[Federal Register Volume 76, Number 53 (Friday, March 18, 2011)]
[Notices]
[Pages 14943-14948]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-6398]
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COMMODITY FUTURES TRADING COMMISSION
Antidisruptive Practices Authority
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed Interpretive Order.
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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, [email protected]; Steven E. Seitz,
Attorney, Office of the General Counsel, 202-418-5615, [email protected];
or Mark D. Higgins, Counsel to the Director of Enforcement, 202-418-
5864, [email protected], 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.
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\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.
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\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.
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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.
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\6\ 75 FR 67301, Nov. 2, 2010.
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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.
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\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.
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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
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letters, which are discussed below in the following sections.
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\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.'').
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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\
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\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.'').
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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\
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\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.'').
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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.
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\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.
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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\
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\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.'').
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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\
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\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.'').
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2. Commission Guidance
The Commission interprets section 4c(a)(5)(A) as prohibiting any
person from buying a contract at a price that is
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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.
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\35\ See, e.g., New York Mercantile Exchange Rule 514.A.3;
Minneapolis Grain Exchange Rule 731.00.
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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.
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\36\ See, e.g., CME Group at 4 (``Order matching algorithms on
electronic platforms preclude bids and offers from being
violated.'').
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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\
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\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).'').
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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\
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\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).
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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.
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\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).
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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
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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\
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\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.
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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\
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\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'.'').
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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.
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\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).
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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.
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\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.
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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