Font Size: AAA // Print // Bookmark

2011-6398

  • Federal Register, Volume 76 Issue 53 (Friday, March 18, 2011)[Federal Register Volume 76, Number 53 (Friday, March 18, 2011)]

    [Notices]

    [Pages 14943-14948]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2011-6398]

    =======================================================================

    -----------------------------------------------------------------------

    COMMODITY FUTURES TRADING COMMISSION

    Antidisruptive Practices Authority

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Proposed Interpretive Order.

    -----------------------------------------------------------------------

    SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

    ``CFTC'') is proposing this interpretive order to provide interpretive

    guidance regarding the three statutory disruptive practices set forth

    in new section 4c(a)(5) of the Commodity Exchange Act (``CEA'')

    pursuant to section 747 of the Dodd-Frank Wall Street Reform and

    Consumer Protection Act (``Dodd-Frank Act''). The Commission requests

    comment on all aspects of the proposed interpretive order.

    DATES: Comments must be received on or before May 17, 2011.

    ADDRESSES: Comments, identified by RIN number, may be sent by any of

    the following methods:

    Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments

    through the Web site.

    Mail: David A. Stawick, Secretary of the Commission,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow the instructions for submitting comments.

    FOR FURTHER INFORMATION CONTACT: Robert Pease, Counsel to the Director

    of Enforcement, 202-418-5863, rpease@cftc.gov; Steven E. Seitz,

    Attorney, Office of the General Counsel, 202-418-5615, sseitz@cftc.gov;

    or Mark D. Higgins, Counsel to the Director of Enforcement, 202-418-

    5864, mhiggins@cftc.gov, Commodity Futures Trading Commission, Three

    Lafayette

    [[Page 14944]]

    Centre, 1151 21st Street, NW., Washington, DC 20581.

    All comments must be submitted in English, or if not, accompanied

    by an English translation. Comments will be posted as received to

    http://www.cftc.gov. You should submit only information that you wish

    to make available publicly. If you wish the Commission to consider

    information that may be exempt from disclosure under the Freedom of

    Information Act (``FOIA''),\1\ a petition for confidential treatment of

    the exempt information may be submitted according to the established

    procedures in Sec. 145.9 of the CFTC's regulations.\2\ The Commission

    reserves the right, but shall have no obligation, to review, prescreen

    filter, redact, refuse, or remove any or all of your submission from

    http://www.cftc.gov that it may deem to be inappropriate for

    publication, such as obscene language. All submissions that have been

    redacted or removed that contain comments on the merits of the

    rulemaking will be retained in the public comment file and will be

    considered as required under the Administrative Procedure Act and other

    applicable laws, and may be accessible under FOIA.

    ---------------------------------------------------------------------------

    \1\ 5 U.S.C. 552.

    \2\ 17 CFR 145.9.

    SUPPLEMENTARY INFORMATION:

    Prohibition of Disruptive Practices

    I. Statutory and Regulatory Authorities

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

    Reform and Consumer Protection Act (``Dodd-Frank Act'').\3\ Title VII

    of the Dodd-Frank Act \4\ amended the Commodity Exchange Act (``CEA'')

    \5\ to establish a comprehensive new regulatory framework for swaps and

    security-based swaps. The legislation was enacted to reduce risk,

    increase transparency, and promote market integrity within the

    financial system by, among other things: (1) Providing for the

    registration and comprehensive regulation of swap dealers and major

    swap participants; (2) imposing clearing and trade execution

    requirements on standardized derivative products; (3) creating robust

    recordkeeping and real-time reporting regimes; and (4) enhancing the

    Commission's rulemaking and enforcement authorities with respect to,

    among others, all registered entities and intermediaries subject to the

    Commission's oversight.

    ---------------------------------------------------------------------------

    \3\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act of 2010, Public Law 111-203, 124 Stat. 1376 (2010). The text of

    the Dodd-Frank Act may be accessed at http://www.cftc.gov./

    LawRegulation/OTCDERIVATIVES/index.htm.

    \4\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may

    be cited as the ``Wall Street Transparency and Accountability Act of

    2010.''

    \5\ 7 U.S.C. 1 et seq.

    ---------------------------------------------------------------------------

    Section 747 of the Dodd-Frank Act amends section 4c(a) of the CEA

    to add a new section entitled ``Disruptive Practices.'' New CEA section

    4c(a)(5) makes it unlawful for any person to engage in any trading,

    practice, or conduct on or subject to the rules of a registered entity

    that--

    (A) Violates bids or offers;

    (B) Demonstrates intentional or reckless disregard for the orderly

    execution of transactions during the closing period; or

    (C) Is, is of the character of, or is commonly known to the trade

    as, ``spoofing'' (bidding or offering with the intent to cancel the bid

    or offer before execution).

    Dodd-Frank Act section 747 also amends section 4c(a) by granting

    the Commission authority under new CEA section 4c(a)(6) to promulgate

    such ``rules and regulations as, in the judgment of the Commission, are

    reasonably necessary to prohibit the trading practices'' enumerated

    therein ``and any other trading practice that is disruptive of fair and

    equitable trading.''

    The Commission is issuing this proposed interpretive order to

    provide market participants and the public with guidance on the scope

    of the statutory prohibitions set forth in section 4c(a)(5). The

    Commission requests comment on all aspects of this proposed

    interpretive order, as well as comment on the specific provisions and

    issues highlighted below.

    II. Background

    On November 2, 2010, the Commission issued an advance notice of

    proposed rulemaking (``ANPR'') asking for public comment on all aspects

    of Dodd-Frank Act section 747.\6\ When the ANPR was issued, the

    Commission was considering whether to adopt regulations regarding the

    disruptive practices set forth in new CEA section 4c(a)(5). After

    reviewing the ANPR comments, the Commission determined that it was

    appropriate to address the statutory disruptive practices through a

    proposed interpretive order. Accordingly, a Commission document

    terminating the ANPR is being published elsewhere in the Proposed Rules

    section of this issue of the Federal Register. Notwithstanding that

    termination, the Commission considered all of the ANPR commentary in

    developing this proposed interpretive order.

    ---------------------------------------------------------------------------

    \6\ 75 FR 67301, Nov. 2, 2010.

    ---------------------------------------------------------------------------

    In the ANPR, commenters were encouraged to address the nineteen

    specific questions posed by the Commission in the ANPR.\7\ The ANPR

    requested, among other things, comment on section 747(A) (``violating

    bids and offers''), section 747(B) (``the disorderly execution of

    transactions around the closing period''), section 747(C)

    (``spoofing''), the role of executing brokers, and the regulation of

    algorithmic and automated trading systems.\8\ The questions in the ANPR

    also formed the basis for a December 2, 2010, roundtable held by

    Commission staff in Washington, DC.\9\ The full-day roundtable

    consisted of three panels \10\ that addressed the ANPR questions, the

    role of exchanges in CFTC-regulated markets, and whether there are

    other potential disruptive trading practices that the Commission should

    prohibit. The ANPR set a deadline of January 3, 2011, by which comments

    had to be submitted.\11\ In response to the ANPR, the Commission

    received 28 comments from interested parties,\12\ including industry

    members, trade associations, consumer groups, exchanges, one member of

    the U.S. Congress, and other interested members of the public.\13\ The

    Commission has carefully considered all of the ANPR comments, as well

    as the roundtable discussion, in proposing this interpretive order.

    ---------------------------------------------------------------------------

    \7\ The ANPR may be accessed through: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=893.

    \8\ 75 FR 67302, Nov. 2, 2010.

    \9\ See Appendix III for a list of roundtable participants and

    discussion panels. A verbatim transcript of the disruptive trading

    practices roundtable may be accessed at http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission24_120210-transcri.pdf.

    \10\ Note that citations to statements by the panelists at the

    public roundtable will be cited as [Panelist name at page X of

    roundtable transcript].

    \11\ 75 FR 67301, Nov. 2, 2010.

    \12\ See Appendix IV for a list of parties submitting comment

    letters in response to the ANPR.

    \13\ The comment letters received by the Commission in response

    to the ANPR may be accessed through: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=893.

    ---------------------------------------------------------------------------

    Throughout the roundtable discussion and comment letters, there was

    widespread support for the Commission's goal of preventing disruptive

    trading practices and ensuring fair and equitable markets.\14\ Several

    themes emerged from the roundtable discussion and the comment

    [[Page 14945]]

    letters, which are discussed below in the following sections.

    ---------------------------------------------------------------------------

    \14\ Liam Connell at 40 (``Allston Trading supports the mission

    of the CFTC to maintain orderly markets and to prohibit deceptive

    practices and manipulative trading.''); Rajiv Fernando at 17 (``I

    support the CFTC's effort to ensure that markets operate in an

    orderly way that's fair for all participants.''); Argus at 1

    (``Argus supports the important goal of preventing disruptive trade

    practices in CFTC jurisdictional markets.'').

    ---------------------------------------------------------------------------

    a. Market Participants Request Additional Guidance Regarding the Scope

    and Application of Section 747's Provisions

    Throughout the Commission roundtable, panelists stated that the

    provisions of section 747 were vague \15\ and did not provide market

    participants with adequate notice of the type of trading, practices,

    and conduct that is prohibited by section 4c(a)(5).\16\ Several comment

    letters also raised concerns about vagueness and believed that Dodd-

    Frank Section 747 was susceptible to constitutional challenge.\17\

    Comment letters requested that the Commission provide additional

    guidance concerning the conduct and trading practices that constitute

    violations under the statute.\18\ During the roundtable discussion,

    panelists also requested additional clarity and refinement in the

    definition of terms such as ``the orderly execution of transactions,''

    \19\ ``closing period,'' \20\ and ``spoofing.'' \21\ The comment

    letters reiterated this concern and expressed the need for the

    Commission to define these terms and other concepts such as violating

    bids and offers.\22\

    ---------------------------------------------------------------------------

    \15\ See. e.g., Gary DeWaal at 57 (``This is an incredibly vague

    provision.''); Greg Mocek at 170 (``There are a lot of issues on

    vagueness.'').

    \16\ See, e.g., Adam Nunes at 20 (``Additional guidance * * * is

    going to be necessary.''); Ike Gibbs at 157 (``We would really

    prefer to see a scenario where the Commission is not overly

    prescriptive [and] we're given guidance as to what's appropriate and

    what's not appropriate.'').

    \17\ See, e.g., Managed Funds Association at 4 (``Dodd-Frank Act

    Section 747 as written is vague and particularly vulnerable to

    constitutional challenge by market participants.''); CME Group at 2

    (``As written, Section 747 is vague and susceptible to

    constitutional challenge.'').

    \18\ See, e.g., American Petroleum Institute at 2 (``The

    Commission should provide specific guidance regarding the scope of

    the trading practices listed in 747.''); Investment Company

    Institute at 2 (Recommending that the ``Commission provide

    additional guidance as to the types of conduct that would constitute

    violations under the statute.''); HETCO at 4 (``The Commission

    should resolve the ambiguity in Section 4c(a)(5) by articulating the

    specific types of disruptive practices that prompted it to request

    the new enforcement authority in Section 747.'').

    \19\ See, e.g., Adam Nunes at 26 (``When we look at disruptive

    trading practices and the intentional reckless disregard for orderly

    execution that is going to be very difficult to define.'').

    \20\ See, e.g., Don Wilson at 46 (``The definition of those

    rules around what is and is not acceptable in the closing period

    needs to be carefully considered.'').

    \21\ See, e.g., Gary DeWaal at 64 (``I'm not sure the definition

    of spoofing can be agreed upon by the ten people around this

    table.''); John J. Lothian at 82 (Referring to `spoofing' as a

    ``very undefined type of term within the industry.'').

    \22\ See, e.g., Futures Industry Association at 3 (``Definitions

    such as `orderly execution,' `violates bids or offers' and

    `spoofing' in Sections 4c(a)(5)(A), (B) and (C), respectively,

    require refinement and clarification by the Commission.'').

    ---------------------------------------------------------------------------

    Panelists and commenters also sought clarity on whether scienter is

    required for each of the enumerated practices of section 4c(a)(5), and

    if so, specificity as to the degree of intent required. Roundtable

    panelists \23\ and commenters \24\ stated that a showing of bad intent

    should be necessary to distinguish prohibited conduct from legitimate

    trading activities. Panelists further stressed that any evaluation of

    trading behavior must consider the historical trading patterns and

    practices of market participants.\25\

    ---------------------------------------------------------------------------

    \23\ See, e.g., Adam Nunes at 36 (``The intent to manipulate * *

    * [is] critically important.''); Cameron Smith at 37 (``What really

    needs to be there in my mind is some notions of intent or phrases

    like ``for the purpose of.''); Don Wilson at 47 (``I think it really

    comes down to intent.''); Mark Fabian at 163 (``I think everyone has

    agreed that intent is something that is required.'').

    \24\ See, e.g., Chopper Trading at 3 (``Any definition of

    spoofing must include an element of an intent to manipulate the

    market.''); FIA at 4 (``The Commission should clarify that

    manipulative intent to create an artificial price is required to

    violate 5(A)'s prohibition on violating bids or offers * * * [and]

    that manipulative intent is necessary under 5(B)'s prohibition.'');

    International Swaps and Derivatives Association at 3 (``Manipulative

    intent is a necessary element of `manipulative' or `disruptive'

    conduct.'').

    \25\ See, e.g., Adam Nunes at 94 (``[I]t's really a pattern and

    practice of activity.''); John Hyland at 147 (``It's patterns and

    practices, facts and circumstances.''); Mark Fabian at 163 (``A

    pattern is also required.'').

    ---------------------------------------------------------------------------

    In response to these comments, the Commission is proposing this

    Interpretive Order to provide additional guidance to market

    participants and the public on the types of trading, conduct, and

    practices that will constitute violations of section 4c(a)(5). This

    proposed interpretive order addresses the concerns expressed by the

    commenters regarding market uncertainty by clarifying how the

    Commission will interpret and implement the provisions of section

    4c(a)(5). By the terms of the statute, 4c(a)(5) applies to trading,

    practices or conduct on or subject to the rules of a registered entity:

    a designated contract market or a swap execution facility

    (``SEF'').\26\ The Commission interprets that section 4c(a)(5) will not

    apply to block trades or exchanges for related positions (``EFRPs'')

    transacted in accordance with the rules of a designated contract market

    or SEF or bilaterally negotiated swap transactions.

    ---------------------------------------------------------------------------

    \26\ The Commission does not believe that a trade becomes

    subject to 4c(a)(5) solely because it is reported on a swap data

    repository, even though a swap data repository is a registered

    entity.

    ---------------------------------------------------------------------------

    The Commission stresses the important role and unique position of

    exchanges and self-regulatory organizations to ensure that markets

    operate in a fair and equitable manner without disruptive trading

    practices.\27\ The Commission agrees with commenters and panelists that

    a multi-layered, coordinated approach is required to prevent disruptive

    trading practices and ensure fair and equitable trading through

    enforcement of these provisions.\28\

    ---------------------------------------------------------------------------

    \27\ See, e.g., CME Group Rule 432B.2 (``It shall be an offense

    * * * to engage in conduct or proceedings inconsistent with just and

    equitable principles of trade.'').

    \28\ See, e.g., FIA at 10 (``FIA strongly believes that a multi-

    layered enforcement approach, which implements policies and

    procedures at the firm, exchange and clearing level, will most

    effectively mitigate the risk of market disruptions.'').

    ---------------------------------------------------------------------------

    i. Violating Bids and Offers

    1. Comments From ANPR and Roundtable

    During the roundtable discussion, panelists questioned how the

    concept of violating bids and offers applies across various trading

    platforms and markets.\29\ Commenters expressed a similar concern \30\

    and requested that the Commission clarify how the prohibition against

    violating bids and offers applies to swaps,\31\ open outcry pits,\32\

    infrequently traded over-the-counter products,\33\ and electronic

    trading venues where the best bid and offer are matched automatically

    by algorithm.\34\

    ---------------------------------------------------------------------------

    \29\ See, e.g., Greg Mocek at 173 (``There's more practical

    issues to think about in the context of the concepts themselves and

    how the industry is structured, like violating a bid and an

    offer.''); Ken Raisler at 176 (generally asking how the concept of

    violating bids and offers applies to over-the-counter markets, swap

    execution facilities, and block trades).

    \30\ See, e.g., CME Group at 4 (``The Commission should make

    clear that the prohibition on violating bids or offers is not

    intended to create a best execution standard across venues as any

    such standard would be operationally and practically untenable.'').

    \31\ See, e.g., ISDA at 2 (``The phrase `violating bids and

    offers' simply has no meaning in most if not all swaps markets. The

    pricing and trading of many swaps involves a variety of factors

    (e.g., size, credit risk) which, taken together, render the concept

    of ``violating bids or offers'' as inapposite.'').

    \32\ See, e.g., CME Group at 4 (generally discussing how the

    concept of violating bids and offers applies to open outcry trading

    environments).

    \33\ See, e.g., FIA at 4 (``The Commission should clarify that

    the prohibition on violating bids or offers does not apply in the

    over-the-counter markets.'').

    \34\ See, e.g., CME Group at 4 (``Order matching algorithms on

    electronic platforms preclude bids and offers from being

    violated.''); FIA at 4 (``Matching engines make it impossible to

    sell or buy except at the best available quote.''); MFA at 5 (``The

    term `violate bids or offers' * * * has virtually no application to

    electronic trading where systems buy or sell at the best available

    quote.'').

    ---------------------------------------------------------------------------

    2. Commission Guidance

    The Commission interprets section 4c(a)(5)(A) as prohibiting any

    person from buying a contract at a price that is

    [[Page 14946]]

    higher than the lowest available offer price and/or selling a contract

    at a price that is lower than the highest available bid price. Such

    conduct, regardless of intent, disrupts the normal forces of supply and

    demand that are the foundation of fair and equitable trading. This

    proposed interpretive order is consistent with exchange rules that

    prohibit the violation of bids and offers.\35\ Notably, Congress did

    not include an intent requirement in section 4c(a)(5)(A) as it did in

    both sections 4c(a)(5)(B) and (C). Accordingly, the Commission

    interprets section 4c(a)(5)(A) as a per se offense, that is, the

    Commission is not required to show that a person violating bids or

    offers did so with any intent to disrupt fair and equitable trading.

    ---------------------------------------------------------------------------

    \35\ See, e.g., New York Mercantile Exchange Rule 514.A.3;

    Minneapolis Grain Exchange Rule 731.00.

    ---------------------------------------------------------------------------

    The Commission agrees that section 4c(a)(5)(A) does not apply where

    a person is unable to violate a bid or offer--i.e. when a person is

    utilizing an electronic trading system where algorithms automatically

    match the best bid and offer.\36\ Section 4c(a)(5)(A) will operate in

    any trading environment where a person exercises some control over the

    selection of the bids or offers against which they transact, including

    in an automated trading system which operates without pre-determined

    matching algorithms. The Commission recognizes that at any particular

    time the bid-ask spread in one trading environment may differ from the

    bid-ask spread in another trading environment. Accordingly, in the view

    of the Commission, section 4c(a)(5)(A) does not create any sort of best

    execution standard across multiple trading platforms and markets;

    rather, a person's obligation to not violate bids or offers is confined

    to the specific trading venue which he or she is utilizing at a

    particular time. Finally, section 4c(a)(5)(A) does not apply where an

    individual is ``buying the board''--that is, executing a sequences of

    trades to buy all available bids or offers on that order book in

    accordance with the rules of the facility on which the trades were

    executed.

    ---------------------------------------------------------------------------

    \36\ See, e.g., CME Group at 4 (``Order matching algorithms on

    electronic platforms preclude bids and offers from being

    violated.'').

    ---------------------------------------------------------------------------

    ii. Orderly Execution of Transactions During the Closing Period

    1. Comments From ANPR and Roundtable

    Roundtable panelists expressed the view that additional clarity was

    needed for the definitions incorporated in section 747(B), in

    particular, terms such as ``closing period.'' \37\ Commenters also

    requested clarification on the definition of closing period and

    requested Commission guidance on whether the prohibition on disorderly

    execution of transactions extends to conduct occurring outside the

    closing period.\38\ More specifically, some commenters requested that

    the prohibitions in section 747(B) be limited to manipulative conduct

    such as ``banging'' or ``marking the close.'' \39\

    ---------------------------------------------------------------------------

    \37\ See, e.g., Greg Mocek at 173 (``It's easy to define the

    term `closing period' presumably in a designated contract market.

    Are you planning on defining that period in a SEF?'').

    \38\ See, e.g., API at 12 (``Trading practices or conduct

    outside the closing period are not relevant to determine whether

    conduct inside the closing period is deemed `orderly'.''); HETCO at

    7 (``HETCO urges the Commission to refrain from applying the

    prohibition against disorderly trading to an overly broad trading

    time period.''); CEF at 6 (``The Commission should refrain from

    looking at trading practices outside of the closing period.'').

    \39\ See, e.g., FIA at 5 (``The Commission should clarify that

    traditionally accepted types of market manipulation, such as

    `banging the close,' `marking the close' and pricing window

    manipulation fall under the prohibition of 5(B).'').

    ---------------------------------------------------------------------------

    2. Commission Guidance

    New CEA section 4c(a)(5)(B) prohibits any trading, practices, or

    conduct on or subject to the rules of a registered entity that

    ``demonstrates intentional or reckless disregard for the orderly

    execution of transactions during the closing period.'' In the view of

    the Commission, Congress's inclusion of a scienter requirement means

    that accidental, or even negligent, trading conduct and practices will

    not suffice for a claim under section 4c(a)(5)(B); rather a market

    participant must at least act recklessly.\40\ Accordingly, section

    4c(a)(5)(B) will not capture legitimate trading behavior and is not ``a

    trap for those who act in good faith.'' \41\

    ---------------------------------------------------------------------------

    \40\ See, e.g., Hammond v. Smith Barney, Harris Upham & Company,

    Inc., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 24,617

    (CFTC Mar. 1, 1990) (scienter requires proof that a defendant

    committed the alleged wrongful acts ``intentionally or with reckless

    disregard for his duties under the Act''); Drexel Burnham Lambert,

    Inc. v. CFTC, 850 F.2d 742, 748 (DC Cir. 1988) (holding that

    recklessness is sufficient to satisfy scienter requirement and that

    a reckless act is one where there is so little care that it is

    ``difficult to believe the [actor] was not aware of what he was

    doing'') (quoting First Commodity Corp. v. CFTC, 676 F.2d 1, 7 (1st

    Cir. 1982)).

    \41\ United States v. Ragen, 314 U.S. 513, 524 (1942).

    ---------------------------------------------------------------------------

    The Commission interprets the closing period to be generally

    defined as the period in the contract or trade when the daily

    settlement price is determined under the rules of that trading

    facility.\42\ While the Commission interprets the prohibition in

    section 4c(a)(5)(B) to encompass any trading, conduct, or practices

    occurring inside the closing period that affects the orderly execution

    of transactions during the closing period, potential disruptive conduct

    outside that period may nevertheless form the basis for an

    investigation of potential violations under this section and other

    sections under the Act. With respect to swaps executed on a SEF, a swap

    will be subject to the provisions of section 4c(a)(5)(B) if a closing

    period or daily settlement price exists for the particular swap.

    Additionally, section 4c(a)(5)(B) violations will include executed

    orders as well as any bids and offers submitted by individuals for the

    purposes of disrupting fair and equitable trading.

    ---------------------------------------------------------------------------

    \42\ Closing periods may include the time period in which a

    daily settlement price is determined, the expiration day for a

    futures contract, and any period of time in which the cash-market

    transaction prices for a physical commodity are used in establishing

    a settlement price for a futures contract, option, or swap (as

    defined by the CEA).

    ---------------------------------------------------------------------------

    Similar to other intent-based violations of the CEA, the Commission

    will consider all of the relevant facts and circumstances in

    determining whether a person violated section 4c(a)(5)(B). The

    Commission will evaluate the facts and circumstances as of the time the

    person engaged in the relevant trading, practices, or conduct (i.e. the

    Commission will consider what the person knew, or should have known, at

    the time he or she was engaging in the conduct at issue). The

    Commission will use existing concepts of orderliness of markets when

    assessing whether trades are executed, or orders are submitted, in an

    orderly fashion in the time periods prior to and during the closing

    period. In the view of the Commission, an orderly market may be

    characterized by, among other things, parameters such as a rational

    relationship between consecutive prices, a strong correlation between

    price changes and the volume of trades, levels of volatility that do

    not materially reduce liquidity, accurate relationships between the

    price of a derivative and the underlying such as a physical commodity

    or financial instrument, and reasonable spreads between contracts for

    near months and for remote months.\43\ Participants and regulators in

    [[Page 14947]]

    the commodity and securities markets are already familiar with these

    assessments of orderliness in connection with issues of market

    manipulation \44\ and risk mitigation. The Commission believes that

    market participants should assess market conditions and consider how

    their trading practices and conduct affect the orderly execution of

    transactions during the closing period.\45\

    ---------------------------------------------------------------------------

    \43\ Concepts applicable to the securities markets are useful in

    analyzing commodity markets because of similarities between the two

    areas. Concerning orderliness of markets, see, e.g., In re NYSE

    Specialists Securities Litigation, 503 F.3d 89 (2d Cir. 2007)

    (discussing role of specialists in maintaining orderly market and

    various circumventions of that role); Last Atlantis Partners, LLC v.

    AGS Specialist Partners, 533 F.Supp. 2d 828 (N.D. Ill. 2008)

    (allegation that trading specialists disengaged automated order

    execution mechanism to discriminate against customers having direct

    access to markets); LaBranche & Co., NYSE AMEX Hearing Board

    Decisions 09-AMEX-28, -29, and -30 (Oct. 2009) and NYSE Member

    Education Bulletin 2006-19 (discussing the proper design and use of

    specialist algorithms to avoid taking liquidity from the market at

    and surrounding the prevailing market price).

    \44\ See, e.g., Cargill, Inc. v. Hardin, 452 F.2d 1154, 1170-71

    (8th Cir. 1971) (market disruption through ``squeeze'' of shorts

    characterized by extraordinary price fluctuations, with little

    relationship to basic supply and demand factors for wheat; other

    markets not similarly affected; long employed unusual mechanism to

    liquidate position).

    \45\ For example, absent an intentional or reckless disregard

    for the orderly execution of transactions during the closing period,

    a person would not be liable under 4c(a)(5)(B) upon executing an

    order during the closing period simply because the transactions had

    a substantial effect on the settlement price.

    ---------------------------------------------------------------------------

    iii. Spoofing

    1. Comments From ANPR and Roundtable

    Roundtable panelists commented that there is no commonly-accepted

    definition of ``spoofing'' throughout the industry.\46\ Some commenters

    expressed a similar concern \47\ and requested additional Commission

    guidance that any definition of ``spoofing'' set forth in section

    4c(a)(5)(C) would not capture legitimate trading behavior.\48\ In

    particular, several comment letters also expressed views on whether

    partial fills should be exempt from the definition of ``spoofing.''

    \49\

    ---------------------------------------------------------------------------

    \46\ See, e.g., John J. Lothian at 82 (referring to spoofing as

    ``a very undefined type of term within the industry'').

    \47\ See, e.g., Chopper Trading at 3 (``The Commission must

    consider that spoofing does not have a generally understood

    definition in the futures markets.'').

    \48\ See, e.g., CME Group at 8 (``The statute's definition of

    `spoofing' as `bidding or offering with the intent to cancel the bid

    or offer before execution,' is too broad and does not differentiate

    legitimate market conduct from manipulative conduct that should be

    prohibited. The distinguishing characteristic between `spoofing'

    that should be covered by paragraph (C) and the legitimate

    cancellation of other unfilled or partially filled orders is that

    `spoofing' involves the intent to enter non bona fide orders for the

    purpose of misleading market participants and exploiting that

    deception.''); HETCO at 7 (``The Commission should describe, with

    specificity, what trade practices constitute spoofing, particularly

    where this is not a concept familiar to the markets for commodities

    and derivatives.''); ICE at 8 (generally discussing the practice of

    ``spoofing'' as defined in paragraph (C) of Section 747 may capture

    legitimate trading behavior).

    \49\ See, e.g., API at 14 (``The Commission has requested

    comment on whether a ``partial fill of an order * * * necessarily

    exempts that activity from being defined as `spoofing.' The answer

    is yes.''); HETCO at 8 (``A partial fill of an order or series of

    orders should not exempt the activity described above from being

    defined as `spoofing'.'').

    ---------------------------------------------------------------------------

    2. Commission Guidance

    New CEA section 4c(a)(5)(C) prohibits any trading, practice, or

    conduct that ``is, is of the character of, or is commonly known to the

    trade as, ``spoofing'' (bidding or offering with the intent to cancel

    the bid or offer before execution).'' To violate section 4c(a)(5)(C), a

    market participant must act with some degree of intent, or scienter, to

    engage in the ``spoofing'' trading practices prohibited by section

    4c(a)(5)(C). In the view of the Commission, a 4c(a)(5)(C) ``spoofing''

    violation requires that a person intend to cancel a bid or offer before

    execution; therefore, the Commission believes that reckless trading,

    conduct, or practices will not result in violations of section

    4c(a)(5)(C).\50\ Furthermore, orders, modifications, or cancellations

    will not be classified as ``spoofing'' if they were submitted as part

    of a legitimate, good-faith attempt to consummate a trade. Thus, the

    legitimate, good-faith cancellation of partially filled orders would

    not violate section 4c(a)(5)(C). However, a partial fill does not

    automatically exempt activity from being classified as ``spoofing.''

    When distinguishing between legitimate trading involving partial

    executions and ``spoofing'' behavior, the Commission will evaluate the

    market context, the person's pattern of trading activity (including

    fill characteristics), and other relevant facts and circumstances. For

    example, if a person's intent when placing a bid or offer was to cancel

    the entire bid or offer prior to execution, regardless of whether such

    bid or offer was subsequently filled, that conduct may violate section

    4c(a)(5)(C). Accordingly, under this interpretation, section

    4c(a)(5)(C) will not capture legitimate trading.

    ---------------------------------------------------------------------------

    \50\ Similar to violations under section 4c(a)(5)(B), accidental

    or negligent trading, practices, and conduct will not constitute

    violations of section 4c(a)(5)(C).

    ---------------------------------------------------------------------------

    This ``spoofing'' prohibition covers bid and offer activity on all

    registered entities, including all regulated futures, options, and swap

    execution facilities, including all bids and offers in pre-open periods

    or during other exchange-controlled trading halts. ``Spoofing'' also

    includes, but is not limited to: (i) Submitting or cancelling bids or

    offers to overload the quotation system of a registered entity, (ii)

    submitting or cancelling bids or offers to delay another person's

    execution of trades; and (iii) submitting or cancelling multiple bids

    or offers to create an appearance of false market depth.\51\ However,

    the ``spoofing'' provision is not intended to cover non-executable

    market communications such as requests for quotes and other authorized

    pre-trade communications.

    ---------------------------------------------------------------------------

    \51\ See, e.g., Trillium Brokerage Services, LLC, Letter of

    Acceptance, Waiver and Consent, No. 2007007678201, from the

    Financial Industry Regulatory Authority (``FINRA'') (issued

    September 12, 2010) for a discussion of a ``spoofing'' case

    involving an illicit high frequency trading strategy. Under their

    ``spoofing'' strategy, Trillium entered numerous layered, non-bona

    fide market moving orders to generate selling or buying interest in

    specific stocks. By entering the non-bona fide orders, often in

    substantial size relative to a stock's overall legitimate pending

    order volume, Trillium traders created a false appearance of buy- or

    sell-side pressure. This trading strategy induced other market

    participants to enter orders to execute against limit orders

    previously entered by the Trillium traders. Once their orders were

    filled, the Trillium traders would then immediately cancel orders

    that had only been designed to create the false appearance of market

    activity. The Letter of Acceptance, Waiver and Consent and

    accompanying press release from FINRA can be accessed at http://www.finra.org/Newsroom/NewsReleases/2010/P12195.

    ---------------------------------------------------------------------------

    As with other intent-based violations, the Commission distinguishes

    between legitimate trading and ``spoofing'' by evaluating all of the

    facts and circumstances of each particular case, including a person's

    trading practices and patterns. Notably, a section 4c(a)(5)(C)

    violation does not require a pattern of activity, even a single

    instance of trading activity can be disruptive of fair and equitable

    trading.

    Issued in Washington, DC, on February 24, 2011 by the

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    Appendices to Antidisruptive Practices Authority--Commission Voting

    Summary; Statements of Commissioners; List of Roundtable Participants

    and Commenters

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn, Chilton

    and O'Malia voted in the affirmative; Commissioner Sommers voted in

    the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed interpretive order regarding disruptive

    practices on designated contract markets or swap execution

    facilities. Congress expressly prohibited three trading practices

    that it deemed were disruptive of fair and equitable trading.

    Today's order provides additional guidance to market participants

    and the public on the trading, practices and conduct that violate

    these statutory provisions. The order also addresses comments

    received by the Commission at the December 2nd roundtable and in

    response to the Advanced Notice of

    [[Page 14948]]

    Proposed Rulemaking on disruptive trading practices. The order

    addresses the comments by clarifying how the Commission will

    interpret and implement the provisions of Section 747. I look

    forward to hearing from the public in response to this proposed

    interpretive order. The comment letters and staff roundtable were

    extremely helpful in formulating this proposed order.

    Appendix III

    December 2, 2010 CFTC Staff Roundtable on Disruptive Trading Practices

    I. Panel One: Opportunities and Challenges to Fair and Equitable

    Trading

    i. Ensuring Fair and Equitable Trading at the Close

    ii. Exploring ``the character of'' Spoofing

    a. Panelists: John Hyland--U.S. Natural Gas Fund; Rajiv

    Fernando--Chopper Trading LLC; Adam Nunes--Hudson River Trading

    Group; Cameron Smith--Quantlab Financial, LLC; Liam Connell--Allston

    Trading, LLC; Don Wilson--DRW Trading Group; Joel Hasbrouck--New

    York University; Gary DeWaal--Newedge USA, LLC; Mark Fisher--MBF

    Clearing Corp; John Lothian--John J. Lothian & Company.

    II. Panel Two: Rules ``Reasonably Necessary'' To Prohibit Disruptive

    Trading

    a. Panelists: Tom Gira--Financial Industry Regulatory Authority;

    Chris Heymeyer--National Futures Association; Ike Gibbs--

    ConocoPhillips; Dean Payton--Chicago Mercantile Exchange; Mark

    Fabian--IntercontinentalExchange; Joe Mecane--New York Stock

    Exchange; Greg Mocek--McDermott Will & Emery; Ken Raisler on behalf

    of Futures Industry Association--Sullivan and Cromwell LLP; Micah

    Green--Patton Boggs LLP; Tyson Slocum--Public Citizen; Andrew Lo--

    Massachusetts Institute of Technology.

    III. Panel Three: Exchange Perspectives on Disruptive Trading;

    Potential New Disruptive Trading Practices

    a. Panelists: Tom Gira--Financial Industry Regulatory Authority;

    Chris Heymeyer--National Futures Association; Dean Payton--Chicago

    Mercantile Exchange; Mark Fabian--IntercontinentalExchange; Joe

    Mecane--New York Stock Exchange; Andrew Lo--Massachusetts Institute

    of Technology.

    Appendix IV

    Parties Submitting Comment Letters in Response to Disruptive Trading

    Practices ANPR

    A. Flachman

    American Petroleum Institute (API)

    Argus Media, Inc. (Argus)

    Better Markets (BM)

    Bix Weir

    Chopper Trading, LLC (Chopper Trading)

    CME Group, Inc. (CME Group)

    Commodity Markets Council (CMC)

    David S. Nichols

    DeWitt Brown

    Edison Electric Institute (EEI)

    Emilie Lauran

    Futures Industry Association (FIA)

    Hess Energy Trading Company, LLC (HETCO)

    IntercontinentalExchange, Inc., and ICE Futures U.S., Inc.

    (collectively, ICE)

    International Swaps and Derivatives Association, Inc. (ISDA)

    Investment Company Institute (ICI)

    Managed Funds Association (MFA)

    Minneapolis Grain Exchange, Inc. (MGEX)

    Newedge USA, LLC (Newedge USA)

    Nicole Provo

    Peter J. Carini

    Petroleum Marketers Association of America (PMAA)

    Rebecca Washington

    Securities Industry and Financial Markets Association (SIFMA)

    U.S. Senator Carl Levin

    West Virginia Oil Marketers & Grocers Association (OMEGA)

    Working Group of Commercial Energy Firms (CEF)

    [FR Doc. 2011-6398 Filed 3-17-11; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: March 18, 2011



See Also:

OpenGov Logo

CFTC's Commitment to Open Government

Gavel and Book

Follow the Status of Enforcement Actions