October 26, 2010
Mr. Chairman, I would like to thank the teams who have spent many long hours developing the rules we will consider here today. The staff has actively sought input from the Commissioners and worked cooperatively to make improvements to each of these rulemakings.
I would like to commend Bella Rosenberg and her team in developing a thoughtful and well constructed rulemaking on provisions common to registered entities. The rulemaking is clear in its guidance regarding new products, rules and amendments.
I would also like to extend my thanks to Adrianne Joves and her team for their work on finding alternatives to credit ratings.
I would like to thank Eileen Donovan and her team for coming up with a workable process for the Commission to use to determine whether swaps are clearable.
With respect to the Investment of Customer Funds, I am thankful to Phyllis Dietz and Jon DeBord for their efforts. However, I am quite concerned that the proposed rules are overly prescriptive, especially given that the Commission released an Advance Notice of Public Rulemaking on this very issue in May of 2009.1 My main concern with this proposal is that the Commission is proposing to significantly revise the scope and character of the types of permitted investments of customer funds in the face of numerous public comments to the contrary. In fact, the concentration limits in today’s proposed rule seem to suggest that the 2,000 plus pages of the Dodd-Frank Act have done nothing to improve the safety and liquidity of money-market mutual fund investments. I strongly urge the public to comment on the reasonableness of the asset-based concentration limits, especially the 10% limit on money-market mutual funds. I also question whether it is wise to allow 50 percent of the allocation to be invested in one government sponsored enterprise. I intend to oppose this proposed rulemaking as it fails to adequately consider the public comments and fails to provide sufficient justification for the proposed allocations.
Now, moving to the Anti-Manipulation proposal, I would like to thank Bob Pease and Mark Higgins for all their efforts to present us with rules regarding an incredibly controversial area of our law. In the vernacular of the futures industry, there is one term that stands out above all others: manipulation. “M” is the Scarlet Letter of the futures markets. When the Enforcement Division, traders, or the defense bar speaks of the big “M”, they are thinking of a very specific kind of conduct: the intentional creation of an artificial price. It requires having the specific intent to affect prices in a manner that is not legitimately brought about by the forces of supply and demand.
To fully comprehend the scope of this rulemaking and the advanced notice of proposed rulemaking on disruptive trading practices, one must understand the range of prohibited misconduct under the Commodity Exchange Act (“CEA”). To do this, it helps to think of the possible violations under the CEA on a continuum ranging from trade practice violations such as wash sales to price manipulation. New sections provided by the Dodd-Frank Act add additional points on the continuum in the form of disruptive trading practices and fraud-based manipulative schemes. The placement of these points on the continuum will be largely determined in these rulemakings. The institution of big “M” manipulation is preserved at the one end of the continuum through new section 6(c)(3) of the CEA, and the proposed rule that mirrors that statutory prohibition is intended to clarify the Commission’s interpretation of price manipulation as the intentional interference with the legitimate forces of supply and demand.
The fraud-based manipulative schemes described in new section 6(c)(1) differ from big “M” manipulation in that the prohibited conduct may be intentional or reckless and there is no requirement that such conduct results in an artificial price—though an artificial price remains a possible outcome. The newly proposed anti-manipulation rules therefore target intentional or reckless conduct which, while not driven by a specific intent to create an artificial price, nevertheless may impact markets behavior to the detriment of market integrity.
Taking one step back along the continuum (towards trade practice violations), disruptive trading practices are also defined in some instances as reckless conduct. Accordingly under the statute and as described in the advance notice, a trading strategy that is executed under unpredictable, atypical market conditions could misfire and fall under one of the enumerated disruptive trading practices. If the Commission determines that the strategy was engaged in recklessly, under its new authority it could find that the strategy was manipulative—even though the trader executing the strategy had no intent to impact market prices or to disrupt the market itself. Now that would be an aggressive outcome, but it is entirely possible on the continuum.
It is therefore incumbent upon this Commission to be clear about which type of activity is permitted along the continuum and how we intend to use our new authorities.
Last week NFL Commissioner Roger Goodell notified the teams that players that strike an opponent in the head or neck area in violation of the rules will face more significant discipline than they had before, including possible suspension.2 Commissioner Goodell’s action was taken after an unusually high number of severe injuries had occurred.
When I read this, I realized Commissioner Goodell’s job is similar to the job facing the Commission. Commissioner Goodell places a high priority on protecting the players from needless injury. The CFTC also places an equally important value on protecting market participants from manipulation, disruptions to market integrity, fraudulent behavior, and other abusive practices. The new statutory provisions charge us with defining controls to ensure that trading is neither disruptive nor manipulative. These provisions also impose high penalties for conduct which may only be reckless—which is a relatively low standard of intent under the law—to ensure that market participants are incentivized to follow the rules.
To the NFL’s credit, it has been very specific about what will and will not be tolerated on the field. However, in my opinion, this rulemaking will not provide market participants with similar comfort.
This is especially true with regard to the disruptive trade practices. One would think after requesting this language in the legislation, the Commission could provide some details as to how the Commission will interpret the language on spoofing or trading in the close.
As a result, it is appropriate for the Commission to receive more feedback from the public to better refine these definitions and to better understand how they might impact markets and the market “players.”
We must not lose sight of the technology investments such rulemakings will require. In order to effectively oversee trading schemes and practices, the Commission will need to reconstruct the order book to understand how various bidding strategies might have impacted market prices. Regardless of whether we apply an “intent” or “recklessness” standard, all cases must be supported by the facts and empirical data.
As we work through these particular rulemakings, it is critical to remember that our responsibility is broader than simply responding to the last crisis. Going forward, prevention and deterrence must be the twin goals that are furthered by the anti-manipulation and disruptive trading practice rules. Stating up front that the Commission may always go to the instant replay to review the call on the “field” does not provide market participants with any fair notice as to when their strategies will run afoul of the rules. It is my sincerest request that the public provide input on these complicated rulemakings to ensure that everyone is in agreement as to the boundaries of fair play.
1 Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 74 Fed. Reg. 23962 (advance notice of proposed rulemaking May 22, 2009) (to be codified at 17 C.F.R. pts 1 and 30).
2 “‘One of our most important priorities is protecting our players from needless injury,’ Commissioner Goodell said. ‘In recent years, we have emphasized minimizing contact to the head and neck, especially where a defenseless player is involved. It is clear to me that further action is required to emphasize the importance of teaching safe and controlled techniques, and of playing within the rules. It is incumbent on all of us to support the rules we have in place to protect players.’” National Football League, Goodell Issues Memo Enforcing Player Safety Rules (October 20, 2010), available at www.nfl.com/news/story/09000d5d81b7bef/article/goodell-issues-memo-enforcing-player-safety-rules.
Last Updated: January 18, 2011