is currently allowed under trading laws. “There are people who are using the futures markets to hedge price risk based on information they have from and about their individual businesses and there’s nothing in the Commodity Exchange Act that requires disclosure,” Young said. “If you apply insider trading concepts to the futures markets, our concern is that you’re going to take those people and treat them as felons and I think that’s wrong.” Co-Location Investigation The 18 panelists that testified yesterday overwhelmingly backed the need for “cross margining,” which would allow firms to share margin accounts for both stock options and futures. Though the products are economically similar, they carry different margin and other requirements. Cross margining would require the SEC and CFTC to align their bankruptcy, margin and segregation rules, which “are three sets of rules that need to be addressed, which I’m glad to answer,” Gensler said. Separately, Gensler said the CFTC is investigating whether some Wall Street firms are given an unfair edge by locating their computers servers close to exchanges, a practice called co-location. “Some of the major Wall Street firms have put their computers next door to the computers of the exchanges because physics dictates how fast electronic messages move at the speed of light,” Gensler said yesterday. He said the CFTC is in an “investigative and learning stage” right now and has “asked the exchanges some very detailed questions” about their co- location policies. Flash Orders Lawmakers including Senator Ted Kaufman, a Delaware Democrat, have pressured regulators to crack down on practices that may give certain investors an unfair edge over others. Kaufman listed co-location alongside flash orders and dark pools as market practices regulators should investigate. In a flash order, an exchange allows brokerages, market makers and dark-pool participants a fraction of a second to see the order before routing it to rival platforms. In a dark pool, trades are matched without posting quotes on public exchanges. “The issue is that there is fair and equal access, that there isn’t some way some organizations are getting an advantage, either by paying for it or otherwise, over other market participants,” Gensler told reporters after yesterday’s hearing. Gensler said he wants to know whether certain fees charged for technology services are true costs or reflect payments to get preferential treatment. “There’s a difference, frankly, between a technology service and a price to be at the head of the line,” Gensler said. To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Joshua Gallu in Washington at jgallu@bloomberg.net.

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