Federal Register, Volume 78 Issue 102 (Tuesday, May 28, 2013)[Federal Register Volume 78, Number 102 (Tuesday, May 28, 2013)]
[Notices]
[Pages 31890-31897]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-12365]
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COMMODITY FUTURES TRADING COMMISSION
RIN 3038-AD96
Antidisruptive Practices Authority
AGENCY: Commodity Futures Trading Commission.
ACTION: Interpretive guidance and policy statement.
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SUMMARY: The Commodity Futures Trading Commission (the ``Commission''
or ``CFTC'') is issuing this interpretive guidance and policy statement
(``interpretive statement'') to provide guidance on section 747 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (the ``Dodd-
Frank Act''), which prohibits certain disruptive trading, practices, or
conduct as set forth in new section 4c(a)(5) of the Commodity Exchange
Act (the ``CEA''). This interpretive statement will provide market
participants and the public with guidance on the scope and application
of the statutory prohibitions set forth in CEA section 4c(a)(5).
DATES: This interpretive statement will become effective May 28, 2013.
FOR FURTHER INFORMATION CONTACT: David Meister, Director, Division of
Enforcement, [email protected], Vincent McGonagle, Senior Deputy
Director, Division of Enforcement, [email protected] or Robert Pease,
Counsel to the Director of Enforcement, 202-418-5863, [email protected];
Three Lafayette Centre, 1151 21st Street NW., Washington, DC 20581.
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'').\1\ Title VII
of the Dodd-Frank Act \2\ amended the Commodity Exchange Act (``CEA'')
\3\ 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 doing, among other things, the following: (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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\1\ 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.
\2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 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
(``Prohibited Transactions'') 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) of the CEA by
granting the Commission authority under new section 4c(a)(6) of the CEA
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.'' \4\
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\4\ 7 U.S.C. 4(a)(6). At this time, the Commission is only
providing interpretive guidance on the disruptive trading,
practices, or conduct discussed herein. The Commission does not
foreclose subsequent promulgation of rules and regulations pursuant
to CEA section 4c(a)(6). The Commission also notes that new CEA
section 4c(a)(5) is self-effectuating.
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The Commission is issuing this interpretive guidance and policy
statement (``interpretive statement'') to provide market participants
and the public with guidance on the manner in which it intends to apply
the statutory prohibitions set forth in section 4c(a)(5) of the CEA.
The public has the ability to present facts and circumstances that
would inform the application of these policies.
[[Page 31891]]
II. Proposed Interpretive Order
On March 18, 2011, the Commission issued a proposed interpretive
order (``Proposed Order'') providing proposed interpretive guidance on
the three new statutory provisions of section 4c(a)(5) of the CEA.\5\
In the Proposed Order, the Commission stated that CEA section 4c(a)(5)
applied to trading, practices, or conduct on registered entities,
including designated contract markets (``DCMs'') and swap execution
facilities (``SEFs'').\6\ The Proposed Order also provided that CEA
section 4c(a)(5) would not apply to block trades, bilaterally
negotiated swap transactions, or exchanges for related positions
(``EFRPs'') transacted in accordance with the rules of a DCM or SEF.\7\
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\5\ 76 FR 14943 (Mar. 18, 2011). On November 2, 2010, the
Commission issued an Advance Notice of Proposed Rulemaking (the
``ANPR'') asking for public comment on section 747 of the Dodd-Frank
Act. 75 FR 67301 (Nov. 2, 2010). The ANPR formed the basis for a
roundtable held on December 2, 2010, by Commission staff in
Washington, DC. The Commission subsequently terminated the ANPR on
March 18, 2011. 76 FR 14826 (Mar. 18, 2011).
\6\ 76 FR at 14945. The Commission also stated that a trade does
not become subject to CEA section 4c(a)(5) because it is reported to
a swap data repository, even though such swap data repository is a
registered entity.
\7\ Id. at 14946.
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With respect to CEA section 4c(a)(5)(A)'s prohibition on violating
bids and offers, the Proposed Order stated that a person is prohibited
from buying a contract at a price that is higher than the lowest
available offer price and/or from selling a contract at a price that is
lower than the highest available bid price.\8\ Such conduct, regardless
of intent, disrupts the foundation of fair and equitable trading. The
Commission further proposed that CEA section 4c(a)(5)(A) was a per se
offense where the Commission would not be required to show that a
person violating bids or offers did so with any intent to disrupt fair
and equitable trading.\9\
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\8\ Id.
\9\ Id.
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In the Proposed Order, the Commission also stated that CEA section
4c(a)(5)(A) is applicable in any trading environment where a person
exercises some control over the selection of bids and offers against
which they transact, including when using an automated trading system
that operates without pre-determined matching algorithms.\10\ The
Commission further explained that CEA 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 using an order matching algorithm.\11\ The Commission also
proposed that CEA section 4c(a)(5)(A) would not apply where an
individual is executing a sequence of trades to buy all available bids
or sell to all available offers on an order book in accordance with the
rules of the facility on which the trades were executed.\12\
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\10\ Id.
\11\ Id.
\12\ Id.
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In regard to CEA section 4c(a)(5)(B), the provision for orderly
execution during the closing period, the Commission interpreted the
provisions as requiring that a market participant must at least act
recklessly to violate CEA section 4c(a)(5)(B).\13\ The Proposed Order
stated that accidental, or even negligent trading, is not a sufficient
basis for the Commission to claim a violation has occurred under CEA
section 4c(a)(5)(B). The Proposed Order also generally defined the
closing period as the period in the contract or trade when the
settlement price is determined under the rules of that registered
entity.\14\
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\13\ Id.
\14\ Id.
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The Proposed Order also explained that while CEA section
4c(a)(5)(B) encompasses any trading, practices, or conduct inside the
closing period that affects the orderly execution of transactions
during the closing period, disruptive conduct outside the closing
period may also form the basis for investigations of potential CEA
section 4c(a)(5)(B) violations.\15\ Section 4c(a)(5)(B) violations may
also include executed orders, as well as bids and offers submitted by
market participants for the purpose of disrupting fair and equitable
trading.\16\
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\15\ Id.
\16\ Id.
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When determining whether a person violated CEA section 4c(a)(5)(B),
the Commission proposed to evaluate the facts and circumstances as of
the time the person engaged in the trading, practices, or conduct.\17\
The Commission proposed to use existing concepts of orderliness when
assessing whether trades were executed, or orders were submitted, in an
orderly fashion in the time periods prior to and during the closing
period.\18\ The Proposed Order also expressed that market participants
should assess market conditions and consider how their trading
practices and conduct would affect the orderly execution of
transactions during the closing period.\19\
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\17\ Id.
\18\ Id.
\19\ Id.
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With respect to CEA section 4c(a)(5)(C), the Proposed Order stated
that a market participant must act with some degree of intent to
violate the ``spoofing'' provision.\20\ Reckless trading, practices, or
conduct would not violate CEA section 4c(a)(5)(C); instead, a person
must intend to cancel a bid or offer before execution.\21\
Additionally, orders, modifications, or cancellations would not be
considered ``spoofing'' if they were submitted as part of a legitimate,
good-faith attempt to consummate a trade.\22\ While the Proposed Order
did not exempt partial fills from CEA section 4c(a)(5)(C), legitimate,
good-faith cancellations of partially filled orders would not violate
CEA section 4c(a)(5)(C).\23\ Similar to the Commission's proposed
approach to CEA section 4c(a)(5)(B), the Commission proposed to
evaluate the facts and circumstances when distinguishing between
legitimate trading and ``spoofing'' behavior.\24\
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\20\ Id.
\21\ Id.
\22\ Id.
\23\ Id.
\24\ Id.
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Under the Proposed Order, CEA section 4c(a)(5)(C) covers bid and
offer activity on all registered entities, including all bids and
offers in pre-open periods or during exchange-controlled trading halts.
The Proposed Order also provided three non-exclusive examples of
``spoofing'' behavior.\25\ The Commission further proposed that CEA
section 4c(a)(5)(C) does not cover non-executable market communications
such as requests for quotes and other authorized pre-trade
communications.\26\ Finally, the Commission proposed that a violation
of CEA section 4c(a)(5)(C) does not require a pattern of activity, even
a single instance of trading activity can be disruptive of fair and
equitable trading.\27\
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\25\ The Proposed Order described ``spoofing'' to include the
following: (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. 76 FR at 14946.
\26\ 76 FR at 14946.
\27\ Id.
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The Commission requested comment on all aspects of the Proposed
Order, with the comment period ending on May 17, 2011. In response to
the Proposed Order, the Commission received 16 comments from industry
members, trade associations, exchanges, and other members of the
public.\28\ In
[[Page 31892]]
drafting this interpretive statement, the Commission also considered
the ANPR and December 2, 2010 roundtable comments, as well as comments
related to section 747 of the Dodd-Frank Act that were filed in
response to the SEF notice of proposed rulemaking (the ``SEF
NPRM'').\29\
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\28\ Appendix 3 contains the list of commenters that responded
to the Proposed Order. The comment letters may be accessed through
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=893.
\29\ 76 FR 1214 (Jan. 7, 2011).
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III. Comments on the Proposed Order
A. General Applicability of CEA Section 4c(a)(5)
1. Comments
In response to the Proposed Order, several commenters requested
additional guidance and suggested that additional clarity was needed
regarding how the Commission would interpret and apply new CEA section
4c(a)(5).\30\ Some commenters supported the statutory requirement in
new CEA section 4c(a)(5) to prohibit the enumerated trading practices
and prevent the disruption of fair and equitable trading.\31\ Other
commenters noted that the Commission should recognize the complementary
role of the exchanges and continue relying on the exchanges' self-
regulatory organization (``SRO'') authority to identify and pursue
trading practices that are manipulative or detrimental to the
exchange's markets.\32\ Commenters also requested that CEA section
4c(a)(5) violations be limited to those trading platforms on DCMs or
SEFs that have order book functionality.\33\ Lastly, some commenters
requested that the Commission incorporate a manipulative intent
requirement into its new antidisruptive practices authority to ensure
that the prohibitions in CEA section 4c(a)(5) do not capture legitimate
trading practices that may be indistinguishable from the proposed
prohibited conduct.\34\
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\30\ See, e.g., FIA at 2 (``The Proposed Order does not go far
enough in offering guidance to market participants.''); ICE at 2
(``Additional clarity is required with respect to the Commission's
interpretation and guidance regarding paragraphs (A) through (C) of
Section 747.'').
\31\ See, e.g., ISDA at 2 (``ISDA supports the Commission's
effort to facilitate fair and equitable trading on registered
entities by issuing guidance as to the parameters of the three
statutory disruptive practices found in Subsection 5.''); ICE at 2
(``ICE continues to support the Commission's efforts to promote open
and competitive markets while improving the ability to deter
improper trading practices that are disruptive to legitimate trading
and orderly markets.''); Barnard at 2 (``I welcome and support your
proposed interpretive order. It brings clarity to the antidisruptive
practices authority, and strikes the right balance between rules-
and principles-based regulation.'').
\32\ See, e.g., ICE at 5 (``ICE respectfully suggests that the
Commission continue to rely on exchange SRO authority to identify
and pursue trading practices that are determined to be manipulative
or detrimental to the exchange's markets, including practices that
are the character of spoofing.''); FIA at 7 (``The Associations
believe that any rulemaking under 747 must reinforce the distinct
yet complementary roles of the Commission and the exchanges.''); and
CMC at 2 (``SROs and the Commission historically have served
distinct but largely complementary roles.'').
\33\ See, e.g., ISDA at 2 (``Subsection 5, though stated to
apply to all ``registered entities''--that is . . . swap execution
facilities (`SEFs') and designated contract markets (`DCMs')--should
be clearly limited at the outset only to those order-book trading
facilities within the Commission's proposed regulation, 17 CFR
37.9(a)(1)(i)(C), for the definition of `order book.''').
\34\ See, e.g., FIA at 5 (``Unfortunately, the antidisruptive
practices authority captures many legitimate trading practices
which, without a manipulative intent requirement, are objectively
indistinguishable from the proposed prohibited conduct.'').
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2. Commission Guidance
The Commission recognizes commenters' requests for additional
guidance on CEA section 4c(a)(5) and is issuing this interpretive
statement to clarify how the Commission interprets and intends to apply
the three statutory provisions of CEA section 4c(a)(5). With respect to
the role of exchanges in ensuring fair and equitable markets, the
Commission agrees with commenters that exchanges serve an important
role in preventing the disruptive practices prohibited in CEA section
4c(a)(5) and ensuring fair and equitable trading in CFTC-regulated
markets.
The Commission declines the request by commenters to interpret CEA
section 4c(a)(5) as applying to only those trading platforms or venues
that have order book functionality. In accordance with the statutory
language of CEA section 4c(a)(5), the Commission interprets CEA section
4c(a)(5) to apply to any trading, practices or conduct on a registered
entity \35\ such as a DCM or SEF.\36\ Depending on the particular facts
and circumstances, CEA section 4c(a)(5) violations may also occur on
trading platforms or venues that are distinct from order books, even if
such platforms or venues may have similar functionality.
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\35\ Section 1a(40) of the CEA defines ``registered entity'' as
``(A) a board of trade designated as a contract market under section
5; (B) a derivatives clearing organization registered under section
5b; (C) a board of trade designated as a contract market under
section 5f; (D) a swap execution facility registered under section
5h; (E) a swap data repository registered under section 21; and (F)
with respect to a contract that the Commission determines is a
significant price discovery contract, any electronic trading
facility on which the contract is executed or traded.'' 7 U.S.C.
1a(40).
\36\ The Commission confirms that a trade does not become
subject to CEA section 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 also declines commenters' requests to read a
manipulative intent requirement into the CEA section 4c(a)(5)
prohibitions. The Commission interprets the prohibitions in CEA section
4c(a)(5) provisions to be distinct statutory provisions from the anti-
manipulation provisions in section 753 of the Dodd-Frank Act; the
Commission does not interpret the CEA section 4c(a)(5) violations as
including any manipulative intent requirement. Including such a
manipulative intent requirement is contrary to the statutory language.
The Commission does not intend to apply CEA section 4c(a)(5) to
either block trades or exchanges for related positions (``EFRPs'') that
are transacted in accordance with Commission regulation 1.38.
In addition to these general comments on CEA section 4c(a)(5),
commenters provided comments on the three new statutory provisions,
which are discussed in the following sections.
B. Violating Bids and Offers
1. Comments to the Proposed Interpretive Order
Commenters requested that the Commission modify its interpretation
that a CEA section 4c(a)(5)(A) violation is a per se offense and
incorporate a requirement that a person must intend to disrupt fair and
equitable trading.\37\ Commenters noted that the Commission's
interpretation that the violation of bids or offers is a per se offense
conflicts with exchange rules.\38\ Other commenters requested that the
Commission adopt either a ``specific'' intent or ``extreme
recklessness'' standard for CEA section 4c(a)(5)(A).\39\ Commenters to
the Proposed Order also requested guidance on how CEA section
4c(a)(5)(A) would apply to the trading of swaps on SEFs.\40\ In
particular, commenters stated that end-users should have discretion
when choosing a
[[Page 31893]]
counterparty and also requested clarification on whether market
participants may consider additional non-price factors when trading on
a SEF.\41\ Commenters also requested guidance on whether CEA section
4c(a)(5)(A)'s prohibition applies to bids and offers on non-cleared
swaps.\42\ Commenters also stated that swaps with different clearing
destinations should not be deemed comparable for the purposes of CEA
section 4c(a)(5)(A).\43\
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\37\ See, e.g., Working Group at 3 (``The Working Group strongly
recommends that the Commission interpret new CEA Section 4c(a)(5)(A)
as requiring an intent to disrupt the market.'').
\38\ See, e.g., CME at 4 (``Contrary to the Commission's
assertion, this broad construction is not consistent with exchange
rules, which only proscribe market participants' intentional
violation of bids and offers.'').
\39\ See, e.g., CMC at 3 (``The Commission should clarify that
only intentional or extremely reckless action to violate transparent
bids or offers contravenes this prohibition.'').
\40\ See, e.g., FIA at 4 (``The Associations recommend that the
Commission provide further clarification. One example is the
application to swap execution facilities (`SEFs')''); BF at 14 (``We
further recommend that the CFTC confirm that transactions executed
other than on a SEF's central order book will not be deemed to
``violate bids or offers'' for purposes of CEA Section 4c(a)(5)(A),
regardless of their price level.''
\41\ See, e.g., Coalition at 4 (``An interpretation that
precludes end-users from exercising discretion in its counterparty
selection could force end-users to make sub-optimal decisions when
determining the most suitable swap counterparty on a given
transaction.'').
\42\ See, e.g., MarketAxess at 3 (``The final order should make
clear that the CFTC's interpretation of new CEA Sec. 4c(a)(5)(A)
does not apply to uncleared swaps.'').
\43\ See, e.g., Consolidated Banks at 14 (``Nor should swaps
with different bilateral counterparties or clearing destinations be
deemed comparable to each other for such purposes.'').
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Commenters further asked whether CEA section 4c(a)(5)(A) requires
market participants to transact at the best price across a particular
SEF's different trading systems or platforms, such as the SEF's order
book and request-for-quote system. Commenters also asked for
clarification on how CEA section 4c(a)(5)(A) applies to request-for-
quote systems on SEFs and whether request-for-quotes (``RFQs'') must
interact with the SEF's order book or centralized electronic
screen.\44\ One commenter stated that the Proposed Order would
effectively impose a ``trade through'' requirement on market
participants executing swap transactions across a particular SEF's
trading systems or platforms.\45\ Commenters further requested that the
Commission confirm that the final order would not create a best
execution requirement across multiple SEFs.\46\
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\44\ See, e.g., MarketAxess at 3 (``We ask that the Commission
confirm in its final Interpretive Order that a person would not
violate bids or offers by buying or selling a contract on a SEF's
Request for Quote System when that contract is available to buy or
sell at a `better' price through another permitted execution method
offered by that SEF such as an Order Book or a centralized
electronic screen.'').
\45\ See, e.g., GFI at 2 (``GFI believes that the Proposed
Interpretation would effectively impose a trade-through rule on SEFs
that utilize trading methods that are not strictly automated, and
that such a requirement is neither required by the Dodd-Frank Act
nor furthers the purposes of the CEA.'').
\46\ See, e.g., Working Group at 3 (``The Working Group supports
the Commission's statement `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' and strongly recommends that such
interpretation of new CEA Section 4c(a)(5)(A) be adopted in any
final interpretive order.'').
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A commenter also agreed with the statement in the Proposed Order
that CEA section 4c(a)(5)(A) should not apply where an individual is
``buying the board'' and executing a sequence of trades to buy all
available bids or sell to all available offers on the order book in
accordance with the rules of the facility executing the trades.\47\
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\47\ See CME at 3 (``We also concur with the Commission's
determination that this section does not apply where an individual
is `buying the board.' '').
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2. Commission Guidance
The Commission declines requests to interpret CEA section
4c(a)(5)(A) as applying only where a person intends to disrupt fair and
equitable trading. The Commission interprets CEA section 4c(a)(5)(A) as
a per se offense. Congress did not include an intent requirement in CEA
section 4c(a)(5)(A) as it did in both CEA sections 4c(a)(5)(B) and
4c(a)(5)(C). Therefore, the Commission does not interpret CEA section
4c(a)(5)(A) as requiring the Commission to show that a person acted
with scienter in violating bids and offers (e.g., that a person acted
with either the intent to disrupt fair and equitable trading or with
the intent to violate bids and offers). Unlike certain exchange rules
that prohibit the intentional violation of bids and offers, the
statutory language of CEA section 4c(a)(5)(A) does not contain a
similar intent requirement.\48\ While the Commission's determination of
whether to bring an enforcement action depends on facts and
circumstances, the Commission does not, for example, intend to exercise
its discretion to bring an enforcement action against an individual
who, purely by accident, makes a one-off trade in violation of CEA
section 4c(a)(5)(A). Whether such an accidental violation gives rise to
some other violation of the CEA or Commission regulations depends,
again, on the facts and circumstances of the particular situation.
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\48\ See, e.g., New York Mercantile Exchange Rule 514.A.3;
Minneapolis Grain Exchange Rule 731.00.
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As a general matter, the Commission interprets CEA section
4c(a)(5)(A) as operating in any trading environment where a person is
not utilizing trading algorithms that automatically match the best
price for bids and offers. With respect to SEFs, the Commission
interprets CEA section 4c(a)(5)(A) as being applicable only when a
person is using a SEF's ``order book,'' and not when a person uses a
SEF's other execution methods (such as the RFQ system in conjunction
with the order book). The Commission recognizes that market
participants may consider a number of factors in addition to price when
trading or executing less liquid swaps, which are more likely to be
traded on a SEF's RFQ system or a different execution method. However,
as SEFs and the swaps markets evolve, the Commission may revisit these
issues in the future. The Commission agrees with commenters that
parties trading non-cleared swaps may take into consideration factors
other than price, such as counterparty risk, when determining how to
best execute their trades.\49\ Therefore, the Commission interprets CEA
section 4c(a)(5)(A) as not applying to non-cleared swap transactions,
even if they are transacted on or through a registered entity. In such
swap transactions, the credit considerations of the counterparties are
important components of choosing which bid or offer to accept.
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\49\ See, e.g., Coalition at 3 (``To understand the impact of
applying section 4c(a)(5)(A) to non-cleared transactions executed
off-facility, we have to understand how corporate treasurers have a
fiduciary duty to optimize numerous factors--not solely the
transaction price of a particular derivative--in achieving `best
execution' '').
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The Commission also agrees with commenters that parties may take
into account clearing considerations, such as the use of a particular
clearing house, when trading cleared swaps on certain platforms on a
SEF or on a DCM.\50\ The Commission interprets CEA section
4c(a)(5)(A)'s prohibition as not applying to bids or offers on swaps
that would be cleared at different clearing houses because each
clearing house may have different cost, risk, and material clearing
features.\51\ For example, the choice of a clearing house may affect a
party's net and gross outstanding exposures, which may result in
differing capital and cost of financing effects. Additionally, the
pricing of swaps may also incorporate other potential considerations
such as the available credit capacity at the clearing member or
clearing house, margining arrangements, or post-trade market risk.
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\50\ As stated previously, the Commission interprets new CEA
section 4c(a)(5)(A) as applying to any cleared swap traded on a
SEF's order book, regardless of whether such cleared swap is subject
to the mandatory trade execution requirement of new CEA section
2(h).
\51\ See, e.g., GFI at 2 (``Because market participants that
execute transactions on a SEF may clear their transactions at
different clearinghouses, they must have the flexibility to take
factors other than price into account when executing transactions on
a SEF.'').
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Therefore, the Commission interprets CEA section 4(c)(a)(5)(A) as
prohibiting a person from buying a contract on a registered entity at a
price that is higher than the lowest available price offered for such
contract or selling a contract on a registered entity at a price that
is lower than the highest available price bid for such contract subject
to the situations described above. Such
[[Page 31894]]
conduct, regardless of intent, disrupts fair and equitable trading by
damaging the price discovery function of CFTC-regulated markets. By
adopting a policy that market participants cannot execute trades at
prices that do not accurately reflect the best price for such
contracts, this interpretive statement furthers the CEA's purpose of
ensuring the integrity of the price discovery process by helping ensure
that the prices disseminated to market users and the public reflect
bona fide prices that accurately reflect the normal forces of supply
and demand.
The Commission further recognizes that at any particular time the
best price in one trading environment such as a particular SEF may
differ from the best price in a different trading environment such as a
second, distinct SEF. Accordingly, the Commission does not interpret
CEA section 4c(a)(5)(A) as creating any sort of best execution standard
across multiple registered entities, including SEFs or DCMs; rather,
the Commission interprets a person's obligation to not violate bids or
offers as applying only to the specific registered entity being
utilized at a particular time.\52\
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\52\ A person's obligation to not violate bids or offers is
confined to the particular SEF or DCM he is utilizing at a
particular time and does not extend across multiple SEFs or DCMs or
between different trading systems or platforms within a particular
SEF or DCM, such as between a pit and any electronic trading
platform within a DCM or a SEF's ``order book'' and RFQ system in
conjunction with the order book. However, as the swaps and SEF
markets evolve, the Commission may revisit these issues in other
Commission regulations. For example, the Commission may consider
whether a person's obligation to not violate bids or offers when
trading swaps should extend across multiple SEFs or DCMs or across a
particular SEF's different trading systems or platforms, including
whether the CEA section 4c(a)(5)(A) prohibition should apply to the
scenario where market participants can access multiple SEFs through
one trading platform.
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The Commission does not interpret CEA section 4c(a)(5)(A) as
applying where an individual is executing a sequence of trades to buy
all available offers or sell to all available bids on an order book in
accordance with the rules of the facility on which the trades were
executed. Similar to the treatment of block trades and EFRPs described
above, the Commission expects that ``buying the board'' transactions,
absent other facts and circumstances, would not violate CEA section
4c(a)(5) or disrupt fair and equitable trading.
C. Disregard for the Orderly Execution of Transactions During the
Closing Period
1. Comments to the Proposed Interpretive Order
Commenters supported the Commission's proposed guidance that
accidental or negligent conduct does not constitute a violation of new
CEA section 4c(a)(5)(B).\53\ With respect to the scienter required for
a CEA section 4c(a)(5)(B) violation, commenters requested that the
Commission require, at a minimum, a scienter of ``extreme
recklessness.'' \54\ Commenters also stated that manipulative intent
should be required to violate CEA section 4(c)(a)(5)(B) and that these
prohibitions should be limited to manipulative conduct such as
``banging'' or ``marking the close.'' \55\
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\53\ See, e.g., CME at 4 (``We commend the Commission for
clarifying that, consistent with the plain language of Section 747,
accidental or negligent conduct does not constitute a violation of
subsection (B).'').
\54\ See id. (``We believe that the Commission should provide in
its final order that a violation of subsection (B) requires a
showing of scienter--that is, that the person acted knowingly,
intentionally, or with extreme recklessness to commit the prohibited
conduct.'').
\55\ 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 Section 4c(a)(5)(B). . . . Additionally, the
Commission should clarify that manipulative intent is required to
violate Section 4c(a)(5)(B)'').
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Commenters requested that the Commission provide additional clarity
regarding the meaning of the term ``closing period'' as used in CEA
section 4c(a)(5)(B).\56\ Commenters expressed the view that, unlike
futures, certain swaps, such as physical products that are priced using
indices, do not have defined closing periods.\57\ Some commenters
disagreed with the Commission's view that the prohibition on disorderly
execution of transactions should extend to conduct occurring outside
the closing period.\58\
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\56\ See, e.g., BGA at 3 (``BGA is concerned that the Commission
has not provided sufficient clarity around the terms `orderly
execution,' `disruptive conduct,' or `closing period.' ''); CME at 5
(``We understand that the Commission cannot precisely define the
parameters of `orderly execution' and whether certain executions
during the closing period are `orderly' must necessarily be inferred
from the totality of the facts and circumstances. Indeed, we noted
in our comment letter in response to the ANPR that `orderly
execution' can be evaluated only in the context of the specific
instrument, market conditions, and participant circumstances at the
time in question.'').
\57\ See id. (``It appears that the Commission is changing the
definition of `closing period' relating to physical products that
are pricing using indices or benchmarks. These products do not have
defined closing periods; therefore, it is inappropriate to apply a
`closing period' concept to them.'').
\58\ See, e.g., CME at 6 (``It is unclear how trading practices
or conduct outside of the `closing period' would demonstrate
intentional or reckless disregard for the orderly execution of
transactions during the closing period.'').
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Commenters also requested that the Commission further clarify the
term ``orderly execution'' as set forth in section CEA section
4c(a)(5)(B).\59\ Commenters stated that the Commission should not
engage in post hoc evaluations as to what types of trading, conduct, or
practices violate CEA section 4c(a)(5)(B).\60\ Commenters also claimed
that having the Commission rely on concepts of orderliness as developed
in securities law precedent was problematic because of the significant
differences between the securities and CFTC-regulated markets.\61\
Commenters further stated that requiring market participants to assess
market conditions before trading conflicts with the Commission's
assertion that CEA section 4c(a)(5)(B) will not capture legitimate
trading behavior.\62\ Commenters also noted that in today's highly
automated trading environments, it is impractical for market
participants to assess market conditions prior to the entry of each
order.\63\
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\59\ See, e.g., BGA at 3 (``BGA is concerned that the Commission
has not provided sufficient clarity around the terms `orderly
execution,' `disruptive conduct,' or `closing period.' ''); CME at 5
(``We understand that the Commission cannot precisely define the
parameters of `orderly execution' and whether certain executions
during the closing period are `orderly' must necessarily be inferred
from the totality of the facts and circumstances. Indeed, we noted
in our comment letter in response to the ANPR that `orderly
execution' can be evaluated only in the context of the specific
instrument, market conditions, and participant circumstances at the
time in question.'').
\60\ See, e.g., MFA at 4 (``The definition of the term `orderly'
is not only vague, but also subjective and would allow for post hoc
judgments as to what constitutes violative, disruptive conduct.'');
FIA at 5 (``Market participants should not fear that their trading
activity may be the subject of a post hoc analysis which labels a
trade or a series of trades ``disruptive.' '').
\61\ See, e.g., CME at 6-7 (``In light of these and other
significant differences that exist in their respective market and
regulatory structures, as well as the fundamental purposes of the
markets, we caution the Commission against importing securities-
based concepts to the derivatives markets.'').
\62\ See id. (Requiring participants to assess market conditions
and consider how their trading may affect orderly execution during
the closing period is ``at odds with the Commission's assertion that
this section `will not capture legitimate trading behavior and is
not a trade for those who act in good faith.' '').
\63\ See, e.g., CME at 4 (``Given today's highly automated
environment and the millisecond speed with which liquidity can be
sourced, consumed and withdrawn, it is impractical to require such
analysis prior to the entry of each order, much less presume that
market participants can always accurately assess market conditions
or divine market impact, particularly during the closing period
which is often the most volatile period of the day and a period in
which certainty of execution may be a more material consideration
than price.'').
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[[Page 31895]]
2. Commission Guidance
The Commission interprets Congress's inclusion of a scienter
requirement in CEA section 4c(a)(5)(B) as meaning that accidental, or
even negligent, trading, practices, or conduct will not be a sufficient
basis for the Commission to claim a violation under CEA section
4c(a)(5)(B). The Commission interprets CEA section 4c(a)(5)(B) as
requiring a market participant to at least act recklessly to violate
CEA section 4c(a)(5)(B).\64\ The Commission declines to interpret CEA
section 4c(a)(5)(B) to include either an extreme recklessness standard
or a manipulative intent requirement because this modification would
alter the scienter standard mandated by the statute, which prohibits
conduct that demonstrates ``intentional or reckless disregard for the
orderly execution of transactions during the closing period.'' \65\
Recklessness is a well-established scienter standard, which has
consistently been defined as conduct that ``departs so far from the
standards of ordinary care that it is very difficult to believe the
actor was not aware of what he or she was doing.'' \66\ Consistent with
long-standing precedent under commodities and securities law, the
Commission intends to apply this commonly-known definition of
recklessness to CEA section 4c(a)(5)(B). A person with manipulative
intent, such as one attempting to ``bang'' or ``mark the close'' may
also intend to disrupt the orderly execution of transactions during the
closing period, but the finding of a manipulative intent is not a
prerequisite for a finding of a violation of CEA section 4c(a)(5)(B).
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\64\ 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)).
\65\ 7 U.S.C. 4c(a)(5)(B).
\66\ Drexel Burnham Lambert Inc. at 748; see also Sundstrand
Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977), cert.
denied, 434 U.S. 875 (1977) (holding that recklessness under SEC
Rule 10b-5 means ``an extreme departure from the standards of
ordinary care, and which presents a danger of misleading buyers or
sellers that is either known to the defendant or is so obvious that
the actor must have been aware of it'') (internal quotation marks
and citation omitted); SEC v. Platforms Wireless Int'l Corp., 617
F.3d 1072, 1093-94 (9th Cir. 2010) (``scienter [under SEC Rule 10b-
5] requires either deliberate recklessness or conscious
recklessness, and [ ] it includes a subjective inquiry turning on
the defendant's actual state of mind'') (internal quotation marks
and citations omitted). See also, the final rules issued by the
Commission on July 14, 2011 (Prohibition on the Employment, or
Attempted Employment, of Manipulation and Deceptive Devices and
Prohibition on Price Manipulation), 76 FR, July 14, 2011.
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The Commission interprets the prohibition in CEA section
4c(a)(5)(B) to apply to any trading, conduct, or practices occurring
within the closing period that demonstrates an intentional or reckless
disregard for the orderly execution of transactions during the closing
period. The Commission interprets the closing period to be defined
generally as the period in the contract or trade when the settlement
price is determined under the rules of a trading facility such as a DCM
or SEF. 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).
With respect to swaps, the Commission interprets a swap as being
subject to the provisions of section 4c(a)(5)(B) if a DCM or SEF
determines that a settlement or pricing period exists for that
particular swap.\67\ Additionally, the Commission's policy is that
conduct outside the closing period may also disrupt the orderly
execution of transactions during the closing period and may thus form
the basis of a violation under CEA section 4c(a)(5)(B) and any other
applicable CEA sections. For example, a CEA section 4c(a)(5)(B)
violation may occur when a market participant accumulates a large
position in a product or contract in the period immediately preceding
the closing period with the intent (or reckless disregard) to disrupt
the orderly execution of transactions during that product's, or a
similar product's, defined closing period.
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\67\ The Commission disagrees with commenters that physical
products priced using indices or benchmarks do not have defined
closing periods. For physical products priced using indices, price
reporting agencies may use the transaction prices during a certain
window of time to calculate price indexes. Market participants have
the same ability to disrupt trading during these windows of time as
they do during the closing periods as defined by the DCM or SEF.
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The Commission interprets CEA section 4c(a)(5)(B) violations as
including not only executed orders by market participants that disrupt
the orderly execution of transactions during the closing period, but
also any bids and offers submitted by market participants that disrupt
the orderly execution of transactions during the closing period. For
example, bids and offers submitted by a person, even if they are not
executed against by other market participants, may disrupt orderly
trading in the closing period by sending false signals to the
marketplace that consequently affect the trading behavior of market
participants in the closing period. As such, bids and offers submitted
by a person who intends to cancel the bid or offer before execution may
have violations of both CEA section 4c(a)(5)(B), a disruption of
orderly trading in the closing period, and CEA section 4c(a)(5)(C),
``spoofing.''
Similar to other scienter-based violations of the CEA, the
Commission intends to consider all of the relevant facts and
circumstances when determining whether a person violated CEA section
4c(a)(5)(B). The Commission recognizes that an evaluation of ``orderly
execution'' should be based on the totality of the facts and
circumstances as of the time the person engaged in the relevant
trading, practices, or conduct--i.e., the Commission intends to
consider what the person knew or should have known, and the information
available at the time he or she was engaging in the conduct at issue.
For example, a CEA section 4c(a)(5)(B) violation would not occur simply
because a person's execution of orders during the closing period had a
substantial effect on a contract's settlement price; rather, such
person's conduct must also demonstrate an intentional or reckless
disregard for the orderly execution of transactions during the closing
period.
While the Commission recognizes there are differences between
securities markets and CFTC-regulated markets, fundamental concepts of
how an orderly market should function are similar in both markets. In
light of the differences between these two markets, the Commission will
be guided, but not controlled, by the substantial body of judicial
precedent applying the concepts of orderly markets established by the
courts with respect to the securities markets. To this end, the
Commission's policy is that 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 dramatically 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
[[Page 31896]]
for remote months.\68\ For example, trading in a manner that
intentionally or recklessly causes the price relationships between the
price of a derivative and the underlying commodity to diverge, or cause
spreads between contracts for near months and for remote months to
diverge could constitute a violation of the statute.
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\68\ While the role of market specialists is unique to the
securities markets as of this time, the economic concepts applicable
to orderly markets in securities markets may help guide the
Commission when analyzing orderly trading in CFTC-regulated markets.
---------------------------------------------------------------------------
Finally, the Commission recommends 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. Market participants should assess market conditions before
placing a bid or offer, or executing an order, because this will help
prevent market participants from engaging in trading, practices, or
conduct that disrupts fair and equitable trading in CFTC-regulated
markets.
D. ``Spoofing''
1. Comments to the Proposed Interpretive Order
Commenters requested additional Commission guidance on the
definition of ``spoofing'' as set forth in CEA section 4c(a)(5)(C).\69\
Commenters stated that any violations should not capture legitimate
trading behavior. For example, to differentiate ``spoofing'' from
legitimate trading behavior, commenters state that any person violating
CEA section 4c(a)(5)(C) must also intend to mislead market participants
and to exploit that deception for the spoofing entity's benefit.\70\
Commenters further requested that if a bid or offer has the risk of
being hit or lifted by the market, for any period of time, such trading
activity should be exempt from being classified as a ``spoofing''
violation.\71\ Commenters expressed a similar view that partial fills
should also be exempt from the definition of ``spoofing.'' \72\ Lastly,
one commenter stated CEA section 4c(a)(5)(C) violations should only be
applicable to order-book facilities.\73\
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\69\ See, e.g., ICE at 4 (``The Commission should provide
additional guidance as to what specific types of improper trading
practices or activity would be broadly characterized as being
spoofing and `of the character of' spoofing.'').
\70\ See, e.g., CMC at 4 (``The distinguishing characteristic
between `spoofing' that should be covered by Section 747(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 for the spoofing entity's benefit.'').
\71\ See, e.g., BGA at 4 (``BGA recommends the Commission
clarify that, if a bid or offer has the risk of being hit or lifted
by the market, for any period of time, this activity be deemed
legitimate conduct and not be deemed `spoofing.' '').
\72\ See, e.g., FIA at 6 (``Traders engage in legitimate trading
practices that are unintentionally captured by Section 747's
definition of `spoofing.' For example, traders may enter larger than
necessary orders to ensure their hedging or delivery needs are met
and, once met, they may then cancel part of the original order.'').
\73\ See, e.g., ISDA at 4 (``The entire Proposed Guidance
discussion of spoofing is in exchange terminology and facially
applicable only in an exchange environment. Again, we believe this
is, if applicable at all, applicable at this time only to Order-Book
facilities.'').
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2. Commission Guidance
The Commission interprets a CEA section 4c(a)(5)(C) violation as
requiring a market participant to act with some degree of intent, or
scienter, beyond recklessness to engage in the ``spoofing'' trading
practices prohibited by CEA section 4c(a)(5)(C). Because CEA section
4c(a)(5)(C) requires that a person intend to cancel a bid or offer
before execution, the Commission does not interpret reckless trading,
practices, or conduct as constituting a ``spoofing'' violation.\74\
Additionally, the Commission interprets that a spoofing violation will
not occur when the person's intent when cancelling a bid or offer
before execution was to cancel such bid or offer as part of a
legitimate, good-faith attempt to consummate a trade. Thus, the
Commission interprets the statute to mean that a legitimate, good-faith
cancellation or modification of orders (e.g., partially filled orders
or properly placed stop-loss orders) would not violate section CEA
4c(a)(5)(C). However, the Commission does not interpret a partial fill
as automatically exempt from being classified as ``spoofing'' and
violating CEA section 4c(a)(5)(C).
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\74\ Similar to violations under CEA section 4c(a)(5)(B), the
Commission does not interpret CEA section 4c(a)(5)(C) as reaching
accidental or negligent trading, practices, or conduct.
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When distinguishing between legitimate trading (such as trading
involving partial executions) and ``spoofing,'' the Commission intends
to 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 and not
attempt to consummate a legitimate trade, regardless of whether such
bid or offer was subsequently partially filled, that conduct may
violate CEA section 4c(a)(5)(C).
The Commission interprets and intends to apply CEA section
4c(a)(5)(C) as covering bid and offer activity on all products traded
on all registered entities, including DCMs and SEFs. The Commission
further interprets CEA section 4c(a)(5)(C) to include all bids and
offers in pre-open periods or during other exchange-controlled trading
halts. As noted earlier, the Commission does not interpret CEA section
4c(a)(5)(C) as restricting ``spoofing'' violations to trading platforms
and venues only having order book functionality. ``Spoofing'' may
possibly occur on any trading platform or venue where a market
participant has the ability to either (a) send executable bids and
offers to market participants or (b) transact against resting orders.
The Commission provides four non-exclusive examples of possible
situations for when market participants are engaged in ``spoofing''
behavior,\75\ including: (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, (iii) submitting or cancelling multiple bids or offers to
create an appearance of false market depth, and (iv) submitting or
canceling bids or offers with intent to create artificial price
movements upwards or downwards. The Commission also does not intend to
apply the ``spoofing'' provision as covering market communications such
as authorized pre-trade communications.
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\75\ See 76 FR at 14947.
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As with other intent-based violations, the Commission intends to
distinguish 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. The Commission does not
interpret a CEA section 4c(a)(5)(C) violation as requiring a pattern of
activity; the Commission interprets CEA section 4c(a)(5)(C) such that
even a single instance of trading activity can violate CEA section
4c(a)(5)(C), provided that the activity is conducted with the
prohibited intent.
Issued in Washington, DC, on May 20, 2013, by the Commission.
Christopher J. Kirkpatrick,
Deputy Secretary of the Commission.
[[Page 31897]]
Appendices to Antidisruptive Practices Authority--Commission Voting
Summary; Statements of Commissioners; and List of Roundtable
Participants and Commenters
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Sommers,
Chilton, O'Malia, and Wetjen voted in the affirmative. No
Commissioners voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the Interpretive Guidance and Policy Statement
regarding disruptive practices on swap execution facilities and
designated contract markets. As part of market reform, Congress
expressly prohibited certain trading practices that were deemed
disruptive of fair and equitable trading on CFTC-registered
entities, such as swap execution facilities and designated contract
markets.
These provisions are important because it is a core mission of
the CFTC to protect the markets against abusive and disruptive
practices, particularly those that impede critical price discovery
functions.
The Interpretive Guidance and Policy Statement provides
additional guidance to market participants regarding the scope of
conduct and trading practices that would violate the law. For
instance, the Commission interprets this provision, section 747 of
the Dodd-Frank Wall Street Reform and Consumer Protection Act, to
apply to any trading, practices or conduct on registered SEFs or
DCMs.
The guidance addresses the comments the Commission received in
response to the proposal, including a roundtable.
Appendix 3--Parties Submitting Comment Letters in Response To
Disruptive Trading Practices Proposed Interpretive Order
Banking Firms Consolidated (``BF'')
Better Markets (``BM'')
BG Americas & Global LNG (``BGA'')
Chris Barnard
Coalition for Derivatives End Users (``Coalition'')
CME Group (``CME'')
Commodity Markets Council (``CMC'')
Futures Industry Association/Securities Industry and Financial
Markets Association (``FIA'')
GFI Group, Inc. (``GFI'')
Hampton Technology Resources (``HTR'')
InterContinentalExchange (``ICE'')
International Swaps and Derivatives Association (``ISDA'')
Managed Funds Association (``MFA'')
MarketAxess
Minneapolis Grain Exchange (``MGE'')
Working Group of Commercial Energy Firms (``Working Group'')
[FR Doc. 2013-12365 Filed 5-24-13; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: May 28, 2013