Continuing Cluelessness
The final Rule prohibits any person, directly or indirectly, in connection with the purchase or sale of crude oil, gasoline, or petroleum distillates at wholesale, from (a) knowingly engaging in any act, practice, or course of business – including the making of any untrue statement of material fact – that operates or would operate as a fraud or deceit upon any person, or (b) intentionally failing to state a material fact that under the circumstances renders a statement made by such person misleading, provided that such omission distorts or is likely to distort market conditions for any such product.
The rule, and the enabling legislation, are patterned on the anti-manipulation provisions of the securities laws, rather than the commodity laws. And therein lies a problem, and renders the rule another monument to Congressional cluelessness on commodity market manipulation.
The emphasis on “fraud and deceit” makes some sense in securities markets. Securities values are information-driven, and hence manipulative schemes in such markets frequently rely on fraud and deceit to distort investors’ information sets, and thereby distort securities values.
Things are quite different in commodity markets. Although some manipulative schemes do rely on making untrue statements (e.g., false price reporting), by far the most important type of manipulation in commodity markets–including oil markets–involves the exercise of market power. It is nigh on to impossible to wrench the concept of “fraud and deceit” to cover genuinely manipulative exercises of market power in the oil markets. So, one of two things will happen. Either the rule will prove completely useless, because it does not touch the most troublesome form of conduct in commodity markets; or the FTC will play legal Twister to try to interpret a rule written to attack information-based manipulations in order to take action against market power manipulations.
I would bet that the latter alternative is the more likely outcome, for a several reasons. First, it is in the nature of regulator agencies to extend their power as far as possible, and stretch the rules to the breaking point to do that. Second, the FTC will be under pressure from Congress to act in the event somebody does try to execute a market power manipulation.
I spoke with a group of FTC staffers while the rule was being drafted. It was discouraging in the extreme to hear, that when I told them that the rule did not touch the most important form of manipulative conduct in commodity markets, that they were completely unaware that there was such a thing as market power manipulation. I participated in a workshop on the rule that the Commission held in November, and hammered home the issues of market power manipulation. But to no avail. As stated in the final rule:
Some commenters argued that the final Rule should extend to conduct such as speculative activity or the unilateral exercise of market power, because in their view such conduct is inherently manipulative. See, e.g., CFA at 8 (arguing that the Commission “could have considered the exercise of market power and excessive speculation as manipulation” because they “have no economic justification”); Greenberger at 1 (opining that the proposed Rule could offer a tough enforcement mechanism against speculative activity); Senator Cantwell at 2-3 (asserting that Congress intended for the FTC’s rule to reach a broad range of conduct, including the withholding of supply); Pirrong, NPRM, at 2 (arguing that the proposed Rule should not focus on fraud or deceit, but rather on the exercise of market power). However, the rulemaking record does not support extending the final Rule to cover such conduct, except to the extent that the practices used are part of a course of conduct that otherwise violates the final Rule.
Whatever that means. Translation: we had already released a Notice of Proposed Rulemaking that was totally silent on the issue of market power manipulation, so the train had already left the station and we weren’t about to look like fools and start over.
Actually, the FTC doesn’t bear the primary culpability. Congress is the one that put the train on the wrong track. It wrote the “fraud and deceit language” in the statute. It was the one that had no clue about what manipulation in a commodity market really involves.
Sadly, it’s not the first time that Congress made the same mistake. The law giving FERC anti-manipulation powers does as well, and as a result, FERC’s rule is also fundamentally flawed.
The Congressional cluelessness on all things derivative does not stop with manipulation. It is pervasive. It is on display daily in the myriad efforts to completely reshape derivatives regulation. The ACES (Waxman-Markey) climate change bill contains several sections that would take derivatives regulation back to the days of rumble seats and the Charleston. Other regulatory proposals bouncing around Capitol Hill would do the same.
What’s their motto? “Today we screw up the energy markets! Tomorrow, the world!”? It would fit.
