Commodity Markets Under Scrutiny After New York Raid

A SURPRISE civil and criminal investigation into four of New York's commodity exchanges has sent shock waves throughout the financial community here. ``We've had one shoe drop with the investigation into trading practices at the commodity markets out in Chicago, so it was almost inevitable that the other shoe would have to drop with an inquiry into practices by commodity brokers in New York,'' says Samuel Hayes III, a professor specializing in investment banking at the Harvard Business School.

The probe has also focused attention on an upcoming congressional hearing into federal enforcement practices pertaining to commodity markets in the United States. The Washington hearing - undertaken by the Senate Agriculture Committee - will be held May 17. Lawmakers will take a ``hard look at exactly how well the federal regulators tasked with overseeing the commodity markets are fulfilling their duties,'' says a spokesman for the committee.

Last Thursday, a team of federal agents representing the US Postal Service, the Commodity Futures Trading Commission (CFTC) - the main federal agency that oversees the commodity markets - and the Manhattan US attorney's office made a dramatic raid, unexpectedly swooping down on four key exchanges and in some cases actually pulling stunned traders off the floor. The four exchanges are the New York Mercantile Exchange, the Commodity Exchange Inc., the Coffee, Sugar, and Cocoa Exchange, and the Cotton Exchange. Subpoenas were served on the exchanges, as well as dozens of employees who work for the exchanges.

The exchanges share a large, crowded floor at the World Trade Center. A fifth exchange, the New York Futures Exchange, did not receive a subpoena in last week's investigation.

In January, federal agents served scores of subpoenas at the two main commodity exchanges in the US - the Chicago Mercantile Exchange, and the Chicago Board of Trade. No criminal indictments have yet been issued following that investigation, which is said to be entirely separate from the New York probe. Still, experts such as Professor Hayes see the New York inquiry as a broadening of the federal probe into commodity markets.

``The whole modus of the commodities area has been one of caveat emptor - let the buyer beware,'' Hayes says. The investor ``can go for the long shot,'' in terms of making potentially huge profits on a commodities trade. But the other side of the equation, says Hayes, is that ``there is just not the type of careful, close scrutiny of commodities trading that there is with equities, such as with the New York Stock Exchange or the American Stock Exchange.''

``I really wasn't surprised'' at last week's investigation, says Thomas O'Hara, chairman of the National Association of Investors Corporation of Royal Oak, Mich. The NAIC is a trade group representing clubs of smaller investors throughout the US. ``The commodity exchanges tend to attract individuals who have a strong gambling bent, folks looking for a quick opportunity,'' Mr. O'Hara says. Commodity trading tends to be specialized and limited to relatively small groups of investors compared to the 40 million or so Americans who own common stock. As a result, it has tended to operate away from the hard glare of news media and congressional oversight, O'Hara notes.

Commodity markets deal in ``futures'' - agreements to buy or sell a specific commodity such as oil, cotton, gold, or silver. Traders bargain specific prices for specific future dates. Shrewd investors can make potentially large profits based on the movements of price over time.

The probe by the CFTC here is said to in part involve ``tax trades.'' Tax trades are trading agreements designed to allow an investor to obtain a false loss, which in turn allows the investor to obtain illegal tax benefits.

The CFTC has come under increasing criticism in recent months, following the substantial pattern of trading abuses now alleged to have occurred in Chicago. Thus, during the May 17 hearing lawmakers are expected to probe the day-to-day oversight of the CFTC, as well as whether there are legal loopholes that allow commodities traders to circumvent existing regulations.