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August 31, 2000

Stock Futures Bill Moves to Senate

By William Hoffman

Legislation to reauthorize and reform the Commodities Exchange Act - a major step toward eliminating the ban on single-stock futures trading - has moved to the floor of the U.S. Senate.

But there are fears over the regulatory structure that a new law would bring.

That structure would control the relationships between options, equities, and futures trading.

"[That's] the only part of [S. 2697, the Commodity Futures Modernization Act] that we are concerned with," said Lynne Howard-Reed, a Chicago Board Options Exchange (CBOE) spokesperson.

Concerns Highlighted

The CBOE raised its concern when its chairman and chief executive, William J. Brodsky, testified before the House Banking, Housing and Urban Affairs Committee in May.

Brodsky opposed allowing single-stock futures trading. He described it as "a direct economic substitute for stock" unless it is subject to equivalent securities regulation.

Currently, single stock futures are subject to what equities and options traders regard as a looser regime of commodities regulation.

The Chicago Mercantile Exchange (CME) has carried the torch for single-stock futures this year. Representatives of that exchange could not be reached for comment.

But Scott Gordon, chairman of the board of the CME, told Business Week in May, "We have all the necessary safeguards in place to be able to trade single-stock futures, and we see no reason why we should not be able to... The public interest would be served."

Trading at Work

Here's how single stock futures trading could work under the regulatory structure proposed by S. 2697:

A speculator sees a stock currently trading at $20 a share, which he believes will hit $30 in the next two months. He buys a futures contract for 1,000 shares, and posts $2,000 with a broker, who requires 10 percent margin.

If the stock meets the speculator's expectation, he makes $3,000.

But if the stock tanks, the speculator must put up more margin. His losses, as the stock declines, are potentially endless.

The problems with single-stock futures trading under the current bifurcated regulatory system are many, Brodsky testified before the House.

Equities and options are now supervised by the Securities and Exchange Commission, while commodities and futures are overseen by the Commodity Futures Trading Commission (CFTC). CFTC requires as little as five percent down to buy futures on margin, Brodsky noted, while the SEC requires 50 percent for securities.

Securities are charged a federal transaction fee, while futures and options on futures are not, Brodsky added.

Single stock futures are also not subject to the same market integrity and investor protection regulations on best execution, disclosure, sales practices, and insider trading as those applied to equities and options, he said.

Finally, stock futures customers are also taxed at the more favorable long-term capital gains tax rate, while all of the securities options customer's gain is taxed as ordinary income.

"A different federal tax treatment for economically equivalent instruments creates an intolerable tax arbitrage," Brodksy testified.

Brodsky wants equities, options, and futures subject to "equivalent regulation," preferably through a merger of the SEC and CFTC.

"We have said that if single-stock futures are allowed, we will trade them," Howard-Reed, the CBOE spokesman emphasized. "We are not opposed to single-stock future. We are opposed to the regulatory disparity."

No Agency Merger

But no agency merger is contemplated under S. 2697, said Christi Harlan, spokesperson for Senate Banking Committee Chairman Phil Gramm (R-Texas).

Rather, Harlan said Gramm is considering further regulatory relief for the equities markets, if Gramm's Competitive Market Supervision Act (S. 2107) passes the Senate.

That bill, currently awaiting a vote of the full Senate, encompasses long-awaited relief from Section 31 fees.

But Gramm won't move on additional regulatory reforms, Harlan said, unless S. 2107 passes the Senate. And she refused to discuss particular reforms Gramm might have in mind.