Federal regulators yesterday took steps to improve safeguards for commodity traders in the wake of a gold scandal last March that has tied up $13 million in customer funds and put in doubt a pilot program of futures-options trading on exchanges.
The Commodity Futures Trading Commission voted unanimously to seek public comment on proposals to increase capital requirements for firms involved in this type of trading and to set margin guidelines for certain risky options transactions. The agency also sought comment on how best to transfer or liquidate individuals' accounts when a commodity brokerage firm goes broke, and asked the National Futures Association, a self-regulatory organization, to study establishing an investor insurance fund.
On March 20, Volume Investors Corp., a member of the Commodity Exchange in New York, collapsed when it was unable to come up with funds to meet a margin call by the Comex clearing house. The broker's default was caused by the failure of three customers to come up with $26 million to cover losses on gold options. The customers, apparently betting that gold prices would fall, had sold short-call options promising to sell gold at a fixed price. When gold soared by $44 per ounce overnight, they were unable to cover their losses. Volume Investors failed and its collapse tied up the accounts of about 100 other customers.
Futures options give the buyer the right to buy or sell a futures contract on a commodity. A short-call option means that the option writer, who bets the price of the commodity will decline or remain stable, has to deliver the contract or its cash equivalent if the price goes up.
Last week, Volume's owners agreed to a tentative settlement that calls for a payment of $2.5 million in cash and a $1.6 million promissory note. In exchange, Comex agreed not to take action for violation of its rules.
The results of CFTC's investigation of Volume were announced yesterday. Among the six major factors cited in its demise were the low cost of acquiring short option positions, the lack of minimum margin requirements that encourage speculation, and the failure of existing market surveillance techniques to spot the extent of risks taken.
The CFTC said Volume failed to stop doing new business once it got into trouble and, as a result, other customers' money was used to pay some of the three defaulting customers' margin calls.
The gold default occurred in the third year of a four-year pilot program in trading futures options. This should serve as an "ominous warning to the whole options pilot program," said CFTC Commissioner Fowler West. "This failure was the kind of thing that put options out of business for years in the United States." The pilot program was restored by CFTC after a four-year ban. Congress is due to review it in October.
Under the capital requirements proposed yesterday, Volume would have needed an additional $14 million to carry on its trading.