Leaders of the Securities and Exchange Commission and the Commodity Futures Trading Commission have pledged to build a stronger working relationship between their two agencies, in the face of ever-more blurry lines between securities, commodities, and futures.

An agreement signed last week establishes a permanent regulatory liaison between the two, provides for enhanced information sharing, and sets out principles governing the review of new derivative securities. The Memorandum of Understanding establishes a framework to facilitate discussions and coordination on other areas of joint interest, such as portfolio margining, foreign security index products, and the oversight of firms registered with both agencies. Under the agreement, the SEC and CFTC staffs will meet formally every quarter.

“There should not be counterproductive turf wars over the jurisdiction of each agency,” SEC Chairman Christopher Cox said during a press conference. “Keeping up with innovations demands nothing less than a unified approach.”

The CFTC regulates future-related products, while the SEC regulates equities-related products. The advent of new financial products that straddle both realms, however, has raised questions about how best to regulate such instruments.


The two agencies previously signed an MOU in 2004 regarding their joint oversight of, and sharing of information on, security futures products under the Commodity Futures Modernization Act of 2000. CFTC Acting Chairman Walter Lukken said the new agreement will “create regulatory synergies between the agencies for the benefit of the public.”

“A debate rages over whether these products are more like securities or more like futures,” says Michael Greenberger, a law professor at the University of Maryland who formerly served as director of the Division of Trading and Markets at the CFTC. He describes the pact as “an attempt by both agencies to get ahead of what’s coming down the road in the next few months.”


Greenberger expects to see Congressional hearings on collateralized debt obligations and other instruments he says are at the heart of the sub-prime mortgage meltdown, “to look at why neither agency did anything to deal with this problem.”

“These instruments have been allowed to grow exponentially in a very damaging way without any meaningful entry in the regulatory field by either the CTFC or the SEC,” Greenberger says. “My own view is that this is a cover for [the agencies] to enter the field collectively to avoid a dispute over whether these products are securities or futures and to begin to do something about it.”

Greenberger says calls to merge the two agencies will continue to increase and “the MOU will be an argument for heading in that direction.”

Views are split on whether the two agencies should be combined. It is a long-debated idea revived recently by a Treasury Department review of financial services regulation. A merger would require approval by Congress.

SEC Proposes Rule to Curb Naked Short Selling

Investment groups that engage in the illegal practice of “naked” short selling may soon be required to cover up.

The SEC recently proposed tougher rules to curb the much-maligned practice, which can leave corporate executives furious as their stock price falls. Short sales are when a seller borrows stock from someone else and sells it, betting the price will soon fall. When it does, the seller buys back the stock on the cheap, returns the shares to the original owner, and pockets the profit. Such transactions are perfectly legal.

Naked shorting, however, is when the seller doesn’t borrow the securities before selling them to a buyer. Abuses occur when sellers intentionally fail to deliver securities to the buyer to manipulate the price of a stock or to avoid the cost of borrowing shares. The SEC says it received more than 400 investor complaints related to naked short selling in the last year.

At its March 4 open meeting, the SEC voted to propose a new Rule 10b-21, which would highlight the specific liability of parties who deceive others, such as broker-dealers and purchasers, about their intention or ability to deliver securities in time for settlement and their failure to deliver securities by the settlement date. The SEC noted that a finding of scienter—intent to deceive—would be required to establish a violation under the rule.


Short selling regulations “need teeth, and this recommendation is aimed at providing them,” Chairman Christopher Cox said at the meeting. “Our experience has shown that [short selling rules] can’t be effective without enforcement.”

The SEC adopted Regulation SHO in 2004 to reduce potential failures to deliver, but such failures to deliver on short sales continued even after the SEC amended the rule last year. Erik Sirri, director of the SEC’s Division of Trading and Markets, said the proposal “puts market participants on notice that the Commission will continue targeting abuses in this area.”


Michael Trocchio of the law firm Bingham McCutchen and formerly special counsel in the SEC’s Division of Market Regulation notes that this is the SEC’s first effort to get a handle on failures to deliver via a rule that applies to customers, rather than broker-dealers.

The proposed rule would bar misrepresenting the quantity of shares the seller owned or could deliver; never actually attempting to borrow the shares; and claiming to be long on shares but actually not being long, at a time when the seller knows that it could not deliver the shares, Trocchio wrote in a recent legal bulletin.

James Angel, an associate finance professor at Georgetown University, says the SEC proposal won’t fix the underlying problem of naked shorting. “Until they fix the economic incentive to fail, people will fail [to deliver shares] anyway they can,” he says. “What we need is massive overhaul of our regulatory architecture.”

The text of the proposing release will be posted to the SEC Website as soon as possible. Comments are due 60 days after publication of the proposed rule in the Federal Register.

Meanwhile, the SEC has started publishing data on failures to deliver on its Website. That data will be updated quarterly. For links to that information and other related resources, see box at right.