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Senate Hearing Criticizes Fund Investments in Commodity Markets

Yesterday, the Senate Permanent Subcommittee on Investigations held a hearing about excessive speculation in the U.S. commodity markets.  Subcommittee Chairman Carl Levin (D-MI) used the hearing to reiterate his concerns about mutual funds investing in commodity-related instruments.  His main concern is that if mutual funds continue to increase their investments in this area, a "tidal wave of speculative money" will be "unleashed" on the commodity markets.  In his opinion, this would increase speculation and price manipulation which distort commodity prices from their actual value derived from supply and demand.  He lauded recent CFTC and IRS efforts to review the use of commodity-related instruments by mutual funds and criticized private letter rulings issued by the IRS that allow mutual funds to invest indirectly in commodities through wholly owned subsidiaries.

As way of background, in order for a fund to maintain its tax status under the Internal Revenue Code, it may only generate 10% of its gross income from commodities.  The IRS has issued about 80 private letter rulings that permit funds to use wholly-owned subsidiaries to invest indirectly in commodity-related instruments without destroying their tax status.  However, in July of this year, the IRS suspended the issuance of these private letter rulings, citing concerns over an increased number of private letter ruling requests, recent congressional action in the area, new CFTC activity related to investment companies and a heightened level of public interest.

The CFTC has also recently focused on the issue of mutual funds investing in commodity markets.  They are currently considering regulations, proposed in January, that may limit funds' ability to invest in certain commodity-linked instruments, such as futures, options on futures and options on commodities. The Mutual Fund Directors Forum submitted a comment letter opposing the proposal and suggesting material changes to how it addresses the role of the directors of registered funds, particularly Independent Directors.