Analysis: Regulators likely lucked out on oil rigging case
WASHINGTON (Reuters) - U.S. regulators, eager to send a tough message to high flying oil markets by bringing its biggest ever oil manipulation case to court, may have simply gotten lucky.
The Commodity Futures Trading Commission announced in late May it was suing two well-known traders and two trading firms owned by Norwegian billionaire John Fredriksen for manipulating oil prices by buying and selling physical crude in Cushing, Oklahoma, the delivery point for the U.S. crude contract.
One source familiar with how the CFTC conducts its surveillance said, the agency would not have detected the alleged manipulative trading in its regular day-to-day practice. They likely discovered it through a tip, said the source.
That's because the alleged manipulation took place in the physical crude oil market, which the CFTC with its limited resources polices more lightly than the huge futures oil market it oversees.
The outsider tip could help damper what some said marked a bold new era in CFTC enforcement, when it charged traders Nick Wildgoose of London-based Arcadia Energy and James Dyer of Oklahoma's Parnon Energy, an Arcadia subsidiary, for a trading scheme that took advantage of how cash and futures markets relate.
Rather than a shot across the bow to those who would use leverage in the opaque physical market to make profits on derivative positions, the case may represent a rare opportunity for the stretched CFTC to flex its muscle in a dark corner of the market that traders have long exploited to their advantage.
"It's a herculean task to find that needle in a haystack," said Geoffrey Aronow, a partner with the law firm of Bingham McCutchen and a former CFTC enforcement director.
"It's more likely that something was brought to their attention," he added.
Nevertheless, win or lose, the case could be pivotal for an agency under pressure to corral oil markets that have caused oil and gasoline prices to soar this year.
CLOSING A LOOPHOLE
The case accuses the traders of amassing large physical positions to create the impression of tight supplies that justified prices moving higher. Later, as they sold those barrels back onto the market, prices fell. They racked up profits from short positions accumulated in futures contracts, the suit alleged.
The CFTC does pay attention to the physical oil market, but they can only take action if illegal moves there spill into the futures market.
"They don't have a federal regulator," Dan Waldman, a former CFTC general counsel and now a partner with Arnold & Porter, said of the physical market.
"They are governed by state commercial law for the most part, and nobody monitors who is buying and selling dishwashers anymore than who is buying and selling oil," Waldman said.
Industry watchers said the suit could prompt the CFTC to expand the time it spends closely monitoring price relationships between the two markets.
Under the current practice, CFTC ramps up its surveillance during the last few days before a futures contract expires. The market becomes most vulnerable to corners and squeezes during this trading period.
But the traders took advantage of a narrow window in which the physical market continues to trade after the expiration of the futures contract. This time period is far less likely to catch the attention of the understaffed and overworked surveillance personnel at the CFTC.
"The one thing that is going to change is the fact that now that the cat's out of the bag and people know this is a game that can be played. And the CFTC will try its best to make sure it is catching that stuff," said Michael Gorham, a former CFTC market oversight director, now teaching at the Illinois Institute of Technology Stuart School of Business.
CFTC TO FLEX MUSCLES
It has been rare for the CFTC to pursue cases involving market manipulation, because current regulations make it almost impossible to prove an individual intended to manipulate prices.
The CFTC can claim only a single victory in a manipulation suit: a case that accused a trader of gaming electricity futures in 1998. The case dragged on for over a decade before the agency finally won.
The CFTC may be better placed in the future, however, when it's armed with the new Dodd-Frank anti-manipulation powers. The new rules lower the burden of proof, only requiring the CFTC to show a trader acted in a manner that had the potential to disrupt the market.
David Meister, CFTC Chairman Gary Gensler's new enforcement chief, has promised to take on more cases and aggressively use a "bigger arsenal of weapons," that he is about to inherit under Dodd-Frank.
"I think the bringing of this case could signal some willingness on the part of the CFTC to take more risk in bringing cases," Brad Berry, a former CFTC deputy general counsel and now a partner at Baker Botts.
"That's one thing that could account for the bringing of this case," Berry added.
Many expect Meister to follow through on his promise to target, "more cutting edge, high-impact cases," by investigating broader industry, OTC fraud and manipulative schemes.
"There will be suits to follow," said Michael Greenberger, a former CFTC trading and markets director, who is now a professor at the University of Maryland School of Law.
"This will be very therapeutic for the market as I think a lot of people in the market thought there was nobody looking over their shoulders," professor said.
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