Evidence of Continued Uncertainty

Appendix III

The Shad-Johnson Jurisdictional Accord

governing futures trading did not mirror securities regulation in important

areas such as insider trading prohibitions, customer protections, floor

trading rules, and margin requirements. The former CFTC chairman said

that at the time the accord was negotiated, CFTC had been willing to

address these concerns but the two agencies could not reach agreement on

jurisdiction over the prohibited products.

Questions have remained about how to regulate products covered by the

Evidence of Continued

accord. In 1987, after the stock market crash, SEC and the New York Stock

Uncertainty

Exchange cited trading in stock index futures for exacerbating stock

volatility during the crash and threatening the future stability of the stock

market. As a result, SEC requested that Congress shift oversight

responsibility for stock index futures from CFTC to SEC. No action was

taken on this request; however, Congress granted oversight authority for

setting margins on stock index futures to the Federal Reserve under the

Futures Trading Practices Act of 1992.

In 1989, several stock exchanges introduced contracts, called index

participations, to provide investors with a relatively low-cost way to obtain

an index-equivalent portfolio. The courts subsequently ruled, in response

to a suit by Chicago futures exchanges, that the index participations were

futures contracts and thus could be offered only on CFTC-regulated

futures exchanges. As a result, these contracts ceased trading. The

American Stock Exchange subsequently developed a securities product

that offered investors a benefit similar to these contracts by providing

them an interest in the holdings of a trust.

The Futures Trading Practices Act of 1992 gave CFTC broad authority to

exempt swaps and other OTC derivatives from all CEA provisions except

section 2(a)(1)(B), which codified the accord. Because of their similarities

to exchange-traded futures, certain OTC derivatives faced the possibility of

falling within the judicially crafted definition of a futures contract. This

possibility posed a legal risk for such contracts because of the CEA

requirement that futures be traded on an exchange to be legal and, thus,

enforceable. CFTC's 1993 swaps exemption eliminated this legal risk for

qualifying contracts. However, the exemption did not eliminate the legal

risk for securities-based swaps, contracts whose returns are based on the

prices of securities or securities indexes, because these contracts might be

prohibited by or subject to CEA section 2(a)(1)(B).

According to market observers, if securities-based swaps were found to be

futures contracts, they could be in violation of section 2(a)(1)(B) and,

thus, be illegal and unenforceable. First, swaps on individual securities

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