Have you hedged today? The inevitable advent of consumer derivatives

Fordham Law Review

Volumn 67, Issue 6, 1999, Pages 3205-3260

  Jackson, Carolyn H ^a  

^a NONE

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EID: 0033423075     PISSN: 0015704X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (491)

1. Peter L. Bernstein, Against the Gods: The Remarkable Story of Risk 326 (1996).
2. See Robert M. McLaughlin, Over-the-Counter Derivative Products: A Guide to Business and Legal Risk Management and Documentation 1 (1998) (commenting on the forces that moved derivatives markets to the "forefront of the world economic scene"); Willa E. Gibson, Investors, Look Before You Leap: The Suitability Doctrine Is Not Suitable for OTC Derivatives Dealers, 29 Loy. Chi. L.J. 527, 530 (1998) (discussing derivatives, "predominant role in the financial markets"). Derivative transactions fall broadly into three segments: (1) privately negotiated derivatives between two arms-length participants; (2) derivatives traded on an organized exchange, i.e., futures; and (3) derivatives that are embedded in a capital raising security. The scope of this Note is limited to privately negotiated derivatives. For an overview of the segmentation of derivatives transactions into these three broad categories, see Christopher L. Culp Competitive Enter. Inst., A Primer on Derivatives: Their Mechanics, Uses, Risks, and Regulation, 3-30 (1995) [hereinafter Culp, Primer on Derivatives]. See also infra notes 41-84 and accompanying text (discussing the various derivative products within the three categories).
3. See Robert M. McLaughlin, Over-the-Counter Derivative Products: A Guide to Business and Legal Risk Management and Documentation 1 (1998) (commenting on the forces that moved derivatives markets to the "forefront of the world economic scene"); Willa E. Gibson, Investors, Look Before You Leap: The Suitability Doctrine Is Not Suitable for OTC Derivatives Dealers, 29 Loy. Chi. L.J. 527, 530 (1998) (discussing derivatives, "predominant role in the financial markets"). Derivative transactions fall broadly into three segments: (1) privately negotiated derivatives between two arms-length participants; (2) derivatives traded on an organized exchange, i.e., futures; and (3) derivatives that are embedded in a capital raising security. The scope of this Note is limited to privately negotiated derivatives. For an overview of the segmentation of derivatives transactions into these three broad categories, see Christopher L. Culp Competitive Enter. Inst., A Primer on Derivatives: Their Mechanics, Uses, Risks, and Regulation, 3-30 (1995) [hereinafter Culp, Primer on Derivatives]. See also infra notes 41-84 and accompanying text (discussing the various derivative products within the three categories).
4. See Robert M. McLaughlin, Over-the-Counter Derivative Products: A Guide to Business and Legal Risk Management and Documentation 1 (1998) (commenting on the forces that moved derivatives markets to the "forefront of the world economic scene"); Willa E. Gibson, Investors, Look Before You Leap: The Suitability Doctrine Is Not Suitable for OTC Derivatives Dealers, 29 Loy. Chi. L.J. 527, 530 (1998) (discussing derivatives, "predominant role in the financial markets"). Derivative transactions fall broadly into three segments: (1) privately negotiated derivatives between two arms-length participants; (2) derivatives traded on an organized exchange, i.e., futures; and (3) derivatives that are embedded in a capital raising security. The scope of this Note is limited to privately negotiated derivatives. For an overview of the segmentation of derivatives transactions into these three broad categories, see Christopher L. Culp Competitive Enter. Inst., A Primer on Derivatives: Their Mechanics, Uses, Risks, and Regulation, 3-30 (1995) [hereinafter Culp, Primer on Derivatives]. See also infra notes 41-84 and accompanying text (discussing the various derivative products within the three categories).
5. See Culp, Primer on Derivatives, supra note 2, at 40-42.
6. See id. at 81-82 (discussing the absence of "widows and orphans" in what is generally regarded as a wholesale market); Ronald H. Filler, Two-Tiered Regulation, Futures Industry, Feb./Mar. 1999, at 1, 21 (stating that retail comprises a "very small part" of the industry); Gibson, supra note 2, at 539 (categorizing derivatives players as either dealers, consisting of banks, securities firms and other financial institutions, and end-users, consisting of sophisticated institutions such as corporations and government entities).
7. See George Crawford & Bidyut Sen, Derivatives for Decision Makers 197-98 (1996).
8. See id.
9. See Culp, Primer on Derivatives, supra note 2, at 41. Derivatives enable firms to manage the risks of anticipated expansion by increasing the certainty of the firm's net cash flow. See id. Derivatives provide an efficient method for corporations to manage their interest rate and currency risk. See id.
10. See Culp, Primer on Derivatives, supra note 2, at 41. Derivatives enable firms to manage the risks of anticipated expansion by increasing the certainty of the firm's net cash flow. See id. Derivatives provide an efficient method for corporations to manage their interest rate and currency risk. See id.
11. See Culp, Primer on Derivatives, supra note 2, at 41. Derivatives enable firms to manage the risks of anticipated expansion by increasing the certainty of the firm's net cash flow. See id. Derivatives provide an efficient method for corporations to manage their interest rate and currency risk. See id.
12. See generally Christopher L. Culp, Functional and Institutional Interaction, Regulatory Uncertainty, and the Economics of Derivatives Regulation, in Derivatives Handbook: Risk Management and Control 458, 486-87 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1997) [hereinafter Culp, Functional and Institutional Interaction] (discussing the regulatory uncertainty for privately negotiated derivatives, as no bright line exclusions exist to definitively place the transactions outside of the regulatory jurisdiction of the securities or commodities laws). Culp asserts that both the regulators and even swap dealers themselves due to their own self-interest, actually promote this uncertainty. See id. at 486-87.
13. See generally Christopher L. Culp, Functional and Institutional Interaction, Regulatory Uncertainty, and the Economics of Derivatives Regulation, in Derivatives Handbook: Risk Management and Control 458, 486-87 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1997) [hereinafter Culp, Functional and Institutional Interaction] (discussing the regulatory uncertainty for privately negotiated derivatives, as no bright line exclusions exist to definitively place the transactions outside of the regulatory jurisdiction of the securities or commodities laws). Culp asserts that both the regulators and even swap dealers themselves due to their own self-interest, actually promote this uncertainty. See id. at 486-87.
14. See generally Christopher L. Culp, Functional and Institutional Interaction, Regulatory Uncertainty, and the Economics of Derivatives Regulation, in Derivatives Handbook: Risk Management and Control 458, 486-87 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1997) [hereinafter Culp, Functional and Institutional Interaction] (discussing the regulatory uncertainty for privately negotiated derivatives, as no bright line exclusions exist to definitively place the transactions outside of the regulatory jurisdiction of the securities or commodities laws). Culp asserts that both the regulators and even swap dealers themselves due to their own self-interest, actually promote this uncertainty. See id. at 486-87.
15. See id. at 481-86.
16. See infra Part III.B.2.
17. See Kenneth R. Kapner & John F. Marshall, The Swaps Handbook: Swaps and Related Risk Management Instruments 288-89 (1990). Commodity swaps are similar in structure to interest rate swaps. One counterparty to the swap makes payments at a fixed price for a commodity, in return for receiving payments at a variable price of the commodity. The transaction is cash settled, i.e., there is no exchange of the physical commodity. The Chase Manhattan Bank pioneered the first commodity swap in 1986. See id.; see also Tanya Styblo Beder, Equity Derivatives for Investors, in Advanced Strategies in Financial Risk Management 223, 223-39 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1993) (discussing the evolution and applications of equity swaps). In a common form of an equity swap, one counterparty makes future payments based on an equity index in exchange for receiving future payments in reference to another index, such as a fixed interest rate. See id. at 236-38.
18. See Kenneth R. Kapner & John F. Marshall, The Swaps Handbook: Swaps and Related Risk Management Instruments 288-89 (1990). Commodity swaps are similar in structure to interest rate swaps. One counterparty to the swap makes payments at a fixed price for a commodity, in return for receiving payments at a variable price of the commodity. The transaction is cash settled, i.e., there is no exchange of the physical commodity. The Chase Manhattan Bank pioneered the first commodity swap in 1986. See id.; see also Tanya Styblo Beder, Equity Derivatives for Investors, in Advanced Strategies in Financial Risk Management 223, 223-39 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1993) (discussing the evolution and applications of equity swaps). In a common form of an equity swap, one counterparty makes future payments based on an equity index in exchange for receiving future payments in reference to another index, such as a fixed interest rate. See id. at 236-38.
19. See Kenneth R. Kapner & John F. Marshall, The Swaps Handbook: Swaps and Related Risk Management Instruments 288-89 (1990). Commodity swaps are similar in structure to interest rate swaps. One counterparty to the swap makes payments at a fixed price for a commodity, in return for receiving payments at a variable price of the commodity. The transaction is cash settled, i.e., there is no exchange of the physical commodity. The Chase Manhattan Bank pioneered the first commodity swap in 1986. See id.; see also Tanya Styblo Beder, Equity Derivatives for Investors, in Advanced Strategies in Financial Risk Management 223, 223-39 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1993) (discussing the evolution and applications of equity swaps). In a common form of an equity swap, one counterparty makes future payments based on an equity index in exchange for receiving future payments in reference to another index, such as a fixed interest rate. See id. at 236-38.
20. See Kenneth R. Kapner & John F. Marshall, The Swaps Handbook: Swaps and Related Risk Management Instruments 288-89 (1990). Commodity swaps are similar in structure to interest rate swaps. One counterparty to the swap makes payments at a fixed price for a commodity, in return for receiving payments at a variable price of the commodity. The transaction is cash settled, i.e., there is no exchange of the physical commodity. The Chase Manhattan Bank pioneered the first commodity swap in 1986. See id.; see also Tanya Styblo Beder, Equity Derivatives for Investors, in Advanced Strategies in Financial Risk Management 223, 223-39 (Robert J. Schwartz & Clifford W. Smith, Jr. eds., 1993) (discussing the evolution and applications of equity swaps). In a common form of an equity swap, one counterparty makes future payments based on an equity index in exchange for receiving future payments in reference to another index, such as a fixed interest rate. See id. at 236-38.
21. See Crawford & Sen, supra note 5, at 198.
22. See Philip McBride Johnson, Relying on Consumer Protection Laws, Futures Industry, Feb./Mar. 1999, at 18, 20 (stating that, "The United States cannot risk losing its pre-eminence as a financial center simply to make work for the CFTC.").
23. See Satyajit Das, Swap Financing-Interest Rate and Currency Swaps, LTFX, FRAs, Caps, Floors and Collars: Structures, Pricing, Applications and Markets 17 (1989) [hereinafter Das, Swap Financing].
24. John Greenwald, The Secret Money Machine, Time, Apr. 11, 1994, at 28, 30. One reporter has admitted that a financial product, "if it's complex,. . . [is] apt to get the name [derivative]." Carol J. Loomis, Untangling the Derivatives Mess, Fortune, Mar. 20, 1995, at 50, 54.
25. John Greenwald, The Secret Money Machine, Time, Apr. 11, 1994, at 28, 30. One reporter has admitted that a financial product, "if it's complex,. . . [is] apt to get the name [derivative]." Carol J. Loomis, Untangling the Derivatives Mess, Fortune, Mar. 20, 1995, at 50, 54.
26. Henry T.C. Hu, Hedging Expectations: "Derivative Reality" and the Law and Finance of the Corporate Objective, 73 Tex. L. Rev. 985, 989 (1995) [hereinafter Hedging Expectations].
27. See Ravi E. Dattatreya et al., Interest Rate & Currency Swaps: The Markets, Products and Applications 12 (1994).
28. See id. at 1.
29. See Edward S. Adams & David E. Runkle, The Easy Case for Derivatives Use: Advocating a Corporate Fiduciary Duty to Use Derivatives, 41 Wm. & Mary L. Rev. (forthcoming 1999) (manuscript at 12, on file with the Fordham Law Review).
30. See id. (manuscript at 12).
31. See id. (manuscript at 12).
32. See Das, Swap Financing, supra note 14, at 31-32.
33. See id. at 216-21.
34. See id. at 33. The swap is a legal contract completely independent of the underlying borrowing agreements of Corporations A and B. The institutions that provided the original loans to Corporations A and B are not parties to the swap. Corporations A and B, despite entering into the swap agreement, continue to be obligated to their distinct institutional lender for the payment of the principal and interest. The lenders may even be unaware of the swap contract between Corporations A and B. See id.
35. See id. at 33. The swap is a legal contract completely independent of the underlying borrowing agreements of Corporations A and B. The institutions that provided the original loans to Corporations A and B are not parties to the swap. Corporations A and B, despite entering into the swap agreement, continue to be obligated to their distinct institutional lender for the payment of the principal and interest. The lenders may even be unaware of the swap contract between Corporations A and B. See id.
36. See Dattatreya, supra note 17, at 47.
37. See International Swaps and Derivatives Association, Inc., Summary of Market Survey Statistics: 1997 Year End. The survey reports that at the end of 1997, the notional principal amount of interest rate swaps outstanding was approximately $22 billion, in contrast to $1.8 billion of currency swaps. See id.
38. See Das, Swap Financing, supra note 14, at 5-6.
39. See id.
40. See Kapner & Marshall, supra note 11, at 6.
41. See Roberta Romano, A Thumbnail Sketch of Derivative Securities and Their Regulation, 55 Md. L. Rev. 1, 49 (1996).
42. See id.
43. See id.
44. See id.
45. See id.
46. See 1 Satyajit Das, Swaps & Financial Derivatives: The Global Reference to Products, Pricing, Applications and Markets 66 (2d ed. 1994) [hereinafter Das, Global Reference].
47. See id.
48. See id.
49. See Kapner & Marshall, supra note 11, at 281.
50. See Das, Global Reference, supra note 35, at 67.
51. See id.
52. See Martin Mayer, The Bankers: The Next Generation 289 (1997).
53. See Global Derivatives Study Group, Group of Thirty, Derivatives Practices and Principles 28 (1993); Adams & Runkle, supra note 19, at 4.
54. See Saul S. Cohen, The Challenge of Derivatives, 63 Fordham L. Rev. 1993, 2000-01 (1995); supra note 2.
55. See Global Derivatives Study Group, supra note 42, at 29.
56. See Cohen, supra note 43, at 1994.
57. See Global Derivatives Study Group, supra note 42, at 29-30.
58. See id. at 29.
59. See id. at 29-30.
60. See id. at 30.
61. See Adams & Runkle, supra note 19, (manuscript at 6).
62. See Global Derivatives Study Group, supra note 42, at 30.
63. See id.
64. See id.
65. See id. at 32.
66. See id.
67. See id.
68. See Charles W. Smithson, A Building Block Approach to Financial Engineering: An Introduction to Forwards, Futures, Swaps and Options 6 (CIBC Wood Gundy School of Financial Products, reprinted from Midland Corporate Finance Journal, Winter 1987).
69. See Global Derivatives Study Group, supra note 42, at 29.
70. See id.
71. See 1 Das, Global Reference, supra note 35, at 453.
72. See id.
73. See id.
74. See Global Derivatives Study Group, supra note 42, at 29.
75. See John Hull, Introduction to Futures and Options Markets 342 (1991).
76. See id.
77. See id.
78. See id.
79. See Smithson, supra note 57, at 2.
80. See Adams & Runkle, supra note 19, (manuscript at 7).
81. See id. at 8; Global Derivatives Study Group, supra note 42, at 32.
82. See Adams & Runkle, supra note 19, (manuscript at 8). The law has not given the term futures contract a precise definition, although one characteristic that is important to courts is whether the contract is offset or settled for cash rather than taking actual delivery of the underlying asset. See Culp, Primer on Derivatives, supra note 2, at 63. This characteristic is the basis for the Forward Contract Exemption under the Commodity Exchange Act ("CEA"). See 7 U.S.C. § 1(a)(11) (1994) ("The term 'future delivery' does not include any sale of any cash commodity for deferred shipment or delivery."); Culp, Primer on Derivatives, supra note 2, at 62. This exemption is a statutory exclusion. See id. There is no precise method for determining which transactions are covered by this exclusion. See id. at 63. There are three characteristics, however, that will increase the probability that a forward contract is likely to fall under the exclusion. First, the parties must intend physical transfer of the actual underlying commodity, i.e., they must actually expect to make or take actual delivery. Second, the parties must enter into the contracts for "commercial purposes." Finally, in addition to intending to make or take actual delivery, the parties must also have the ability to make or take delivery. See id.
83. See Adams & Runkle, supra note 19, (manuscript at 8). The law has not given the term futures contract a precise definition, although one characteristic that is important to courts is whether the contract is offset or settled for cash rather than taking actual delivery of the underlying asset. See Culp, Primer on Derivatives, supra note 2, at 63. This characteristic is the basis for the Forward Contract Exemption under the Commodity Exchange Act ("CEA"). See 7 U.S.C. § 1(a)(11) (1994) ("The term 'future delivery' does not include any sale of any cash commodity for deferred shipment or delivery."); Culp, Primer on Derivatives, supra note 2, at 62. This exemption is a statutory exclusion. See id. There is no precise method for determining which transactions are covered by this exclusion. See id. at 63. There are three characteristics, however, that will increase the probability that a forward contract is likely to fall under the exclusion. First, the parties must intend physical transfer of the actual underlying commodity, i.e., they must actually expect to make or take actual delivery. Second, the parties must enter into the contracts for "commercial purposes." Finally, in addition to intending to make or take actual delivery, the parties must also have the ability to make or take delivery. See id.
84. See Adams & Runkle, supra note 19, (manuscript at 8). The law has not given the term futures contract a precise definition, although one characteristic that is important to courts is whether the contract is offset or settled for cash rather than taking actual delivery of the underlying asset. See Culp, Primer on Derivatives, supra note 2, at 63. This characteristic is the basis for the Forward Contract Exemption under the Commodity Exchange Act ("CEA"). See 7 U.S.C. § 1(a)(11) (1994) ("The term 'future delivery' does not include any sale of any cash commodity for deferred shipment or delivery."); Culp, Primer on Derivatives, supra note 2, at 62. This exemption is a statutory exclusion. See id. There is no precise method for determining which transactions are covered by this exclusion. See id. at 63. There are three characteristics, however, that will increase the probability that a forward contract is likely to fall under the exclusion. First, the parties must intend physical transfer of the actual underlying commodity, i.e., they must actually expect to make or take actual delivery. Second, the parties must enter into the contracts for "commercial purposes." Finally, in addition to intending to make or take actual delivery, the parties must also have the ability to make or take delivery. See id.
85. See Adams & Runkle, supra note 19, (manuscript at 8). The law has not given the term futures contract a precise definition, although one characteristic that is important to courts is whether the contract is offset or settled for cash rather than taking actual delivery of the underlying asset. See Culp, Primer on Derivatives, supra note 2, at 63. This characteristic is the basis for the Forward Contract Exemption under the Commodity Exchange Act ("CEA"). See 7 U.S.C. § 1(a)(11) (1994) ("The term 'future delivery' does not include any sale of any cash commodity for deferred shipment or delivery."); Culp, Primer on Derivatives, supra note 2, at 62. This exemption is a statutory exclusion. See id. There is no precise method for determining which transactions are covered by this exclusion. See id. at 63. There are three characteristics, however, that will increase the probability that a forward contract is likely to fall under the exclusion. First, the parties must intend physical transfer of the actual underlying commodity, i.e., they must actually expect to make or take actual delivery. Second, the parties must enter into the contracts for "commercial purposes." Finally, in addition to intending to make or take actual delivery, the parties must also have the ability to make or take delivery. See id.
86. See Adams & Runkle, supra note 19, (manuscript at 8). The law has not given the term futures contract a precise definition, although one characteristic that is important to courts is whether the contract is offset or settled for cash rather than taking actual delivery of the underlying asset. See Culp, Primer on Derivatives, supra note 2, at 63. This characteristic is the basis for the Forward Contract Exemption under the Commodity Exchange Act ("CEA"). See 7 U.S.C. § 1(a)(11) (1994) ("The term 'future delivery' does not include any sale of any cash commodity for deferred shipment or delivery."); Culp, Primer on Derivatives, supra note 2, at 62. This exemption is a statutory exclusion. See id. There is no precise method for determining which transactions are covered by this exclusion. See id. at 63. There are three characteristics, however, that will increase the probability that a forward contract is likely to fall under the exclusion. First, the parties must intend physical transfer of the actual underlying commodity, i.e., they must actually expect to make or take actual delivery. Second, the parties must enter into the contracts for "commercial purposes." Finally, in addition to intending to make or take actual delivery, the parties must also have the ability to make or take delivery. See id.
87. See Global Derivatives Study Group, supra note 42, at 29.
88. See Hull, supra note 64, at 264.
89. See id.
90. See id. at 265.
91. See id.
92. See Global Derivatives Study Group, supra note 42, at 31.
93. See McLaughlin, supra note 2, at 70.
94. See id.
95. A swaption is an option (the right but not the obligation) to enter into a swap. The buyer of a swaption can exercise his right, on a set forward date, to enter into a swap whose terms were known and specified at the time the swaption was transacted. See Kapner & Marshall, supra note 11, at 519.
96. A cap is a series of forward period cash settled options on an underlying index. The cap buyer receives a payment (exercises the period option) whenever the underlying index exceeds the cap level on an exercise date. See id. at 503.
97. A floor is a series of forward period cash settled options on an underlying index. The floor buyer receives a payment (exercises the period option) whenever the underlying index falls below the floor level on an exercise date. See id.
98. A collar is the purchase (sale) of a cap and a simultaneous sale (purchase) of a floor. See id.
99. See Cohen, supra note 43, at 2001.
100. See International Swaps and Derivatives Ass'n, Inc., Summary of Market Survey Statistics: 1997 Activity. The survey only measures interest rate swap, currency swap, and interest rate option activity. See id. Other privately negotiated derivative transactions, such as commodity and equity swaps, are not surveyed due to the significantly lower volume of transactions as compared with interest rate and foreign exchange derivatives. See id. The survey reports that in 1997, 77% of the surveyed privately negotiated derivatives executed that year were interest rate swaps; 5% were currency swaps; and 18% were interest rate options. See id. at 1.
101. Graham Cooper, Uncertainty Mounts for U.S. Swappers, RISK, July 1998, at 20, 23.
102. Id.
103. See 2 Das, Global Reference, supra note 35, at 1354.
104. See Das, Swap Financing, supra note 14, at 6.
105. See International Swaps and Derivatives Ass'n, ISDA Survey Shows Swaps Volume Rose 13% to $28.7 Trillion in First Half of 1997; New Business Activity Climbed 46%, at 1 (unpublished news release, Jan. 12, 1998). To say the least, the wide-ranging financial applicability of swaps and the tremendous advances in portfolio risk management techniques and computer/systems technology that would enable high volume activity, were not anticipated. See Crawford & Sen, supra note 5, at 67 (discussing the importance of computer sophistication in the growth of derivatives); 1 Das, Global Reference, supra note 35, at 19-28 (discussing the factors behind the rapid growth of swaps).
106. See Das, Swap Financing, supra note 14, at 168.
107. See id. at 183-214.
108. See id. at 168.
109. See id.
110. See id. at 171. It is possible to arbitrage across the different capital market because the price of capital is not consistent at all times. See id. at 168.
111. See 1 Das, Global Reference, supra note 35, at 629.
112. See Das, Swap Financing, supra note 14, at 172-73.
113. See Carolyn H. Jackson, Legal Challenges for the Millennium: A Speculation, 7 J. Fin. Engineering 203, 205 (1998).
114. See Das, Swap Financing, supra note 14, at 172-73.
115. See id. at 540.
116. 7 U.S.C. §§ 1-26 (1994).
117. 15 U.S.C. §§ 77-78 (1994).
118. See McLaughlin, supra note 2, at 182.
119. See Romano, supra note 30, at 59.
120. See id.
121. See id.
122. See id. at 59-60.
123. See id. at 61. Prior to 1988, swaps and other off-balance sheet financial instruments were free of bank regulatory capital requirements. In 1988, the Basle Accord was negotiated by the Bank for International Settlements (BIS), United States banking regulators, and banking regulators from many other nations. The Basle Accord imposed risk-based capital requirements on swaps and other off-balance sheet financial products. The capital provides a reserve against potential losses that would arise from a couterparty default (credit risk). The Basle Accord became fully operative in 1992. See id. In 1993, the BIS wrote a proposal that the capital requirements be extended to include the market risk arising from swap transaction and other off-balance sheet financial instruments. See id. at 62.
124. See supra note 11 and accompanying text.
125. See infra notes 154-56, 173-80, and accompanying text.
126. See Romano, supra note 30, at 55.
127. See id.
128. See id.; supra note 11 (describing commodity swaps).
129. See James D. Cox et al., Securities Regulation: Cases and Materials 3 (2d ed. 1997).
130. See id.
131. See id.
132. See id. at 4.
133. See id.
134. See id.
135. See id. at 5.
136. See id.
137. See id. at 5-6.
138. See id. at 6-7.
139. See id. at 7-9.
140. See Thomas A. Tormey, Note, A Derivatives Dilemma: The Treasury Amendment Controversy and the Regulatory Status of Foreign Currency Options, 65 Fordham L. Rev. 2313, 2323 (1997).
141. See id.
142. See id.
143. See id.
144. See Culp, Primer on Derivatives, supra note 2, at 61 (citation omitted).
145. Bucket shops claimed to execute futures transactions for the public. The bucket shop merchant, however, "bucketed" trades, meaning that he took the customer order but did not register them with any board of trade or exchange. Rather, if the value of the contract fell, he would collect from the customer. If the value of the contract increased, such that the customer was owed money the bucket shop would disappear, avoiding paying the customer. See Mayer, supra note 41, at 329.
146. Ch. 86, 42 Stat. 187 (1921).
147. See Tormey, supra note 125, at 2324.
148. See id.
149. See Hill v. Wallace, 259 U.S. 44, 68-69 (1922).
150. Ch. 369, 42 Stat. 998 (1922).
151. U.S. Const, art. I, § 8, cl. 3. The Commerce Clause gives Congress the authority "to regulate Commerce . . . among the several States . . . ." Id.
152. See Tormey, supra note 125, at 2325. The constitutionality of the Grain Futures Act was upheld by the Supreme Court in 1923. See Board of Trade v. Olsen, 262 U.S. 1 (1923).
153. See Tormey, supra note 125, at 2325-26.
154. Ch. 545, 49 Stat. 1491 (1936) (codified as amended at 7 U.S.C. §§ 1-26 (1994)); see Tormey, supra note 125, at 2325.
155. Commodity Exchange Act, § 3(a) (1936). According to the CEA, "[t]he word 'commodity' shall mean wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs and Solanum tuberosum (Irish potatoes)." Id.
156. Commodity Exchange Act, § 9 (1936).
157. See Tormey, supra note 125, at 2326.
158. 7 U.S.C. §§ 1-26, (1994).
159. See Tormey, supra note 125, at 2326-27.
160. Romano, supra note 30, at 22. Prior to the 1974 Act, the administration of the CEA had been overseen by the Secretary of Agriculture. See Tormey, supra note 125, at 2327.
161. See 7 U.S.C. § 2(i). This section provides, in pertinent part: The [CFTC] shall have exclusive jurisdiction . . . with respect to accounts, agreements (including any transaction which is of the character of, or is commonly known to the trade as, an "option . . ."), and transactions involving contracts of sale of a commodity for future delivery, traded or executed on a contract market designated pursuant to section 7 of this title or any other board of trade, exchange, or market . . . . Id.
162. 7 U.S.C. § 1(a)(3); see also supra note 140 (providing the original 1936 definition of commodity).
163. See McLauglin, supra note 2, at 188. Today, transactions in financial futures dominate the activity of the exchanges - not transactions in agricultural futures. See Global Derivatives Study, supra note 42, at 32.
164. Romano, supra note 30, at 23.
165. See id.
166. See id.
167. 7 U.S.C. § 2(ii). The Treasury Amendment provides: Nothing in this chapter [the CEA] shall be deemed to govern or in any way be applicable to transactions in foreign currency, security warrants, security rights, resales of installment loan contracts, repurchase options, government securities, or mortgages and mortgage purchase commitments, unless such transactions involve the sale thereof for future delivery conducted on a board of trade. Id. The Treasury Amendment is a statutory exclusion and therefore all transactions that fall within the Treasury Amendment are not "covered by the CEA at all and thus are subject neither to the exchange-trading (or contract market) requirements nor to CEA antifraud and antimanipulation provisions." McLauglin, supra note 2, at 185 (emphasis in original).
168. See Tormey, supra note 125, at 2326-28.
169. In a December 1997 address at Fordham Law School, the Honorable Brooksley Born, Chairperson of the Commodity Futures Trading Commission, stated: The Commodity Exchange Act grants the Commission exclusive jurisdiction over futures and commodity options, whether they are traded on-or-off exchange, and authorizes the Commission to enforce the federal commodities laws with respect to such instruments. Using powers granted to the Commission by Congress in 1992, the Commission has exempted certain over-the-counter transactions primarily between sophisticated traders, from many of the regulations and provisions of the Commodity Exchange Act, including the on-exchange requirement. Brooksley Born, Keynote address at the Derivatives & Risk Management Symposium at Fordham University School of Law (1997), reprinted in 66 Fordham L. Rev. 761, 761-62 (1997).
170. See Culp, Functional and Institutional Interaction, supra note 8, at 479. A foreign currency option is an option, the underlying value of which is pegged to the price of a particular currency. See Tormey, supra note 125, at 2316 n.5; see also supra notes 54-57 and accompanying text (discussing options generically). A currency forward is a forward contract, the underlying value of which is pegged to the price of a particular currency. As with other forward contracts, the foreign currency forward is a customized transaction. See Tormey, supra note 125, at 2316 n.11; see also supra notes 49-53 and accompanying test (discussing forwards generically).
171. Joanne T. Medero, The Great Treasury Amendment Debate, Futures Industry, Mar. 1997, at 19, 19.
172. CFTC Policy Statement Concerning Swap Transactions, 54 Fed. Reg. 30,694 (1989). Specifically, the Policy Statement provided: "This statement reflects the Commission's view that at this time most swap transactions, although possessing elements of futures or options contacts, are not appropriately regulated as such under the Act and regulations." Id.
173. See Romano, supra note 30, at 55.
174. 54 Fed. Reg. 30,697 (1989).
175. See Romano, supra note 30, at 56.
176. See Office of the General Counsel, Securities and Exchange Comm'n, Recent Legislative Developments Affecting the Work of the Securities and Exchange Commission, in The SEC Speaks in 1998, at 469, 529 (PLI Corporate Law & Practice Handbook Series No. 1037, 1998). An exclusion is preferable over an exemption because it provides certainty that swaps are excluded from the provisions of the CEA. "[A]n exemptive approach . . . could allow some market participants to argue later that, because swaps are exempted from the CEA, they are futures; otherwise, no exemption would have been necessary." Id.
177. See Office of the General Counsel, Securities and Exchange Comm'n, Recent Legislative Developments Affecting the Work of the Securities and Exchange Commission, in The SEC Speaks in 1998, at 469, 529 (PLI Corporate Law & Practice Handbook Series No. 1037, 1998). An exclusion is preferable over an exemption because it provides certainty that swaps are excluded from the provisions of the CEA. "[A]n exemptive approach . . . could allow some market participants to argue later that, because swaps are exempted from the CEA, they are futures; otherwise, no exemption would have been necessary." Id.
178. Pub. L. No. 102-546 (1992), 106 Stat. 3590, 3629.
179. 7 U.S.C. § 6(d) (1994); see Culp, Primer on Derivatives, supra note 2, at 66.
180. 7 U.S.C. § 6(d); see Romano, supra note 30, at 56.
181. 17 C.F.R. § 35 (1996).
182. See id. § 35.1(b)(2). The Swaps Exemption only applies to eligible swaps participants. See id.
183. Over-the-Counter Derivatives, 63 Fed. Reg. 26,114 (1998) (to be codified at 7 C.F.R. pts. 34 & 35).
184. William P. Albrecht, Reforming U.S. Regulatory Structure, Futures Industry, Feb./Mar. 1999, at 14, 15.
185. Id.
186. See McLauglin, supra note 2, at 189.
187. See John D. Benson, Comment, Ending the Turf Wars: Support for a CFTC/ SEC Consolidation, 36 Vill. L. Rev. 1175, 1190 (1991).
188. Thomas A. Russo & Marlisa Vinciguerra, Financial Innovation and Uncertain Regulation: Selected Issues Regarding New Product Development, in Advanced Strategies in Financial Risk Management, supra note 11, at 439, 442.
189. See id. at 442 n.8.
190. See generally Christopher L. Culp, Competitive Enter. Inst., Regulatory Uncertainty and the Economics of Derivatives Regulation, Financier: ACMT, Dec. 1995, at 46 [hereinafter Culp, Regulatory Uncertainty] (discussing functional and institutional regulation and the overlap between the two forms). As articulated by Culp, financial regulation comes in two types: functional and institutional. See id. at 53. Functional regulation purports to regulate the economic functions that the financial system provides, such as capital formation and hedging. See id. at 55. The SEC and the CFTC are functional regulatory regimes. See id. In contrast, institutional regulation purports to regulate the institutions that provide financial activities. See id. at 53. Commercial bank regulation by the Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency exemplify institutional regulation. See id. at 54. In response to significant losses by corporations and institutional entities allegedly due to their activity in derivatives, see infra note 435, Congress has debated whether a functional regulator should be created for all derivative activity. One such proposal was the Risk Management Improvement and Derivatives Oversight Act of 1995, which called for the establishment of a Federal Derivatives Commission for the purpose of setting oversight standards for financial institutions engaged in derivative transactions. See H.R. 20, 104th Cong., (1995); Thomas C. Singher, Note, Regulating Derivatives: Does Transnational Regulatory Cooperation Offer a Viable Alternative See to Congressional Action?, 18 Fordham Int'l L.J. 1397, 1438-42 (1995). Nobel Laureate Merton Miller predicts that proposed efforts to redraw United States regulatory jurisdictions along logical functional lines would ultimately end in regulatory dysfunction. See Merton H. Miller, Functional Regulation, in Derivatives Handbook: Risk Management and Control supra note 8, at 446, 457.
191. See generally Christopher L. Culp, Competitive Enter. Inst., Regulatory Uncertainty and the Economics of Derivatives Regulation, Financier: ACMT, Dec. 1995, at 46 [hereinafter Culp, Regulatory Uncertainty] (discussing functional and institutional regulation and the overlap between the two forms). As articulated by Culp, financial regulation comes in two types: functional and institutional. See id. at 53. Functional regulation purports to regulate the economic functions that the financial system provides, such as capital formation and hedging. See id. at 55. The SEC and the CFTC are functional regulatory regimes. See id. In contrast, institutional regulation purports to regulate the institutions that provide financial activities. See id. at 53. Commercial bank regulation by the Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency exemplify institutional regulation. See id. at 54. In response to significant losses by corporations and institutional entities allegedly due to their activity in derivatives, see infra note 435, Congress has debated whether a functional regulator should be created for all derivative activity. One such proposal was the Risk Management Improvement and Derivatives Oversight Act of 1995, which called for the establishment of a Federal Derivatives Commission for the purpose of setting oversight standards for financial institutions engaged in derivative transactions. See H.R. 20, 104th Cong., (1995); Thomas C. Singher, Note, Regulating Derivatives: Does Transnational Regulatory Cooperation Offer a Viable Alternative See to Congressional Action?, 18 Fordham Int'l L.J. 1397, 1438-42 (1995). Nobel Laureate Merton Miller predicts that proposed efforts to redraw United States regulatory jurisdictions along logical functional lines would ultimately end in regulatory dysfunction. See Merton H. Miller, Functional Regulation, in Derivatives Handbook: Risk Management and Control supra note 8, at 446, 457.
192. See generally Christopher L. Culp, Competitive Enter. Inst., Regulatory Uncertainty and the Economics of Derivatives Regulation, Financier: ACMT, Dec. 1995, at 46 [hereinafter Culp, Regulatory Uncertainty] (discussing functional and institutional regulation and the overlap between the two forms). As articulated by Culp, financial regulation comes in two types: functional and institutional. See id. at 53. Functional regulation purports to regulate the economic functions that the financial system provides, such as capital formation and hedging. See id. at 55. The SEC and the CFTC are functional regulatory regimes. See id. In contrast, institutional regulation purports to regulate the institutions that provide financial activities. See id. at 53. Commercial bank regulation by the Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency exemplify institutional regulation. See id. at 54. In response to significant losses by corporations and institutional entities allegedly due to their activity in derivatives, see infra note 435, Congress has debated whether a functional regulator should be created for all derivative activity. One such proposal was the Risk Management Improvement and Derivatives Oversight Act of 1995, which called for the establishment of a Federal Derivatives Commission for the purpose of setting oversight standards for financial institutions engaged in derivative transactions. See H.R. 20, 104th Cong., (1995); Thomas C. Singher, Note, Regulating Derivatives: Does Transnational Regulatory Cooperation Offer a Viable Alternative See to Congressional Action?, 18 Fordham Int'l L.J. 1397, 1438-42 (1995). Nobel Laureate Merton Miller predicts that proposed efforts to redraw United States regulatory jurisdictions along logical functional lines would ultimately end in regulatory dysfunction. See Merton H. Miller, Functional Regulation, in Derivatives Handbook: Risk Management and Control supra note 8, at 446, 457.
193. See McLauglin, supra note 2, at 183, 239-40.
194. See Culp, Regulatory Uncertainty, supra note 174, at 63-64.
195. See Romano, supra note 30, at 58. Romano states, "Indeed, the release is internally incoherent." Id.
196. See id.
197. See id.
198. See In re BT Securities Corp., Exchange Act Release No. 35,136; 58 SEC Docket 1182 (Dec. 22, 1994). The $10 million dollar payment made pursuant to the SEC order also satisfied Bankers Trust's obligation under a related CFTC opinion and settlement order. See id. at 1193.
199. See Office of the Comptroller of the Currency, Decision of the Office of the Comptroller of the Currency on the Request by Chase Manhattan Bank, N.A., to Offer the Chase Market Investment Deposit Account 1 (1988) [hereinafter OCC Interpretive Letter], available in 1988 WL 282282. In March 1987, Chase began offering time deposits known as the Market Index Investment deposit which paid interest at a rate based upon the Standard and Poor's 500 Composite Stock Index (S&P Index). See id.
200. See Joseph P. Ogden, A Strategic Analysis of Stock Index-Linked CDs, in Derivatives, Regulation and Banking 193, 206 (Barry Schachter ed., 1997).
201. See Eugene H. Cantor & Barry Schachter, Indexed Certificates of Deposit, in Derivatives, Regulation and Banking, supra note 182, at 159, 162. The S&P Index, which is listed on the New York Stock Exchange, consists of an index of 500 stocks of generally the largest firms that is weighted by market value. See id. at 162 n.5. The value of the S&P index is determined by comparing the current aggregate market value of the 500 stocks against a 1940 base index. See id. at 162-63 n.5.
202. See id. at 162-63.
203. See id. at 163. The Guaranteed Return was similar to a fixed interest rate, and could be set at various levels, such as two percent, four percent, or zero. Id.
204. See id.
205. See id.
206. See id.
207. For a thorough discussion of the hedging of S&P Indexed CDs see Ogden, supra note 182, at 194-05, and OCC Interpretive Letter, supra note 181, at 13-21.
208. See OCC Interpretive Letter, supra note 181, at 1. The Investment Company Institute (ICI) is the American trade association of the investment company industry, whose membership consists primarily of open-end investment companies. It members also include closed-end investment companies and unit investment trusts. See John E. Baumgardner, Jr. & Paul N. Roth, Developments in the Regulation of Offshore Investment Funds and Other International Investment Vehicles; Developments in International Advice Regulation, 1077 PLI/Corp 303, 339 n.1 (1998).
209. See OCC Interpretive Letter, supra note 181, at 1-2; 12 U.S.C. § 24 (Seventh) (1994).
210. See Cantor & Schachter, supra note 183, at 162 n.4.
211. Henry T.C. Hu, Illiteracy and Intervention: Wholesale Derivatives, Retail Mutual Funds, and the Matter of Asset Class, 84 Geo. L. J. 2319, 2368-69 (1996) [hereinafter Hu, Illiteracy and Intervention].
212. See supra notes 182-88 and accompanying text.
213. In the ICI's charges against Chase for offering the S&P Indexed CDs, it stressed that one of the reasons the CD was outside of Chase's banking authority was due to the fact that Chase used S&P Indexed futures to hedge its position. See OCC Interpretive Letter, supra note 181, at 13-16. The use of stock-indexed futures is regarded by many as one of the main factors behind the stock market crash of October 19, 1987. See Robert J. Barro et al., Black Monday and the Future of Financial Markets 364 (1989). Despite its ominous origins, S&P indexed CDs are now offered by many institutions. These institutions include Bankers Trust, Citibank, Republic New York, Merrill Lynch, Paine Webber, Salomon Brothers, and Warburg and Co. See Ogden, supra note 182, at 193 & n.1. CDs can have their return tied to indexes other than equity. Examples include commodity-linked CDs whose returns are keyed to increases in the price of gold or other commodities, or commodities indexes and bonus CDs whose return increase when particular events occur, "such as the victory of a particular football team in the Superbowl or the occurrence of a prescribed minimum amount of rainfall or snowfall in the issuing bank's local area." Cantor & Schachter, supra note 183, at 159.
214. See McLaughlin, supra note 2, at 189.
215. See Roger L. Anderson, The Treasury Department's Role in Regulating the Derivatives Marketplace, 66 Fordham L. Rev. 775, 777 (1997).
216. See McLauglin, supra note 2, at 167, 184-85.
217. See Culp, Functional and Institutional Interaction, supra note 8, at 463. A counterparty to a swap has an incentive to walk away from the contract when the underlying index of the contract has moved against them. See id. Even a swap counterparty who is using a swap as a hedge and not as a speculation can have the incentive to walk away from a swap contract that is in a loss position, claiming, for example, it is an illegal off-exchange futures contract and therefore unenforceable, allowing him to benefit from a gain on his underlying position. In such a case, by walking away from the swap contract, the swap counterparty will be left with a wind-fall gain on his underlying position. See Hull, supra note 64, at 129-32 (discussing a fundamental principal of hedging that the gains (loss) on a hedge offset the loss (gains) of the underlying transaction).
218. See McLaughlin, supra note 2, at 184.
219. Should a derivative be declared a security, derivative dealers would be required to register the transactions under the Acts, and be subject to the SEC's net capital rules as contained in Rule 15c3-1 under the Exchange Act. See 17 C.F.R. § 240.15c3-1 (1997).
220. See McLaughlin, supra note 2, at 184.
221. See Alton B. Harris, The CFTC and Derivative Products: Purposeful, Ambiguity and Jurisdictional Reach, 71 Chi.-Kent L. Rev. 1117, 1166 (1996).
222. See id.
223. See Culp, Primer on Derivatives, supra note 2, at 85; supra note 4 and accompanying text. Some however, have conceded the possibility that retail derivatives whether exchange-traded or privately negotiated may develop, but such a development in their view should lead to the development of a two-tiered institutional/consumer regulatory structure. See Filler, supra note 4, at 22 (arguing that derivatives regulation should be less stringent for institutional participants); Tormey supra note 125, at 2371-73 (supporting a "safe-harbor of maximum legal certainty for the Interbank industry," while supporting CFTC regulation of retail foreign exchange option activity).
224. See Tormey, supra note 125, at 2350-51.
225. 58 F.3d 50 (2d Cir. 1995).
226. Amicus Brief for the Foreign Exchange Committee, Dunn v. Commodity Futures Trading Comm'n, 117 S. Ct. 913 (1997) (No. 95-1181), available in 1996 WL 392512, at *27. The trade associations were The Foreign Exchange Committee, The New York Clearing House Association, The Futures Industry Association, The Managed Futures Association, and The Public Securities Association. See id., available in 1996 WL 392512, at *1.
227. 58 F.3d 50.
228. See id. at 53.
229. See id. In 1997, the Supreme Court reversed the Second Circuit's opinion, holding that foreign currency options fell under the Treasury Amendment and were therefore excluded form CFTC jurisdiction. See Dunn v. Commodity Futures Trading Comm'n., 117 S. Ct. 913, 917 (1997).
230. See Russo, supra note 172, at 439.
231. See 2 Das, Global Reference, supra note 35, at 1237. An individual swap can create a large number of cashflows. For example, a swap with a five-year maturity structured to have semi-annual interest payments will involve 10 settlement payments, 10 resets to determine the appropriate floating cashflows, and 10 calculations of the net settlement amount. See id. at 1237-38.
232. See Robert M. Mark, Risk Oversight for the Senior Manager: Controlling Risk in Dealers, in Derivatives Handbook: Risk Management and Control, supra note 8, at 354, 401.
233. See id. (discussing the development of a model for senior management to take explicit account of trading, marketing, hedging, credit, risk management, operations technology, regulatory, and legal costs in the pricing of derivative transactions); see also 2 Das, Global Reference, supra note 35, at 1237-64 (providing a thorough analysis of the multitude of costs incurred by a financial firm in maintaining an ongoing derivatives operation). Das divides the costs across three structural areas: (1) front office; (2) middle office; and (3) back office. See id. at 1241. Among the front office costs are the costs of the traders and salesman, the dealing room, trade brokerage commission, systems for pricing, hedging, risk management simulation, and client relationship management. See id. at 1240-44. The middle office costs include the costs of producing risk, profit and loss, general ledger, credit, and market data reports as well as the costs of the underlying technological support systems. See id. at 1241. The back office costs include the systems necessary to generate trade confirmations, notifications, and the resets on underlying variable indexes. See id.
234. See Kapner & Marshall, supra note 29, at 429.
235. See id.
236. See id. at 429-31. One scholar espouses the theory that as financial innovation has led to the creation of derivatives, derivatives in turn have led to a process of "legal engineering" and "legal innovation." See McLauglin, supra note 2, at 1, 159. He states, "A modern paradigm of legal innovation is the development of the standard industry form 'master agreements' that now pervade both OTC derivatives and other financial market." Id. at 159. McLauglin notes that without the development of this legal engineering to remove the uncertainty concerning the key terms and conditions underlying swap transactions, the growth of the product would have been substantially curtailed. See id.
237. See id. at 432.
238. See id. at 433.
239. See id.
240. See Ian Wallace, Legal and Documentation Issues of Swaps and Financial
241. See Ian Wallace, Legal and Documentation Issues of Swaps and Financial Derivatives, in 2 Das, Global Reference, supra note 35, at 1341, 1343-45. Master Swap Agreements were developed by representatives from the leading dealer banks (commercial and investment banks) in a trade association, the International Swap Dealers Association. See Kenneth R. Kapner & John F. Marshall, The Swaps Handbook: Swaps and Related Risk Management Instruments 562-63 (Supp. 1992). The trade association later changed its name to The International Swaps and Derivatives association, Inc. See 2 Das, Global Reference, supra note 35, at 1440.
242. See Wallace, supra note 222, at 1344. The ISDA Master Agreements are structured to contain only fundamental operational terms and conditions. The Schedule gives the parties the ability to modify the core document. The legal matters that are addressed in the Schedule include whether there are any specified entities, cross default provisions, credit support agreements, governing law, or early termination considerations. See id. at 1344-45.
243. See 2 Das, Global Reference, supra note 35, at 1246.
244. See id. at 1254.
245. See id.
246. See Greenwald, supra note 15, at 32.
247. See 2 Das, Global Reference, supra note 35, at 1241-42.
248. See id. at 1242.
249. See id. Ultimately, the consumer may not execute these hypothetical transaction and indicative quotes. See id.
250. See id. at 1020-21.
251. See id. at 954-55.
252. See 1 Das, Global Reference, supra note 35, at 18.
253. McLaughlin, supra note 2, at 17; see 1 Das, Global Reference, supra note 35, at 28-29.
254. See 1 Das, Global Reference, supra note 35, at 162 (detailing the bid-ask spread carried on an electronic pricing screen for United States dollar interest rate swaps); Culp, Primer on Derivatives, supra note 2, at 7 (defining a plain vanilla swap as an interest rate swap in which one party pays a fixed rate and the other party pays a floating rate indexed to prevailing interbank Eurodeposit rate, the London Interbank Offered Rate (LIBOR)). A basis point is an interest rate equal to one one-hundredth of one percentage point, i.e., 0.01 percent. See Kapner & Marshall, supra note 11, at 485.
255. This calculation is performed on a present value basis, discounted annually at five percent.
256. McLaughlin, supra note 2, at 16.
257. Id. (quoting Robert C. Merton, Financial Innovation and Economic Performance, J. Applied Corp. Fin., Winter 1992, at 4).
258. See id. at 16-17, 19.
259. See Philip S. Corwin, The Virtual Dotted Line: Understanding Digital Signatures, Banking Pol'y Rep., Feb. 17, 1997, at 1, 1 ("According to many observers, the explosion of digital commerce facilitated by the Internet is simply a matter of when, not if."). At the American Banking Association convention in 1995, the biggest draw among the convention's proffered demonstrations was that of personal banking in the future. See The Rubber Meets the Road, Economist, Sept. 16, 1995, at 87, 87 ("Using a computer mouse, one can walk from the shopping mall into the bank and conduct financial business."). It has been observed that: As the Web develops, consumers [will] take control of their own financial destinies, national boundaries [will] be removed, distinctions between financial products [will] evaporate and broad offices, administrative centers and piles of marketing literature [will] disappear. . . . [A] customer in Australia, using only his television set [will] obtain his pension in the [United States], buy a German bond in Frankfurt and invest in a tax-exempt scheme in Dublin. Scott Andersen, Calculating Net Worth, Private Banker Int'l, July 1, 1997, at 15, available in 1997 WL 12398033. The Internet volume for United Stated stocks is estimated to be $3.2 billion a day. See Perri Colley McKinney, A New Breed of Investment Company Is Introducing the Masses to Currency Trading, Once the Province of the Rich Internet Forex Attracts Smaller Players, S. China Morning Post, Oct. 4, 1998, at 9, available in 1998 WL 22021545. According to a survey conducted by the Bank Marketing Association, financial websites were visited by 70% of online consumers in 1996 and 34% used financial websites regularly. See Bernadette Tracy, New Customers Are Waiting Online at the Electronic Banking "Window": 1997 Could Be the Year of "Electronic Commerce", Bank Mkt., Jan. 1, 1997, at 8, available in 1997 WL 10172531. A survey revealed that 46% of the people interviewed went online to get help in making their financial decisions, such as buying CDs and mutual funds. Additionally, 31% of these financial "surfers" bought financial products at retail. See id.
260. See Philip S. Corwin, The Virtual Dotted Line: Understanding Digital Signatures, Banking Pol'y Rep., Feb. 17, 1997, at 1, 1 ("According to many observers, the explosion of digital commerce facilitated by the Internet is simply a matter of when, not if."). At the American Banking Association convention in 1995, the biggest draw among the convention's proffered demonstrations was that of personal banking in the future. See The Rubber Meets the Road, Economist, Sept. 16, 1995, at 87, 87 ("Using a computer mouse, one can walk from the shopping mall into the bank and conduct financial business."). It has been observed that: As the Web develops, consumers [will] take control of their own financial destinies, national boundaries [will] be removed, distinctions between financial products [will] evaporate and broad offices, administrative centers and piles of marketing literature [will] disappear. . . . [A] customer in Australia, using only his television set [will] obtain his pension in the [United States], buy a German bond in Frankfurt and invest in a tax-exempt scheme in Dublin. Scott Andersen, Calculating Net Worth, Private Banker Int'l, July 1, 1997, at 15, available in 1997 WL 12398033. The Internet volume for United Stated stocks is estimated to be $3.2 billion a day. See Perri Colley McKinney, A New Breed of Investment Company Is Introducing the Masses to Currency Trading, Once the Province of the Rich Internet Forex Attracts Smaller Players, S. China Morning Post, Oct. 4, 1998, at 9, available in 1998 WL 22021545. According to a survey conducted by the Bank Marketing Association, financial websites were visited by 70% of online consumers in 1996 and 34% used financial websites regularly. See Bernadette Tracy, New Customers Are Waiting Online at the Electronic Banking "Window": 1997 Could Be the Year of "Electronic Commerce", Bank Mkt., Jan. 1, 1997, at 8, available in 1997 WL 10172531. A survey revealed that 46% of the people interviewed went online to get help in making their financial decisions, such as buying CDs and mutual funds. Additionally, 31% of these financial "surfers" bought financial products at retail. See id.
261. See Philip S. Corwin, The Virtual Dotted Line: Understanding Digital Signatures, Banking Pol'y Rep., Feb. 17, 1997, at 1, 1 ("According to many observers, the explosion of digital commerce facilitated by the Internet is simply a matter of when, not if."). At the American Banking Association convention in 1995, the biggest draw among the convention's proffered demonstrations was that of personal banking in the future. See The Rubber Meets the Road, Economist, Sept. 16, 1995, at 87, 87 ("Using a computer mouse, one can walk from the shopping mall into the bank and conduct financial business."). It has been observed that: As the Web develops, consumers [will] take control of their own financial destinies, national boundaries [will] be removed, distinctions between financial products [will] evaporate and broad offices, administrative centers and piles of marketing literature [will] disappear. . . . [A] customer in Australia, using only his television set [will] obtain his pension in the [United States], buy a German bond in Frankfurt and invest in a tax-exempt scheme in Dublin. Scott Andersen, Calculating Net Worth, Private Banker Int'l, July 1, 1997, at 15, available in 1997 WL 12398033. The Internet volume for United Stated stocks is estimated to be $3.2 billion a day. See Perri Colley McKinney, A New Breed of Investment Company Is Introducing the Masses to Currency Trading, Once the Province of the Rich Internet Forex Attracts Smaller Players, S. China Morning Post, Oct. 4, 1998, at 9, available in 1998 WL 22021545. According to a survey conducted by the Bank Marketing Association, financial websites were visited by 70% of online consumers in 1996 and 34% used financial websites regularly. See Bernadette Tracy, New Customers Are Waiting Online at the Electronic Banking "Window": 1997 Could Be the Year of "Electronic Commerce", Bank Mkt., Jan. 1, 1997, at 8, available in 1997 WL 10172531. A survey revealed that 46% of the people interviewed went online to get help in making their financial decisions, such as buying CDs and mutual funds. Additionally, 31% of these financial "surfers" bought financial products at retail. See id.
262. See Philip S. Corwin, The Virtual Dotted Line: Understanding Digital Signatures, Banking Pol'y Rep., Feb. 17, 1997, at 1, 1 ("According to many observers, the explosion of digital commerce facilitated by the Internet is simply a matter of when, not if."). At the American Banking Association convention in 1995, the biggest draw among the convention's proffered demonstrations was that of personal banking in the future. See The Rubber Meets the Road, Economist, Sept. 16, 1995, at 87, 87 ("Using a computer mouse, one can walk from the shopping mall into the bank and conduct financial business."). It has been observed that: As the Web develops, consumers [will] take control of their own financial destinies, national boundaries [will] be removed, distinctions between financial products [will] evaporate and broad offices, administrative centers and piles of marketing literature [will] disappear. . . . [A] customer in Australia, using only his television set [will] obtain his pension in the [United States], buy a German bond in Frankfurt and invest in a tax-exempt scheme in Dublin. Scott Andersen, Calculating Net Worth, Private Banker Int'l, July 1, 1997, at 15, available in 1997 WL 12398033. The Internet volume for United Stated stocks is estimated to be $3.2 billion a day. See Perri Colley McKinney, A New Breed of Investment Company Is Introducing the Masses to Currency Trading, Once the Province of the Rich Internet Forex Attracts Smaller Players, S. China Morning Post, Oct. 4, 1998, at 9, available in 1998 WL 22021545. According to a survey conducted by the Bank Marketing Association, financial websites were visited by 70% of online consumers in 1996 and 34% used financial websites regularly. See Bernadette Tracy, New Customers Are Waiting Online at the Electronic Banking "Window": 1997 Could Be the Year of "Electronic Commerce", Bank Mkt., Jan. 1, 1997, at 8, available in 1997 WL 10172531. A survey revealed that 46% of the people interviewed went online to get help in making their financial decisions, such as buying CDs and mutual funds. Additionally, 31% of these financial "surfers" bought financial products at retail. See id.
263. See Philip S. Corwin, The Virtual Dotted Line: Understanding Digital Signatures, Banking Pol'y Rep., Feb. 17, 1997, at 1, 1 ("According to many observers, the explosion of digital commerce facilitated by the Internet is simply a matter of when, not if."). At the American Banking Association convention in 1995, the biggest draw among the convention's proffered demonstrations was that of personal banking in the future. See The Rubber Meets the Road, Economist, Sept. 16, 1995, at 87, 87 ("Using a computer mouse, one can walk from the shopping mall into the bank and conduct financial business."). It has been observed that: As the Web develops, consumers [will] take control of their own financial destinies, national boundaries [will] be removed, distinctions between financial products [will] evaporate and broad offices, administrative centers and piles of marketing literature [will] disappear. . . . [A] customer in Australia, using only his television set [will] obtain his pension in the [United States], buy a German bond in Frankfurt and invest in a tax-exempt scheme in Dublin. Scott Andersen, Calculating Net Worth, Private Banker Int'l, July 1, 1997, at 15, available in 1997 WL 12398033. The Internet volume for United Stated stocks is estimated to be $3.2 billion a day. See Perri Colley McKinney, A New Breed of Investment Company Is Introducing the Masses to Currency Trading, Once the Province of the Rich Internet Forex Attracts Smaller Players, S. China Morning Post, Oct. 4, 1998, at 9, available in 1998 WL 22021545. According to a survey conducted by the Bank Marketing Association, financial websites were visited by 70% of online consumers in 1996 and 34% used financial websites regularly. See Bernadette Tracy, New Customers Are Waiting Online at the Electronic Banking "Window": 1997 Could Be the Year of "Electronic Commerce", Bank Mkt., Jan. 1, 1997, at 8, available in 1997 WL 10172531. A survey revealed that 46% of the people interviewed went online to get help in making their financial decisions, such as buying CDs and mutual funds. Additionally, 31% of these financial "surfers" bought financial products at retail. See id.
264. Das, Swap Financing, supra note 14, at 651.
265. See Crawford & Sen, supra note 5, at 198-99.
266. See infra Part V.D.
267. Retail participation in energy derivatives through the Internet is also being forecasted. See Douglas F. John & Ronald S. Oppenheimer, The Commodization of Energy, Nat. Resources & Env't, Spring 1998, at 251, 251. The authors discuss that it may not be long before homeowners "sit down at [their] personal computer screens and order $100 worth of 'cold' or 'hot' from a supplier of [their] choice." Id. This is because various technological developments have led to the "commoditization" of energy which has in turn led to the development of a derivatives products that will ultimately extend to the consumer. See id. 251, 254.
268. See Filler, supra note 4, at 21 (stating that "the retail . . . population could increase both in number and trading volume as electronic trading interfaces are created to permit direct access . . . to anyone owning a PC.").
269. Id. at 198; see supra Introduction. Such a fund is comparable to the Chase S&P Indexed CD. See supra notes 181-95 and accompanying text.
270. See Crawford & Sen, supra note 5, at 198.
271. See id.
272. Id.
273. See id.
274. See Status of ATMs Under State Branching Laws: Hearings on S. 2898 Before the Senate Comm. on Banking, Housing, and Urban Affairs, 98th Cong. 113 (1984) [hereinafter ATM Hearings] (noting that banks are already able to extend credit risk to consumers through ATMs as evidenced by the set up of cash advances against preapproved credit lines).
275. Consumer enthusiasm for executing financial transactions can be gathered by looking to other markets such as electronic securities trading. "On-line securities trading grew 181[%] to 26 million transactions in 1997 and should gain another 91[%] this year." Susan Abbott Gidel, Shifting Markets: Internet Use Growing, Futures Industry, Apr./May 1998, at 14, 14.
276. ATMs first appeared in 1969 and grew to 2900 by the end of 1974. They were initially regarded with skepticism, as it was thought that consumers might not necessarily trust transactions through a machine over those with an actual person. See ATM Hearings, supra note 251, at 58. "These figures . . . underscore the public acceptance of, and reliance upon, the convenient services that ATM's and shared ATM networks provide." Id. at 59.
277. See Crawford & Sen, supra note 5, at 67, 197.
278. See id. at 197. "The growth of . . . derivatives owes much to modern finance theory and to the speed, power, and widespread availability of computers." Id. at 67.
279. See McLaughlin, supra note 2, at 17; see also 2 Das, Global Reference, supra note 35, at 950-55 (discussing the evolution of swaps from a fully matched brokered business to one of market making and portfolio management).
280. Crawford & Sen, supra note 5, at 198. A former chairman of the CFTC, Philip McBride Johnson comments, "cyberspace will make [derivatives] readily available to traders world wide." Johnson, supra note 13, at 20.
281. See Peter Tufano, Securities Innovations: A Historical and Functional Perspective, J. Applied Corp. Fin., Winter 1995, at 90, 92.
282. Id.
283. Id. at 93 (quoting V. Carosso, Investment Banking in America: A History 225 (1970)).
284. See id. at 92-93; supra notes 237-40 and accompanying text (discussing Robert Merton's "innovation spiral" hypothesis).
285. See McLaughlin, supra note 2, at 183. A financial product is potentially subject to the securities laws and SEC jurisdiction if it falls within the definition of a security. Any swap that has a security or a formula tied to a security as its underlying index is also potentially a security. See id.
286. 15 U.S.C. § 77b(1) (1994). The definition section of the '34 Act is virtually identical and encompasses the same instruments as the '33 Act. See id. § 78c(a)(10). The '33 Act requires the registration of most securities and disclosure of information specific to the issuing entity. See Benson, supra note 171, at 1184. The '34 Act created the SEC as an independent, quasi-judicial regulatory agency, charged with the responsibility of "protect[ing] the public from fraud and abuses in the securities markets." Id. The SEC does not analyze securities offerings for their economic return; the SEC's premise is that with adequately disclosed information, an investor can make his own judgment on a security's value. See id. at 1185.
287. See Cox, supra note 114, at 117.
288. See id.
289. See McLaughlin, supra note 2, at 183-84. McLauglin notes that swaps have traditionally been regarded as a risk management device rather than as capital raising investments. See id. Although a small number of swap transactions were executed in the 1970s, swaps were not regarded as an established international capital markets transaction until the August 1981 landmark swap transaction between World Bank and IBM. See Das, Swap Financing, supra note 14, at 6; supra note 89 and accompanying text.
290. 328 U. S. 293 (1946).
291. See id. at 299. In Howey, investors were offered units of a citrus grove development coupled with a contract for cultivating, marketing, and remitting the net proceeds. See id. at 295. The investors provided the capital and shared in the earnings and profits; the promoters managed, controlled, and operated the enterprise. See id. at 299. The Court held that an offering of units of a citrus grove development coupled with a service contract was a security under § 2(1) of the '33 Act. See id. at 298-300. In SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974), the court modified the third prong of the Howey test to eliminate the word "solely." The court held that the securities laws can not be circumvented by requiring investors to nominally participate in the management of their ventures. See id. at 480.
292. 494 U.S. 56 (1990).
293. See id. at 64-65.
294. The types of notes that are not securities under the Acts are detailed in the case of Exchange National Bank v. Touche Ross & Co., 544 F.2d 1126 (2d Cir. 1976). These notes include notes delivered in consumer financing, notes secured by a home mortgage, short-term notes secured by a lien on a small business or some of its assets, notes evidencing a personal loan to bank customer, short-term notes secured by an assignment of accounts receivables, and notes which are collateralized and formalize an open-account debt incurred in the ordinary course of business. See id. at 1138. The court found these notes to essentially be "note[s] or other evidence[s] of indebtedness issued in a mercantile transaction." Id. 112. See Reves v. Ernst & Young, 494 U.S. 56, 66 (1990).
295. McLaughlin, supra note 2, at 184 (quoting Christopher Olander & Cynthia Spell, Interest Rate Swaps: Status Under Federal Tax and Securities Laws, 45 Md. L. Rev. 21, 53-54 (1986), and John C. Coffee, Jr., Bankers Trust Settlement: Whither the Swaps Market?, N.Y. L.J., Jan. 26, 1995, at 5).
296. McLaughlin, supra note 2, at 184 (quoting Christopher Olander & Cynthia Spell, Interest Rate Swaps: Status Under Federal Tax and Securities Laws, 45 Md. L. Rev. 21, 53-54 (1986), and John C. Coffee, Jr., Bankers Trust Settlement: Whither the Swaps Market?, N.Y. L.J., Jan. 26, 1995, at 5).
297. See id. at 183.
298. 925 F. Supp. 1270 (S.D. Ohio 1996).
299. See id. at 1277-83.
300. 455 U.S. 551 (1982).
301. See id. at 555.
302. See Bankers Trust Co., at 1276.
303. See id. at 1276-77.
304. See id.
305. See id. at 1277.
306. See id. at 1274.
307. Id. at 1277.
308. Id.
309. Id. at 1277-78 (citations omitted).
310. See id. at 1278.
311. Id.
312. See id.
313. Id. at 1278-79.
314. See id. at 1279.
315. See id.
316. See id.
317. Id. (citation omitted).
318. See id. at 1280.
319. See id.
320. See id.
321. See id.
322. See id.
323. See id.
324. Id. at 1281.
325. Id. (citation omitted).
326. See id. at 1281-82.
327. See id. at 1282.
328. See id. at 1282-83.
329. See Marine Bank v. Weaver, 455 U.S. 551, 552-53 (1982).
330. See id.
331. See id. at 553-54.
332. See id. at 559-60.
333. Id. at 555.
334. See id. at 556.
335. See id. at 557-58.
336. See id. at 560.
337. 7 U.S.C. §§ 4b, 4o, 6(c)b (1994).
338. See Romano, supra note 30, at 22.
339. See supra note 266 (discussing that although a few swap transactions had been executed in the 1970s, 1981 marked the actual beginning of the swap market). It is interesting to observe that a former CFTC chairman, Mary L. Schapiro, has noted that derivatives were not contemplated at the time of the drafting of the CEA. See Harris, supra note 203, at 1167. In a 1995 speech, she stated that the application of "[the] 'inflexible' [exchange trading] 'requirement to innovative OTC financial products . . . [was] clearly never envisioned [by the law's drafters].'" See id. (quoting Chairperson Mary L. Schapiro, Remarks to the National Capital of the National Association of Business Economists (Feb. 15, 1995)).
340. See Romano, supra note 30, at 24.
341. See id. at 25.
342. Culp, Primer on Derivatives, supra note 2, at 62.
343. The original definition of commodity under the CEA was limited to agricultural products. See supra note 140. In 1974, the definition was broadened with language that could cover financial futures as well. See supra note 147 and accompanying text (providing the broadened definition of commodity).
344. See Culp, Primer on Derivatives, supra note 2, at 62.
345. See infra notes 384-87, and accompanying text.
346. See Romano, supra note 30, at 55; supra Part II.B.
347. CFTC Policy Statement Concerning Swap Transactions, 54 Fed. Reg. 30,694 (1989).
348. CFTC Exemption of Swap Agreements, 17 C.F.R. § 35 (1996).
349. 7 U.S.C. § 6(d) (1994); see Romano, supra note 30, at 56. Romano notes that the exemption was limited - prohibiting swaps to be structured as standardized contracts or settled through a clearinghouse. See Romano, supra note 30, at 56. Further, the exemption requires that a swap counterparty's creditworthiness be an essential factor of the transaction. See id. These qualifying conditions were intended to protect the competitiveness of futures exchanges that objected to the Swaps Exemption because swaps, being unregulated, would be cheaper and hence more competitive than futures. See id.; Hillary Davis, A Million A Minute: Inside the World of Securities Trading - The Men, the Women, the Money that Make the Markets Work 157 (1998) (discussing the OTC market's major encroachment into the futures industry, resulting in a precipitous fall in the volume of futures transactions due to more favorable OTC regulation).
350. Romano, supra note 30, at 57.
351. See Culp, Functional and Institutional Interaction, supra note 8, at 478.
352. See id.
353. See id.
354. See id. at 478-79.
355. See id. at 479.
356. See id. at 483.
357. Romano, supra note 30, at 25. The fourth element requires that the contract be cash settled rather than through actual physical delivery. See id.
358. Culp, Functional and Institutional Interaction, supra note 8, at 483 (citation omitted).
359. Id.
360. Procter & Gamble Co. v. Bankers Trust Co., 925 F. Supp. 1270 (S.D. Ohio 1996).
361. Marine Bank v. Weaver, 455 U.S. 551 (1982).
362. See McLaughlin, supra note 2, at 204.
363. See Jackson, supra note 98, at 207. The ISDA Master Swap Agreement provides for the selection of either New York or English law. See 2 Das, Global Reference, supra note 35, at 1374.
364. McLaughlin, supra note 2, at 204-05.
365. See supra Part II.B.2.
366. See supra note 334 and accompanying text.
367. See supra notes 335-36 and accompanying text.
368. See Crawford & Sen, supra note 5, at 197-99.
369. See Culp, Primer on Derivatives, supra note 2, at 22. The standardization of futures contracts and the resulting ease of offset is what makes futures more attractive than other forms of derivatives to some derivatives users. See id. at 18.
370. Russo & Vinciguerra, supra note 172, at 470.
371. McLaughlin, supra note 2, at 187.
372. See Culp, Primer on Derivatives, supra note 2, at 18 (noting that the Chicago exchanges exploited the benefits of standardization in order to offer an attractive product that was different from privately negotiated derivatives).
373. See id. at 19-21.
374. Basis risk arises because the standardized terms of a futures contract do not match the underlying financial transaction to be hedged. This may be due to the fact that the asset whose price is to be hedged may not be exactly equal to the price of the futures contract. Also, the contract dates of the futures may not coincide with the execution, maturity, and payment dates of the underlying asset. Further, the underlying index of the future could differ from that of the underlying asset. See Hull, supra note 64, at 88-104.
375. See id.
376. See Treasury Management Ass'n, 1995 Derivatives Practices and Instruments Survey: Final Results 6 (1995). A market survey of corporate derivatives use by the Treasury Management Association, an industry association of individual treasury managers, found that 72% of the respondents used privately negotiated instruments, whereas only 17% used exchange-traded products. See id. The survey respondents reported that their preference for OTC instruments was due to their ability to selectively match their exposure. See id. at 2, 6.
377. See 2 Das, Global Reference, supra note 35, at 1061-1114. Das provides a thorough analysis of the complications of using futures contracts rather than a tailored privately negotiated contract to hedge financial exposures. These include among other things calculating the hedge, re-balancing the hedge in response to market moves, managing the financing costs of the hedge ("tail risk"), maturity and payment date mismatches, basis risk, and margin costs. See id. Das states that corporations usually have preferred to use privately negotiated derivatives over futures contracts. See id. at 1079. Corporations, in general, enter into privately negotiated derivatives with financial institutions. The financial institutions that are maintaining a portfolio of transactions and hedge their exposure at the margin, in turn hedge their financial risk with futures contract in addition to other financial instruments. See id.
378. See Kapner & Marshall, supra note 11, at 180.
379. Roger L. Anderson, The Treasury Department's Role in Regulating the Derivatives Marketplace, 66 Fordham L. Rev. 775, 778 (1997).
380. Wendy Lee Gramm & Gerald D. Gay, Ready-Fire-Aim: An Antidote to Derivative Regulation by Anecdote, in Derivatives Handbook: Risk Management and Control, supra note 8, at 433, 434.
381. See id. at 443.
382. Id. at 435.
383. See Culp, Primer on Derivatives, supra note 2, at 82.
384. See Crawford & Sen, supra note 5, at 199.
385. See Romano, supra note 30, at 51-53. The credit risk of futures contacts is very minute due to the clearinghouse mechanism (margin system) and is not that of any underlying counterparty, but the exchange itself. See Gibson, supra note 2, at 542. Indeed, futures exchanges were essentially thought to be without credit risk until the trading activity Nick Leeson on behalf of Barings Bank (Singapore office) on the Singapore Monetary Exchange ("SIMEX") resulted in significant losses and fears for the exchange's solvency. See Anatoli Kuprianov, Derivatives Debacles: Case Studies of Large Losses in Derivatives Markets, in Derivatives Handbook: Risk Management and Control, supra note 8, at 605, 617-19.
386. Culp, Primer on Derivatives, supra note 2, at 27.
387. See id.
388. See Crawford & Sen, supra note 5, at 197-98 (detailing several examples of derivatives use by individuals in the future that all involve the individual transacting with a financial institution and not another individual).
389. See Das, Swap Financing, supra note 14, at 34-35; see also 1 Das, Global Reference, supra note 35, at 26 ("As the variety of end-users on both sides of the market increased, potential couterparties grew increasingly reluctant to accept the credit risk involved.").
390. See 1 Das, Global Reference, supra note 35, at 26.
391. Bradley D. Belt & George P. Stamas, The Intangibles: Political, Regulatory and Reputational Risk, in An Introduction to VAR 3, 28 (Rod Beckström & Alyce Campbell eds., 1995) [hereinafter Belt & Stamas, Introduction to VAR].
392. See Loomis, supra note 15, at 59-68. Loomis provides a detailed analysis of the reputational harm and resulting business loss suffered by Bankers Trust as a result of the alleged losses by Procter & Gamble and Gibson Greetings Cards. See id.
393. See Cohen, supra note 43, at 2028-29.
394. See Michael R. Sesit, Morgan Unveils the Way It Measures Market Risk, Wall St. J., Oct 11, 1994, at C1. Sesit observes J.P. Morgan's release of proprietary information as an aggressive effort to establish the standard by which financial institutions and corporations measure risk. See id.
395. See id.
396. Derivatives Policy Group, Framework for Voluntary Oversight: A Framework for Voluntary Oversight of the OTC Derivatives Activities of Securities Firms Affiliates to Promote Confidence and Stability in Financial Markets (Mar. 1995). The Derivatives Policy Group consists of six investment banks: CS First Boston, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley, and Salomon Brothers. The group was established at the recommendation of Arthur Levitt, Chairman of the SEC. See id. at 1. The group established management, reporting, capital, and counterparty regulations. The firms voluntarily agreed to send compliance reports of these requirements to the SEC and CFTC. See id. at 2-3. It has been suggested that the best approach to the regulatory conundrum of derivatives would be an industry wide voluntary implementation of best practices. See Thomas A. Russo, Self Regulation, Futures Industry, Feb./Mar., 1999, at 16, 16. "A more appropriate approach to financial market 'regulation' is not regulation in the traditional sense; rather, a comprehensive, voluntary initiative spanning national boundaries and outdated distinctions among financial products and market participants presents the best answer to the regulatory quandary that has defied legal resolution." Id.
397. See 2 Das, Global Reference, supra note 35, at 1152. Credit ratings for the AAA subsidiaries are analogous to bond ratings. For a description of Moody's and Standard and Poor's bond ratings see Richard A. Brealey & Stewart C. Myers, Principles of Corporate Finance 664-65 (1996). The capital adequacy of a AAA derivatives subsidiary also know as a Special Purpose Derivatives Vehicle (SPDV) is the essential element that provides the subsidiary with a rating above that of its parent. See 2 Das, Global Reference, supra note 35, at 1154. In addition, Moody's and Standard and Poor's consider the proposed portfolio credit quality, counterparty credit risk, managerial and operating guidelines, and controls on the parent-subsidiary relationship. See id. at 1153. The capital level required to be maintained by the AAA is calculated by use of a risk model that estimates the effects of default and market risk on the AAA subsidiary's portfolio. See id. at 1154.
398. See 2 Das, Global Reference, supra note 35, at 1152.
399. See id.
400. Susan M. Phillips, Keynote Address at the Derivatives and Risk Management Symposium at Fordham University School of Law (1997), reprinted in 66 Fordham L. Rev. 767, 773 (1997).
401. Susan M. Phillips, Keynote Address at the Derivatives and Risk Management Symposium at Fordham University School of Law (1997), reprinted in 66 Fordham L. Rev. 767, 773 (1997).
402. Prior to the development of financial transactions on the Internet, Merton Miller noted that as derivatives markets operate telephonically, electronically, and by computer, they are "extremely sensitive to political and financial developments around the world and around the clock." McLauglin, supra note 78, at 195.
403. A eurobond is a bond that is sold by an international syndicate of underwriters to foreign investors. The underwriters are located primarily in London, although eurobonds may be sold throughout the world. See Brealey & Myers, supra note 374, at 682.
404. See Transnor (Bermuda) Ltd. v. BP North America Petroleum, 738 F. Supp. 1472, 1475 (S.D.N.Y. 1990) (defining Brent oil as "a blend of oils produced in various fields in the North Sea and delivered through pipelines for loading onto cargo ships at Sullem Voe in the Shetland Islands."). One of the issues in Transnor was whether or not the Brent oil market was an international or primarily United States market. See id. The court held the Brent market to be a United States market. See id. at 1475-76.
405. See supra note 11.
406. See supra notes 109-13 and accompanying text.
407. McLauglin, supra note 2, at 139.
408. See id. at 139-40.
409. See id. at 140.
410. See id.
411. Tormey, supra note 125, at 2360.
412. See id. at 2342, 2352-56, 2359 n.300.
413. See id.
414. See id. at 2319.
415. See id. at 2353.
416. Commodity Futures Trading Comm'n v. Standard Forex, Inc., No. CV93-0088, 1993 WL 809966, at *7 (E.D.N.Y. Aug. 9, 1993).
417. See Tormey, supra note 125, at 2320-21. "[T]he meaning of the term 'board of trade' has become hopelessly tangled in the controversy over the meaning of the so-called Treasury Amendment." Harris, supra note 203, at 1171. A narrow reading of the term would limit the exchange trading requirement of organized exchanges. See id. at 1172. A broad reading, however, where potentially transactions between two individuals could be included, "would render the Treasury Amendment purposeless, for virtually no transaction would escape CFTC jurisdiction." Id.
418. See Dunn v. Commodities Futures Trading Comm'n, 117 S. Ct. 913, 920-21 (1997).
419. See Tormey, supra note 125, at 2359 n.300.
420. 738 F. Supp. 1472 (S.D.N.Y. 1990).
421. See id. at 1493.
422. See McLaughlin, supra note 2, at 195.
423. See id.
424. Id.
425. See Belt & Stamas, Introduction to VAR, supra note 368, at 6 n.3.
426. See id.
427. See id.
428. See id.
429. See McLaughlin, supra note 2, at 34-35.
430. See id. at 35.
431. See supra notes 377-406 and accompanying text.
432. See Singher, supra note 174, at 1472 n.549.
433. See Wendy Lee Gramm, In Defense of Derivatives, Wall St. J., Sept. 8, 1993, at A12.
434. See generally Hu, Illiteracy and Intervention, supra note 193, at 2324-25 (discussing how current securities disclosure rules that emphasize issuer-specific information has led to asset-class "illiteracy").
435. See id. at 2321-23.
436. See id. at 2322.
437. See id. at 2323.
438. See id.
439. See id.
440. See id. at 2359-60.
441. See id. at 2360.
442. See id.
443. See id. at 2329.
444. Id.
445. See Cox, supra note 114, at 71.
446. See id.
447. 17 C.F.R. § 230.175(c) (1996) (definition of "forward-looking statement" for purposes of Rule 175 safe harbor).
448. See id.
449. 15 U.S.C. § 77z-2 (Supp. II 1996) (definition of "forward-looking statement" for purposes of the Act's safe harbor).
450. Hu, Illiteracy and Intervention, supra note 193, at 2329.
451. See id. at 2358-59.
452. Id. at 2359.
453. See id. at 2362.
454. Id.
455. Id.
456. Id. at 2365.
457. See id. at 2366.
458. Id.
459. In 1994, it was reported that losses by users of derivatives reached $10 billion. See Adams & Runkle, supra note 19, at 1. In discussions of derivative losses, the aggregate reports generally do not distinguish between whether the derivatives involved were swaps, futures, or securities with embedded derivatives. Among the most notable publicly reported or acknowledged losses of users of derivatives include: Gibson Greetings ($23 million); Procter & Gamble ($157 million); MG Corp., the [United States] subsidiary of Germany's Metallgesellschaft AG ($1.5 billion); Dell Computer; Atlantic Richfield Co. ($22 million); Marion Merrell Dow ($11 to $14 million); Mead Corp. ($7.4 million); Paramount Communications ($20 million); Caterpillar's financial services unit ($13.2 million); City Colleges of Chicago ($40 million); Odessa College ($10 to $20 million); Escambia County, Florida ($19 million); Wisconsin's investment fund ($95 million); and Orange County, California ($2 billion). Id. at 1-2.
460. See Gibson, supra note 2, at 529-30.
461. Walter C. Greenough, The Limits of the Suitability Doctrine in Commodity Futures Trading, 47 Bus. Law. 991, 993-94 (1992) (quoting NASD Rules of Capital Fair Practice, art. III, § 2 (a), NASD Manual (CCH) 1 2152, at 2051).
462. Id. at 994 (alteration in original).
463. Jennifer A. Frederick, Note, Not Just for Widows & Orphans Anymore: The Inadequacy of the Current Suitability Rules for the Derivatives Market, 64 Fordham L. Rev. 97, 108 (1995).
464. Id. at 103.
465. See Belt & Stamas, Introduction to VAR, supra note 368, at 16 n.29.
466. See Comptroller of the Currency, Risk Management of Financial Derivatives (1993); Gibson, supra note 2, at 567-68.
467. See id. at 569.
468. Greenough, supra note 437, at 993; see also id. at 1006 ("Is someone with a large net worth and a proclivity for gambling less 'suitable' than someone who is less wealthy but more controlled?").
469. See id. at 1007-08.
470. See id. (detailing that the costs of monitoring the consumer's financial and emotional suitability would be passed onto the consumer, regardless of whether he wanted the service).
471. Id. at 1008.
472. Id.
473. Gibson, supra note 2, at 581.
474. See id.
475. Id. at 581 n.346.
476. George Crawford, A Fiduciary Duty to Use Derivatives?, 1 Stan. J. L. Bus. & Fin., 307, 307 (1995).
477. Brane v. Roth, 590 N.E.2d 587 (Ind. Ct. App. 1992). The derivative instruments involved in Brane are exchange-traded futures, and not privately negotiated derivatives. See supra notes 41-84 and accompanying text.
478. See Brane, 590 N.E.2d at 589.
479. See id.
480. See id.
481. See id.
482. See id.
483. See id.
484. See id.
485. See id. at 589-91.
486. See McLaughlin, supra note 2, at 469-70.
487. See id. at 470 (quoting Daniel P. Cunningham, Do Corporations Have a Duty to Hedge? Brane v. Roth and In re Compaq, in Smithson et al., Managing Financial Risk 67, 67-70 (1995)).
488. Hu, Hedging Expectations, supra note 16, at 1016 & n.143. But see McLaughlin, supra note 2, at 470 (criticizing a broad interpretation of Brane's holding). McLauglin disagrees that the Brane holding supports a proposition that managers and directors, or even trustees have a duty to hedge. He suggests that the case only implies that: (1) management must understand the fundamentals of a hedging product and for what use it is intended before making a decision to use that product; and (2) management must oversee the actual implementation of the hedging product to ensure that it is being used as intended. See id. at 472.
489. See Crawford & Sen, supra note 5, at 195.
490. See 2 Das, Global Reverence, supra note 35, at 1444-45. An interesting idea for a macro swap is discussed by John F. Marshall, Derivatives and Risk Management, in The New Tool Set: Assessing Innovations in Banking 1995, at 79, 83-84. He suggests that the use of macro swaps could ultimately aid in balancing the United States budget. The Treasury could enter into Gross National Product linked swaps to immunize revenues or even enhance revenues during a recession. See id. at 84.
491. In fact, individual investor hedging is the base foundation for the modern financial theory, the Capital Asset Pricing Model. See Brealey & Meyers, supra note 374, at 153-65.