The Commodity Futures Trading Commission (CFTC) last Tuesday voted out proposed rules that would expand its anti-manipulation authority to include fraudulent activity and bar disruptive trading of jurisdictional transactions.
A notice of rulemaking proposed two rules that prohibit all manner of fraud and manipulation in the markets that are subject to the CFTC's jurisdiction. Specifically it makes it illegal for any person, directly or indirectly, in connection with any swap, or contract of sale of any commodity in interstate commerce, or contract for future delivery to "intentionally or recklessly" use or attempt to use any "device, scheme or artifice to defraud" another in the market.
"I'm going to support this proposed rulemaking...I think that [it] really helps the Commission to broaden our ability to police markets...to make sure there's fair and equitable trading," said Chairman Gary Gensler. The proposal gives the CFTC the "ability to police [the markets] for fraud-based manipulation, where the Commission has had price-based manipulation in the past," he noted during the third public meeting, where the agency considered proposals to implement the Dodd-Frank Wall Street Reform Act (see NGI, Oct. 25).
The proposal on fraud-based manipulation is patterned after a section in the Securities Exchange Act of 1934, which the courts have interpreted to cover intentional or reckless conduct that deceives or defrauds market participants.
For the first time, the proposal would give the Commission an antimanipulation rule that seeks to prevent fraudulent conduct in the commodity markets, a CFTC staff member said. It doesn't change the CFTC's existing antimanipulative authority under the Commodity Exchange Act (CEA), "it is additive," said Commissioner Bart Chilton The proposed rule is expected to become effective in July 2011.
Manipulation, as defined by the CEA, "requires having the specific intent to affect prices in a manner that is not legitimately brought about by the forces of supply and demand," said Commissioner Scott O'Malia. However the proposed regulations that cover fraud-based manipulative schemes do not require the agency to prove that "intentional or reckless" conduct resulted in an artificial price, he noted.
"This goes a long way in helping our enforcement division" to address fraud in the market, Commissioner Michael Dunn. The agency's hands have been tied under the existing regulations. In fact, the CFTC has been successful in enforcing only one manipulation case in the past 35 years, Chilton said.
A violation of the proposed anti-manipulation rules would carry a penalty of up to $1 million, according to staff. The CFTC said it defines fraud as "any conduct that impairs, obstructs or defeats well functioning markets or the integrity of the market."
While "there's a tremendous amount of case law" on defining what is manipulation, the cases that come before the CFTC are going to be "really fact- and circumstance-specific," a CFTC staff member said. "This is going to be a case-by-case development."
In related action, the Commission approved an advanced notice of proposed rulemaking (ANOPR) seeking comments on whether the CFTC should implement additional rules to prohibit disruptive trading practices. The practices barred under Dodd-Frank include those that violate bids or offers; demonstrate intentional or reckless disregard for the orderly execution of transactions during the closing period; or are known as "spoofing," which is defined as "bidding or offering with the intent to cancel the bid or offer before execution."
Comments are due within 60 days. Commenters have been asked to respond to all questions in the ANOPR, including what constitutes disorderly execution of trades and what duties of supervision over trades should be required to prevent disruptive trading practices. It also asks if rules should be adopted that are specifically applicable to the use of algorithmic trading methodologies and programs that are reasonably necessary to prevent algorithmic trading systems from disrupting fair and equitable trading. The CFTC said it plans to have a roundtable on the ANOPR on Dec. 2.
The CFTC also turned its attention to determining the eligibility for derivatives clearing organizations (DCOs) to clear swaps. Under the proposed rule, a DCO would be presumed eligible to accept for clearing any swap that is within a group, category, type or class of swaps that it already clears. However, if it plans to accept for clearing any swap that is not within a group, category, type or class of swaps that the DCO already clears, it would be required to request a determination by the Commission of its eligibility to clear the swap.
A DCO would have to file a written request with the Commission that shows it has sufficient financial resources; and the ability to manage the risks associated with clearing the swaps.
The proposed rule also would require a DCO that plans to accept swaps for clearing to submit the swaps to the CFTC for a determination as to whether the swaps are required to be cleared. After deciding that a swap (or group, category, type or class of swaps) should be cleared, the Commission may stay the clearing requirement until it completes a review of the terms of the swap and the clearing arrangement. The stay could apply to either a single swap or a class of swaps.
There currently are eight clearinghouses, with the largest independent one being LCH Clearnet. Without sufficient staff at the CFTC, "it's going to get clogged up pretty fast" as swaps are submitted for review, Gensler acknowledged.
"It is an enormous task," a staff member agreed.
Gensler said the next public meetings will be Nov. 10, Nov. 19 and Dec. 1.
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