Federal Register, Volume 76 Issue 135 (Thursday, July 14, 2011)[Federal Register Volume 76, Number 135 (Thursday, July 14, 2011)]
[Rules and Regulations]
[Pages 41398-41411]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-17549]
[[Page 41398]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 180
RIN Number 3038-AD27
Prohibition on the Employment, or Attempted Employment, of
Manipulative and Deceptive Devices and Prohibition on Price
Manipulation
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is adopting final rules pursuant to section 753 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act''), to implement amended subsections (c)(1) and (c)(3) of section 6
of the Commodity Exchange Act (``CEA''). These rules broadly prohibit
fraud and manipulation in connection with any swap, or contract of sale
of any commodity in interstate commerce, or contract for future
delivery on or subject to the rules of any registered entity.
DATES: Effective Date: These final Rules will become effective August
15, 2011.
FOR FURTHER INFORMATION CONTACT: David Meister, Director, Division of
Enforcement, 202-418-5624, or Mark D. Higgins, Counsel, Office of the
General Counsel, 202-418-5864, [email protected], Commodity Futures
Trading Commission, Three Lafayette Centre, 1151 21st Street, NW.,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act into
law. Title VII of the Dodd-Frank Act amended the CEA 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 authority with respect to, among others, all registered
entities and intermediaries.
In the wake of the financial crisis of 2008, Congress adopted
section 753 of the Dodd-Frank Act, which provided the Commission with
additional and broad authority to prohibit fraud and manipulation. In
the following paragraphs, the Commission summarizes Dodd-Frank Act
section 753's amendments to CEA section 6(c).
New section 6(c)(1), the full text of which is provided in Section
III below, broadly prohibits the use or employment of, or an attempt to
use or employ, any ``manipulative or deceptive device or contrivance''
in contravention of such rules and regulations as the Commission
``shall promulgate no later than 1 year after the date of enactment''
of the Dodd-Frank Act.
As discussed below, final Rule 180.1 implements the provisions of
CEA section 6(c)(1) by prohibiting, among other things, manipulative
and deceptive devices, i.e., fraud and fraud-based manipulative devices
and contrivances employed intentionally or recklessly, regardless of
whether the conduct in question was intended to create or did create an
artificial price. This final Rule will help promote the integrity of
the markets, and protect market participants.
Section 6(c)(1)(A), a ``Special Provision for Manipulation by False
Reporting,'' extends the Commission's prohibition against unlawful
manipulation to include ``delivering, or causing to be delivered for
transmission through the mails or interstate commerce, by any means of
communication whatsoever, a false or misleading or inaccurate report
concerning crop or market information or conditions that affect or tend
to affect the price of any commodity in interstate commerce, knowing,
or acting in reckless disregard of the fact that such report is false,
misleading or inaccurate.'' \1\ Importantly, section 6(c)(1)(C)
provides a ``Good Faith Mistakes'' exception to this prohibition such
that ``[m]istakenly transmitting, in good faith, false or misleading or
inaccurate information to a price reporting service would not be
sufficient to violate subsection (c)(1)(A).''
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\1\ Section 9(a)(2) of the CEA, 7 U.S.C. 13(a)(2), also
expressly prohibits false reporting.
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Section 6(c)(2) prohibits the making of ``any false or misleading
statement of a material fact to the Commission. * * *'' A prohibition
regarding false statements to the Commission was previously included in
section 6(c). Dodd-Frank Act section 753 expands the prohibition
against false statements made in registration applications or reports
filed with the Commission to include any statement of material fact
made to the Commission in any context.
CEA section 6(c)(3), the full text of which is provided in Section
III below, makes it unlawful to ``manipulate or attempt to manipulate
the price of any swap, or of any commodity in interstate commerce, or
for future delivery on or subject to the rules of any registered
entity.'' Final Rule 180.2 codifies section 6(c)(3).
Section 753 of the Dodd-Frank Act also amends prior CEA section
6(c) to provide, in cases of manipulation or attempted manipulation in
violation of sections 6(c) or 9(a)(2), for a civil penalty of up to the
greater of $1,000,000 or triple the monetary gain to the person for
each such violation; and restitution to customers of damages
proximately caused by violations of the person. For other violations,
section 6(c)(10)(C) provides for a civil penalty of not more than an
amount equal to the greater of $140,000 or triple the monetary gain for
each such violation.
Finally, section 753 of the Dodd-Frank Act provides that the above-
summarized amendments to CEA section 6(c) ``shall take effect on the
date on which the final rule promulgated by the Commodity Futures
Trading Commission pursuant to this Act takes effect.'' The final Rules
will take effect 30 days after publication in the Federal Register.
II. The Rulemaking Proceeding Under CEA Section 6(c)
This rulemaking proceeding \2\ began with the issuance of a Notice
of Proposed Rulemaking (``NOPR'') on October 26, 2010, which was
published in the Federal Register on November 3, 2010.\3\ Pursuant to
CEA section 6(c),\4\ as amended by section 753 of the Dodd-Frank Act,
the Commission proposed to add a new Part 180 to Title 17 of the Code
of Federal Regulations. In the NOPR, the Commission solicited comments
on all aspects of proposed Part 180. Twenty-seven parties filed
comments, representing a variety of interested parties, including a
member of the United States Congress, a law professor, economists,
industry members and trade associations, energy news and price
reporting organizations, designated contract markets
[[Page 41399]]
(exchanges), a government-sponsored enterprise, and members of the
public.\5\
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\2\ Rulemaking documents are available at: (http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/23_DFManipulation/index.htm).
\3\ Prohibition of Market Manipulation, 75 FR 67657 (Nov. 3,
2010).
\4\ Section 753 of the Dodd-Frank Act directed the Commission to
promulgate implementing rules and regulations by not later than one
year after the date of enactment of the Dodd-Frank Act.
\5\ Attachment A contains a list of the 27 parties who submitted
comments related to this rulemaking.
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Upon careful review and consideration of the entire record in this
rulemaking and based on its extensive market regulation experience, the
Commission has determined that it is appropriate and in the public
interest to adopt the final Rules, which among other things, define for
the public the statutory prohibition under CEA section 6(c)(1) against
using or employing ``any manipulative or deceptive device or
contrivance'' in connection with any swap, or a contract of sale of any
commodity in interstate commerce, or for future delivery on or subject
to the rules of any registered entity. Consistent with section 6(c)(1),
the final Rule 180.1 prohibits, among other things, fraud and fraud-
based manipulative schemes, employed intentionally or recklessly (as
discussed below), regardless of whether the conduct in question was
intended to or did create an artificial price. Final Rules 180.1 and
180.2 will help to promote the integrity of the markets, and protect
market participants.
After carefully reviewing the entire rulemaking record, the
Commission finds it unnecessary to change the wording of the proposed
regulatory text, except in one respect: Adding ``inaccurate'' to
section 180.1(a)(4) (``* * * no violation of this subsection shall
exist where the person mistakenly transmits, in good faith, false or
misleading or inaccurate information to a price reporting service.'').
This change is necessary to ensure symmetry between final Rule 180.1
and CEA section 6(c)(1)(C). However, based on the public comments, the
Commission has determined to provide clarification and interpretive
guidance in this Preamble to final Rules 180.1 and 180.2.
The Commission's statutory and legal basis for promulgating the
final Rules, their purpose, and the Commission's responses to comments
filed in this rulemaking, are discussed below.
III. Statutory Basis for the Final Rules
CEA section 6(c)(1), entitled ``Prohibition Against Manipulation,''
is the statutory basis for final Rule 180.1, and provides that:
It shall be unlawful for any person, directly or indirectly, to
use or employ, or attempt to use or employ, in connection with any
swap, or a contract of sale of any commodity in interstate commerce,
or for future delivery on or subject to the rules of any registered
entity, any manipulative or deceptive device or contrivance, in
contravention of such rules and regulations as the Commission shall
promulgate by not later than 1 year after the date of enactment of
the [Dodd-Frank Act], provided no rule or regulation promulgated by
the Commission shall require any person to disclose to another
person nonpublic information that may be material to the market
price, rate, or level of the commodity transaction, except as
necessary to make any statement made to the other person in or in
connection with the transaction not misleading in any material
respect.
CEA section 6(c)(3), entitled ``Other Manipulation,'' provides
that:
[I]t shall be unlawful for any person, directly or indirectly,
to manipulate or attempt to manipulate the price of any swap, or of
any commodity in interstate commerce, or for future delivery on or
subject to the rules of any registered entity.
CEA section 6(c)(3) and the Commission's general rulemaking
authority pursuant to CEA section 8a(5) provide the statutory basis for
final Rule 180.2.
Commenters are overwhelmingly supportive of the Commission's
efforts to implement clear and fair rules designed to protect market
participants and promote the integrity of the markets. In the following
sections, the Commission summarizes and responds to the comments
received in this rulemaking.
IV. Discussion of CEA Section 6(c)(1) and Final Rule 180.1
A. Overview
The language of CEA section 6(c)(1), particularly the operative
phrase ``manipulative or deceptive device or contrivance,'' is
virtually identical to the terms used in section 10(b) of the
Securities Exchange Act of 1934 (``Exchange Act'').\6\ The Supreme
Court has interpreted these words to ``clearly connot[e] intentional
misconduct.'' \7\ The Court has also stated that the statute was
``designed as a catchall clause to prevent fraudulent practices.'' \8\
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\6\ 15 U.S.C. 78j(b). Differences between the wording of
Exchange Act Section 10(b) and CEA section 6(c)(1) include, but are
not limited to, the express prohibition of the ``attempt to use''
any ``manipulative or deceptive device or contrivance'' in CEA
section 6(c)(1), and the absence of a ``purchase or sale''
requirement in CEA section 6(c)(1). The Commission understands that
under SEC Rule 10b-5 a plaintiff is not required to prove that money
was actually invested in a specific security. See, e.g., SEC v.
Zandford, 535 U.S. 813, 819-21 (2002).
\7\ Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201 (1976).
\8\ Chiarella v. United States, 445 U.S. 222, 226 (1980), citing
Hochfelder, 425 U.S. at 202, 206.
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Based on the language in Exchange Act section 10(b), the Securities
and Exchange Commission (``SEC'') promulgated SEC Rule 10b-5, which
makes it unlawful for any person:
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit
to state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were made,
not misleading, or
(c) To engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any security.\9\
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\9\ 17 CFR 240.10b-5.
Given the similarities between CEA section 6(c)(1) and Exchange Act
section 10(b), the Commission deems it appropriate and in the public
interest to model final Rule 180.1 on SEC Rule 10b-5.\10\ To account
for the differences between the securities markets and the derivatives
markets, the Commission will be guided, but not controlled, by the
substantial body of judicial precedent applying the comparable language
of SEC Rule 10b-5.\11\ Such extensive judicial review serves as an
important benefit to the Commission and provides the public with
increased certainty because the terms of Exchange Act Section 10(b) and
SEC Rule 10b-5 have withstood challenges to their constitutionality in
both civil and criminal matters.\12\
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\10\ See, e.g., Morissette v. United States, 342 U.S. 246, 263
(1952) (noting that where Congress borrows terms of art it
``presumably knows and adopts the cluster of ideas that were
attached to each borrowed word''); Nat'l Treasury Employees Union v.
Chertoff, 452 F.3d 839, 857 (DC Cir. 2006) (stating that ``[t]here
is a presumption that Congress uses the same term consistently in
different statutes'').
\11\ Further, by modeling final Rule 180.1 on SEC Rule 10b-5,
the Commission takes an important step toward harmonization of
regulation of the commodities, commodities futures, swaps and
securities markets given that new CEA section 6(c)(1) and Exchange
Act Section 10(b) include virtually identical prohibitions against
``any manipulative or deceptive device or contrivance.''
\12\ See, e.g., United States v. Persky, 520 F.2d 283, 287 (2d
Cir. 1975) (rejecting criminal defendant's argument that Exchange
Act section 10(b) and SEC Rule 10b-5 are unconstitutionally vague);
SEC v. Pirate Investor LLC, 580 F.3d 233, 254 (4th Cir. 2009)
(upholding civil judgment and finding that ``[a]ppellants' reliance
on any ambiguity in the [section 10(b)] phrase `in connection with'
as a reason to employ the canon of constitutional avoidance fails in
light of the statute's purpose--providing a flexible regime for
addressing new, perhaps unforeseen, types of fraud''), cert. denied,
130 S. Ct. 3506, 2010 U.S. LEXIS 5345 (2010). The Federal Energy
Regulatory Commission and the Federal Trade Commission have relied
upon a statutory framework largely identical to Exchange Act section
10(b) when promulgating rules similar to SEC Rule 10b-5. In so
doing, both agencies have stated their intent to be guided by
securities law precedent, as appropriate to their unique regulatory
missions. FERC, Prohibition of Energy Market Manipulation, 71 FR
4244, 4250 (Jan. 26, 2006) (FERC final anti-manipulation rule); FTC,
Prohibitions on Market Manipulation, 74 FR 40686, 40688-89 (Aug. 12,
2009) (FTC final anti-manipulation rule).
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[[Page 41400]]
Final Rule 180.1 prohibits fraud and fraud-based manipulations, and
attempts: (1) By any person (2) acting intentionally or recklessly (3)
in connection with (4) any swap, or contract of sale of any commodity
in interstate commerce, or contract for future delivery on or subject
to the rules of any registered entity (as defined in the CEA). CEA
section 6(c)(1) and final Rule 180.1, like Exchange Act section 10(b)
and SEC Rule 10b-5 upon which they are modeled, focus on conduct
involving manipulation or deception.\13\
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\13\ Santa Fe Industries v. Green, 430 U.S. 462, 473-76 (1977);
Dirks v. SEC, 463 U.S. 646, 667 n. 27 (1983) (concluding that ``to
constitute a violation of Rule 10b-5, there must be fraud'');
Chiarella v. United States, 445 U.S. 222, 234-35 (1980) (stating
that Exchange Act ``section 10(b) is aptly described as a catchall
provision, but what it catches must be fraud''); Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 199 (1976) (rejecting argument for
imposition of negligence standard that ``simply ignore[d] the use of
the words `manipulative,' `device,' and `contrivance'--terms that
make unmistakable a congressional intent to proscribe a type of
conduct quite different from negligence. Use of the word
`manipulative' is especially significant. It is and was virtually a
term of art when used in connection with securities markets. It
connotes intentional or willful conduct designed to deceive or
defraud investors by controlling or artificially affecting the price
of securities'') (internal citations omitted).
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In the following paragraphs, the Commission addresses the comments
that pertain to final Rule 180.1 in the following categories: (1) Scope
of application of the final Rule; (2) disclosure implications of the
final Rule; (3) operation of the provision prohibiting material
misstatements and omissions; (4) statutory exception for good faith
mistakes; (5) required scienter for a violation of the final Rule; (6)
scope of the phrase ``in connection with''; and (7) penalty, procedure,
effect on automated trading systems, and a proposal to define
manipulation.\14\
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\14\ The extent to which securities law precedent should apply
is an issue that commenters often linked to more specific comments
pertaining to the interpretation of the statute and proposed rule
text. As such, the Commission considers commenters' views about
securities law precedent in the specific contexts in which they
arise.
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B. The Scope of the Application of Final Rule 180.1
1. Comments
The Commission received several comments on the scope of the
application of proposed Rule 180.1. United States Senator Carl Levin
(``Senator Levin''), Chairman of the Permanent Subcommittee on
Investigations, Committee on Homeland Security and Governmental
Affairs, believes that the CFTC and SEC should harmonize their
regulatory structures for combating disruptive and manipulative
activities.\15\
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\15\ Senator Levin Comment Letter at pages 3-4.
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Better Markets, a non-profit public interest advocacy organization,
states that the proposed Rules are critical to implementing the
important expansion of the Commission's enforcement capability so that
the transparent and reliable marketplace envisioned by the Dodd-Frank
Act can be realized.\16\ Similarly, the Council of Institutional
Investors (``Council'') supports proposed Rule 180.1 and believes that
it will help promote the integrity of the price discovery process and
fair dealing between market participants. The Council believes that, if
accompanied by robust enforcement, the proposed Rule would promote
investor confidence in the markets and contribute to the overall safety
and soundness of the financial system.\17\ Likewise, the Petroleum
Marketers Association of America (``PMAA'') believes that proposed
Rules 180.1 and 180.2 will effectively implement the statutory and
Congressional directive to clearly delineate and prevent impermissible
conduct by market participants.\18\
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\16\ Better Markets Comment Letter at page 1.
\17\ Council Comment Letter at pages 1-2.
\18\ PMAA Comment Letter at page 1.
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University of Maryland School of Law Professor Michael Greenberger
(``Professor Greenberger'') believes that proposed Rule 180.1 reflects
an effective anti-manipulation rule mandated by section 753 of the
Dodd-Frank Act. Professor Greenberger further believes that the
Commission correctly asserts that proposed Rule 180.1 be given a broad,
remedial reading similar to SEC Rule 10b-5.\19\
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\19\ Professor Greenberger Comment Letter at page 2.
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The CME Group, Inc. (``CME Group'') and the Commodity Markets
Council (``CMC'') believe that proposed Rules 180.1 and 180.2 are vague
and fail to provide market participants with sufficient notice of
whether contemplated trading practices run afoul of a prohibition.\20\
Further, CME Group and CMC believe that proposed Rule 180.1 is
susceptible to constitutional challenge under the Due Process
Clause.\21\
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\20\ CME Group Comment Letter at pages 2-3; CMC Comment Letter
at page 2.
\21\ CME Group at page 3; CMC at page 2.
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The Futures Industry Association (``FIA''), International Swaps and
Derivatives Association, Inc. (``ISDA''), and the Securities Industry
and Financial Markets Association (``SIFMA'') (together, ``the
Associations'') believe that the Commission should clarify the scope of
the proposed regulation, the Commission's existing anti-manipulation
authority under CEA section 9(a)(2), and its anti-fraud authority under
CEA section 4b.\22\ The Associations urge the Commission to remove from
all subparts of the proposed Rule language that prohibits an
``attempt'' to manipulate and to clarify that the requirements for
attempted manipulation remain consistent with current law under CEA
section 6(c).\23\ The Managed Funds Association (``MFA'') believes that
the Commission should interpret CEA section 6(c)(1) merely to clarify
and refine the Commission's authority over swaps, and not to create any
new antifraud authority or to create any new duties or obligations.\24\
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\22\ Associations Comment Letter at page 9.
\23\ Associations at page 8.
\24\ MFA Comment Letter at pages 6-7.
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The American Petroleum Institute (``API'') together with the
National Petrochemical and Refiners Association (``NPRA''), and the
Coalition of Physical Energy Companies (``COPE'') state that Congress
intended the scope of section 753 of the Dodd-Frank Act to address only
actual fraudulent manipulation of the commodities markets.\25\ Absent a
manipulative effect on the market, API and NPRA believe that there
should be no liability under proposed Rule 180.1.\26\ Further, API and
NPRA state that the Commission should require proof that a party's
deceptive or fraudulent conduct caused market conditions to deviate
materially from the conditions that would have existed but for that
conduct.\27\ Similarly, the Derivatives and Futures Law Committee of
the Business Law Section of the American Bar Association (``ABA
Derivatives Committee'') states that any Commission rules under CEA
section 6(c)(1) should expressly target intentional or extremely
reckless deceitful conduct specifically intended to cause artificial
prices by corrupting or disabling the integrity of market price-setting
processes and mechanisms rather than by a general anti-fraud rule
patterned on SEC Rule 10b-5.\28\ The ABA Derivatives Committee believes
that mere unfairness or impermissible overreaching without deception
does not violate section 10(b) or SEC Rule 10b-5 thereunder.\29\
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\25\ API and NPRA Comment Letter at page 3; COPE Comment Letter
at page 2.
\26\ API and NPRA at pages 2, 9, and 24.
\27\ API and NPRA at page 10.
\28\ ABA Derivatives Committee Comment Letter at pages 5 and 11-
13. According to the ABA Derivatives Committee, ``[a] rule that does
not require evidence of a specific intent to cause artificial market
prices as an element of a violation would result in a dangerously
vague rule * * * [which] could expose participants to the threat of
arbitrary and unfair enforcement.'' Id. at page 12.
\29\ ABA Derivatives Committee at page 6.
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Freddie Mac recommends that the Commission strengthen the
protection of customers by clarifying that CEA section 6(c), as amended
by section 753 of the Dodd-Frank Act and implemented by proposed Rule
180.1, expressly prohibits ``front running'' and similar misuse of
customer information by swap dealers as a form of fraud-based
manipulation.\30\
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\30\ Freddie Mac Comment Letter at pages 1-5.
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2. Commission Determination
Upon review of the entire rulemaking record, the Commission
determines that final Rule 180.1 is in the public interest and provides
fair, reasonable, and adequate notice of the prohibited conduct. With
respect to comments claiming that final Rule 180.1 is susceptible to a
due process constitutional challenge because it purportedly does not
give market participants fair notice of the prohibited conduct, the
Commission notes that final Rule 180.1 is modeled on SEC Rule 10b-5,
which has been subjected to extensive judicial review and has withstood
constitutional challenges, including those based on a fair notice
argument.\31\
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\31\ The fair notice argument has been repeatedly rejected in
the SEC Rule 10b-5 context in a wide variety of fact patterns. See,
e.g., United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986),
aff'g in part and rev'g in part United States v. Winans, 612 F.
Supp. 827, 848 (S.D.N.Y. 1985); United States v. Newman, 664 F.2d
12, 18-19 (2d Cir. 1981), aff'd after remand, 722 F.2d 729 (2d
Cir.), cert. denied, 464 U.S. 863 (1983); United States v.
Chiarella, 588 F.2d 1358, 1369 (2d Cir. 1978); United States v.
Brown, 555 F.2d 336, 339-40 (2d Cir. 1977); United States v. Persky,
520 F.2d 283, 286-88 (2d Cir. 1975); SEC v. Shapiro, 494 F.2d 1301,
1308 (2d Cir. 1974).
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In response to comments requesting clarification regarding the
relationship among final Rule 180.1 and existing CEA sections 4b and
9(a)(2), the Commission notes that section 753(a) of the Dodd-Frank Act
makes clear that nothing in new CEA section 6(c)(1) ``shall affect, or
be construed to affect, the applicability of section 9(a)(2).''
Likewise, the Commission finds nothing in CEA section 6(c)(1) or final
Rule 180.1 that affects, or should be construed to affect, the
applicability of CEA section 4b.\32\ Section 6(c)(1) and final Rule
180.1 augment the Commission's existing authority to prohibit fraud and
manipulation.
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\32\ Section 4b of the CEA, 7 U.S.C. 6b, prohibits, for example,
a person from defrauding another person in connection with the
making of commodity futures contracts for or on behalf of that other
person. Clayton Brokerage Co. v. CFTC, 794 F.2d 573, 578 (11th Cir.
1986). Thus, a broker's misrepresentations to his customer about
risk may subject the broker to liability under CEA section 4b. Id.
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The Commission declines to adopt the request of one commenter to
remove language from proposed Rules 180.1 and 180.2 that make it a
violation to ``attempt'' to engage in manipulation.\33\ The Commission
is controlled by the language of CEA section 6(c)(1), which
specifically directs the Commission to prohibit the ``attempt[ed]'' use
or employment of any manipulative or deceptive devices or
contrivances.\34\
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\33\ Associations at page 8.
\34\ The Commission understands that courts interpreting the
statutory phrase ``any manipulative or deceptive device'' as it is
used in Section 10(b) of the Exchange Act have deemed it broad
enough to encompass an attempt. See, e.g., SEC v. Martino, 255 F.
Supp. 2d 268, 287 (S.D.N.Y. 2003) (``[A]n attempted manipulation is
as actionable as a successful one'').
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The Commission declines to adopt the request of certain commenters
to interpret CEA section 6(c)(1) as merely extending the Commission's
existing anti-fraud and anti-manipulation authority to cover swaps.
Such an interpretation would be inconsistent with the language of CEA
section 6(c)(1), as amended by section 753 of the Dodd-Frank Act, under
which Congress granted the Commission broad new authority to prohibit
``any manipulative or deceptive device or contrivance'' in connection
with any swap, or a contract of sale of any commodity in interstate
commerce, or for future delivery on or subject to the rules of any
registered entity.
The Commission intends to interpret and apply CEA section 6(c)(1)
and final Rule 180.1 ``not technically and restrictively, but flexibly
to effectuate its remedial purposes.''\35\ Comments that the
Commission's use of the word ``commodity'' in proposed Rule 180.1
``indicates that the rule will apply to virtually every commercial
transaction in the economy'' are misplaced.\36\ The final Rule requires
a fraud or manipulation, or attempted fraud or manipulation, and that
the fraud or manipulation or attempted fraud or manipulation, be ``in
connection with'' any swap, or contract of sale of any commodity in
interstate commerce, or contract for future delivery on or subject to
the rules of any registered entity. The ``in connection with''
requirement is discussed in subsection G. below. And although CEA
section 6(c)(1) and final Rule 180.1 give the Commission broad
enforcement authority to prohibit fraud and manipulation in connection
with a contract of sale for any commodity in interstate commerce, the
Commission expects to exercise its authority under 6(c)(1) to cover
transactions related to the futures or swaps markets, or prices of
commodities in interstate commerce, or where the fraud or manipulation
has the potential to affect cash commodity, futures, or swaps markets
or participants in these markets.\37\ This application of the final
Rule respects the jurisdiction that Congress conferred upon the
Commission and fulfills its core mission and the purposes of the Act to
protect market participants and promote market integrity.
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\35\ See, e.g., Zandford, 535 U.S. at 819 (where a statute has a
remedial purpose such as the prevention of fraud, the statute should
be construed ``not technically and restrictively, but flexibly to
effectuate its remedial purposes'') (internal quotation marks and
citations omitted). See also R&W Technical Servs., Ltd. v. CFTC, 205
F.3d 165, 173 (5th Cir. 2000) (In 1974, Congress gave the CFTC
``even greater enforcement powers in part because of the fear that
unscrupulous individuals were encouraging amateurs to trade in the
commodities markets through fraudulent advertising. Remedial
statutes are to be construed liberally, and in an era of increasing
individual participation in commodities markets, the need for such
protection has not lessened'').
\36\ API and NPRA at page 3.
\37\ By way of non-exclusive example, if an entity employed a
deceptive device to sell precious metals to customers as a way for
the customers to speculate on the value of such commodities, or if
an entity employed a deceptive device to sell an agricultural
commodity to persons seeking to hedge price risk in that commodity,
depending on the facts and circumstances, the Commission would
exercise its authority against the entity under Section 6(c)(1) and
final Rule 180.1.
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The foregoing should not be interpreted, however, to mean that a
violation of final Rule 180.1 necessarily requires proof of a market or
price effect, as some commenters' recommend. It does not.\38\ A market
or price effect may well be indicia of the use or employment of a
manipulative or deceptive device or contrivance; nonetheless, a
violation of final Rule 180.1 may exist in the absence of any market or
price effect.\39\
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\38\ In interpreting Exchange Act section 10(b) and SEC Rule
10b-5, the Supreme Court has recognized that the interest in
preserving the integrity of the securities markets was one of the
purposes animating Exchange Act section 10(b), but rejected the
notion that section 10(b) is limited to serving that objective
alone. See Superintendent of Ins. of N.Y. v. Bankers Life & Casualty
Co., 404 U.S. 6, 11-13 (1971).
\39\ Id.
---------------------------------------------------------------------------
In response to comments requesting that ``front-running'' and
similar misuse of customer information be considered a form of fraud-
based manipulation under final Rule 180.1, the Commission declines to
adopt any per se rule in this regard, but clarifies that final Rule
180.1 reaches all manner of fraud and manipulation within the scope of
the statute it implements, CEA section 6(c)(1).
C. The Disclosure Implications of Final Rule 180.1
1. Comments
Some commenters express concern regarding whether proposed Rule
180.1
[[Page 41402]]
would impose new disclosure obligations on commodities market
participants.\40\ According to the Associations, MFA, CME Group, CMC,
COPE, and the Working Group of Commercial Energy Firms (``CEF''),
futures, options, swaps, and physical commodity markets are different
from securities markets, which have extensive disclosure obligations,
and nothing in the CEA mandates disclosure of market conditions or
facts pertaining to the markets for commodities.\41\
---------------------------------------------------------------------------
\40\ See, e.g., Associations at pages 1-5; MFA at pages 2-4; CME
Group at pages 2-3; CMC at page 2. The Associations assert, for
example, that unlike the securities antifraud laws and rules, which
are designed primarily for investor protection, the antifraud
provisions in the futures markets are focused in large part,
although not exclusively, on protections against manipulation.
Associations at page 4.
\41\ See, e.g., Associations at pages 1-5; MFA at pages 2-5; CME
Group at pages 2-3; CMC at page 2; COPE at page 3; CEF Comment
Letter at pages 3 and 8.
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The Associations, CEF, and MFA state that proposed Rule 180.1
should not impose any new duties of disclosure, inquiry or diligence
between two sophisticated parties to a bilateral transaction.\42\
Likewise, the ABA Derivatives Committee believes the Commission should
make clear that the anti-manipulation rule under section 6(c)(l) does
not create any new duties of inquiry, diligence or disclosure to
parties to futures, options, swaps or cash commodity transactions.\43\
The ABA Derivatives Committee, the Associations, and MFA urge the
Commission to make it explicit that any final Rule will be violated
only if a party violates a pre-existing duty arising under contract,
common law, or some other non-CEA source.\44\
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\42\ Associations at page 4; CEF at page 8; MFA at pages 2 and
4.
\43\ ABA Derivatives Committee at page 15.
\44\ ABA Derivatives Committee at page 15; Associations at pages
4-5; MFA at pages 4-5.
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API and NPRA urge the Commission to state explicitly that silence,
pure omissions (omissions that do not relate to explicit
representations), and ``no comment'' statements are not actionable.
They also contend that ``[t]here should be no affirmative duty to
convey information to a counterparty in the nature of the reporting and
information requirements as under securities law.'' \45\ Similarly, API
and NPRA recommend that the Commission confirm that there is no duty to
update statements that were truthful at the time that they were
made.\46\ CME Group states that the duty to correct inaccurate
statements should be limited to circumstances where a futures market
participant realizes a statement was incorrect when the statement was
made.\47\
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\45\ API and NPRA at page 19.
\46\ API and NPRA at page 24.
\47\ CME Group at page 8.
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The Associations seek clarification that proposed Rule 180.1 will
not impede the ability of market participants to take positions and
trade on the basis of nonpublic information that they obtain
legitimately (i.e., not through the breach of a pre-existing duty to
keep such information confidential or through another party's similar
breach of a pre-existing duty).\48\ CME Group further states that the
Commission should not adopt a ``misappropriation'' theory of ``insider
trading''--that is, where one misappropriates confidential information
for securities trading purposes, in breach of a duty owed to the source
of the information.\49\ The ABA Derivatives Committee recommends the
Commission make clear that securities law doctrines such as the
prohibition on insider trading and the ``fraud-on-the-market'' theory
do not apply under the final Rule.\50\
---------------------------------------------------------------------------
\48\ Associations at page 5.
\49\ CME Group at pages 4-5.
\50\ ABA Derivatives Committee at pages 8-9 (stating that the
fraud-on-the-market theory ``establishes a rebuttable presumption in
private rights of action under Exchange Act Section 10(b) and SEC
Rule 10b-5 that in an efficient market for a security a plaintiff
can be held to have relied on a defendant's fraudulent
misrepresentation or omission in connection with the purchase or
sale of a security--even if the plaintiff was not aware of the
misrepresentation or omission--by virtue of the plaintiff's reliance
on the fact that a security's price reflects the fraudulent
misrepresentation and omission'') (citations omitted) (emphasis in
original).
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The West Virginia Oil Marketers & Grocers Association (``OMEGA'')
states that trading based on inside information should be
prohibited.\51\
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\51\ OMEGA Comment Letter at page 3; accord Mr. Peter Carini
Comment Letter at page 3; Pen Fern Oil Co., Inc. Comment Letter at
page 3; Scullin Oil Co. Comment Letter at page 3.
---------------------------------------------------------------------------
Responding to other commenters that the CFTC should not incorporate
the standards and case law under SEC Rule 10b-5, Professor Greenberger
states that the anti-manipulation rules and regulations are not bound
by the legal frameworks of the two markets. Professor Greenberger
states that the focal point of these anti-manipulation rules is to
maintain market integrity, which is a common goal shared by both the
securities and futures markets.\52\
---------------------------------------------------------------------------
\52\ Professor Greenberger at pages 2-4. Professor Greenberger
further states that the influx of capital from retail investors to
the commodity markets through Exchange Traded Funds has changed the
dynamics of the futures markets. Id.
---------------------------------------------------------------------------
PMAA believes that the Commission, in relying on SEC Rule 10b-5, is
cognizant of and more than capable of advancing its distinct regulatory
responsibilities in ensuring a transparent marketplace free from
manipulation.\53\ PMAA believes that proposed Rule 180.1 will
effectively implement the statutory and Congressional directive to
clearly delineate and prevent impermissible conduct by market
participants.\54\
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\53\ PMAA at page 1.
\54\ PMAA at page 2.
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2. Commission Determination
As a general matter, the Commission does not believe that final
Rule 180.1, or the statute it implements, are problematic or will
create uncertainty as to the existence of disclosure obligations when
applied to the markets the Commission regulates. This is not to say
that commenters did not raise valid concerns about how securities law
precedent will be applied in the commodities markets with respect to
disclosure obligations. The Commission believes that Congress addressed
these concerns, however, by enacting CEA section 6(c)(1), which
provides that ``no rule or regulation promulgated by the Commission
shall require any person to disclose to another person nonpublic
information that may be material to the market price, rate, or level of
the commodity transaction, except as necessary to make any statement
made to the other person in or in connection with the transaction not
misleading in any material respect.'' To be clear, the Commission is
not, by this rulemaking, imposing any new affirmative duties of
inquiry, diligence, or disclosure.\55\
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\55\ The derivatives markets are not, however, caveat emptor
markets. The CEA has many provisions designed to protect market
participants through disclosure requirements applicable to
Commission registrants. See, e.g., 17 CFR part 155 (risk disclosure
obligations); 17 CFR 4.20-27 (duties and disclosure obligations on
Commodity Pool Operators). Depending on the facts and circumstances,
violation of such duties could constitute a violation of the final
Rule.
---------------------------------------------------------------------------
Further, it is not a violation of final Rule 180.1 to withhold
information that a market participant lawfully possesses about market
conditions. The failure to disclose such market information prior to
entering into a transaction, either in an anonymous market setting or
in bilateral negotiations, will not, by itself, constitute a violation
of final Rule 180.1. Therefore, the Commission clarifies that silence,
absent a pre-existing duty to disclose, is not deceptive within the
meaning of final Rule 180.1.\56\ Similarly, the Commission interprets
``no comment'' statements as
[[Page 41403]]
``generally the functional equivalent of silence.'' \57\
---------------------------------------------------------------------------
\56\ Cf. Basic Inc. v. Levinson, 485 U.S. 224, 239 n. 17 (1988)
(``Silence, absent a duty to disclose, is not misleading under [SEC]
Rule 10b-5'').
\57\ Id. (internal quotation marks and citation omitted).
---------------------------------------------------------------------------
The Commission received comments regarding hedging or speculating
(i.e., trading) on the basis of material nonpublic information.\58\
These comments use the label ``insider trading,'' which can mean
different things in different contexts. The Commission recognizes that
unlike securities markets, derivatives markets have long operated in a
way that allows for market participants to trade on the basis of
lawfully obtained material nonpublic information. This final Rule does
not prohibit trading on the basis of material nonpublic information
except as provided in the following paragraph or otherwise prohibited
by law.\59\ Further, the Commission reiterates that the final Rule does
not create an affirmative duty of disclosure (except, as provided by
section 6(c)(1), ``as necessary to make any statement made to the other
person in or in connection with the transaction not misleading in any
material respect'').
---------------------------------------------------------------------------
\58\ See, e.g., Associations at page 5; MFA at page 5.
\59\ See, e.g., Dodd-Frank Act section 746, amending CEA section
4c(a) (7 U.S.C. 6c(a)).
---------------------------------------------------------------------------
Depending on the facts and circumstances, a person who engages in
deceptive or manipulative conduct in connection with any swap, or
contract of sale of any commodity in interstate commerce, or contract
for future delivery on or subject to the rules of any registered
entity, for example by trading on the basis of material nonpublic
information in breach of a pre-existing duty (established by another
law or rule, or agreement, understanding, or some other source), or by
trading on the basis of material nonpublic information that was
obtained through fraud or deception, may be in violation of final Rule
180.1. The Commission believes that this application of the final Rule
would be consistent with our responsibility to protect market
participants and promote market integrity and with our statement in the
NOPR that section 6(c)(1) is a broad catch-all provision, reaching any
manipulative or deceptive device or contrivance.'' \60\
---------------------------------------------------------------------------
\60\ 75 FR at 67658.
---------------------------------------------------------------------------
The Commission declines to adopt comments recommending outright
rejection of the potential application of the ``fraud-on-the-market''
theory under final Rule 180.1.\61\ The ``fraud-on-the-market'' theory
includes a presumption of reliance, which is a required element in
private rights of action arising under SEC Rule 10b-5. Unlike a private
litigant, however, the government is not required to prove reliance in
an enforcement action under SEC Rule 10b-5 just as it is not required
to demonstrate harm to investors.\62\ Consistent with judicial
interpretations of Exchange Act section 10(b) and SEC Rule 10b-5, the
Commission does not interpret the final Rule as requiring a showing of
reliance or harm to market participants in a government action brought
under CEA section 6(c)(1) and final Rule 180.1. At the same time, we
decline to opine on the required elements of a private right of action
under CEA section 6(c)(1) and final Rule 180.1 as it is beyond the
purview of this rulemaking.
---------------------------------------------------------------------------
\61\ In the securities context, ``the `fraud-on-the-market'
presumption helps investors who cannot demonstrate that they,
themselves, relied on fraud that reached the market.'' Stoneridge In
v. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 171
(2008).
\62\ See, e.g., Berko v. SEC, 316 F.2d 137, 143 (2d Cir. 1963)
(finding reliance and injury to private shareholders ``legally
irrelevant'' to the SEC's Exchange Act section 10(b) and SEC Rule
10b-5 claim); see also United States v. Haddy, 134 F.3d 542 (3d Cir.
1998) (concluding that securities laws did not require proof of
reliance in an Exchange Act section 10(b) action brought by
government).
---------------------------------------------------------------------------
D. The Operation of the Provision Prohibiting Material Misstatements
and Omissions
1. Comments
COPE states that inclusion of the words ``attempt to make'' any
untrue or misleading statement of a material fact in proposed Rule
180.1(a)(2) is vague and confusing. COPE requests that the Commission
clarify proposed Rule 180.1(a)(2) to state that the proscribed acts
must be done with the intent to deceive, manipulate, or defraud.\63\
---------------------------------------------------------------------------
\63\ COPE at page 5.
---------------------------------------------------------------------------
API and NPRA believe that the Commission should clarify that only
statements and acts pertaining to transactions in futures, swaps, or
commodities markets underlying futures or swaps may give rise to
liability under proposed Rule 180.1.\64\ API and NPRA also believe that
the Commission should exercise its discretion to exclude ``partial
omissions'' from any final Rule.\65\
---------------------------------------------------------------------------
\64\ API and NPRA at page 11.
\65\ API and NPRA at page 23.
---------------------------------------------------------------------------
Mr. Chris Barnard (``Barnard'') believes the proposed rules should
apply to both positive misconduct and misconduct by omission given the
ongoing nature of the rights and obligations that may be created in a
swap agreement.\66\
---------------------------------------------------------------------------
\66\ Barnard Comment Letter at page 2.
---------------------------------------------------------------------------
2. Commission Determination
The Commission declines to adopt comments recommending deletion of
the phrase ``or attempt to make'' in final Rule subsection 180.1(a)(2).
This phrase captures situations where a person attempts to employ a
manipulative device or artifice to defraud. For example, when a
supervisor attempts to have a subordinate make a fraudulent material
misstatement or omission but that subordinate rebuffs the supervisor,
the phrase ``or attempt to make'' would operate to reach the
supervisor's attempted fraud.
The Commission declines to modify the proposed Rule in response to
comments requesting that only statements and acts pertaining to
``transactions'' in futures, swaps, or commodities markets underlying
futures or swaps may give rise to liability under proposed Rule
180.1.\67\ Rather, CEA section 6(c)(1) prohibits manipulative or
deceptive devices or contrivances in connection with any swap, or a
contract of sale of any commodity in interstate commerce, or for future
delivery on or subject to the rules of any registered entity.\68\ The
Commission also declines to make modifications in response to comments
recommending that the Commission exercise its discretion to exclude
``partial omissions'' from the final Rule.\69\ Fraud-by-partial-
omission or half-truths could violate final Rule 180.1 if the facts and
circumstances of a particular case so warrant. Finally, the Commission
declines to impose any restriction on final Rule 180.1(a)(2) to
misstatements or omissions that distort or, in the case of an attempted
violation of 180.1(a)(2), are likely to distort market conditions. Such
a restriction would be tantamount to requiring a price or market effect
for a violation of final Rule 180.1. As stated above, the Commission
rejects any such requirement for a violation of final Rule 180.1
because the statute it implements, CEA section 6(c)(1), imposes no such
requirement.
---------------------------------------------------------------------------
\67\ API and NPRA at page 11.
\68\ See discussion in subsection G below.
\69\ API and NPRA at page 23.
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E. The Statutory Exception for Good Faith Mistakes
1. Comments
When considering the application of final Rule 180.1(a)(2), several
commenters asked the Commission to extend CEA section 6(c)(1)(C)'s
provision for ``Good Faith Mistakes'' in the mistaken transmission of
``false or misleading or inaccurate information to a price reporting
service'' to other
[[Page 41404]]
violations under CEA section 6(c)(1) and proposed Rule 180.1. API and
NPRA request that the good faith exception be expanded to cover ``all
public statements or reports by a market participant or other
communications covered by the proposed rule.'' \70\ Platts seeks
extension of CEA section 6(c)(1)(C)'s good faith mistakes exception to
proposed Rules 180.1 and 180.2, and Argus Media, Inc. (``Argus'') asks
the Commission to extend CEA section 6(c)(1)(C) to CEA section
9(a)(2).\71\
---------------------------------------------------------------------------
\70\ API and NPRA at page 25.
\71\ Platts Comment Letter at pages 4-6; Argus Comment Letter at
pages 1 and 5-6.
---------------------------------------------------------------------------
2. Commission Determination
In crafting CEA section 6(c)(1)(C), Congress could have extended
the exception for good faith mistakes to all of CEA sections 6(c) and
9(a)(2) but did not do so. Following the plain text of CEA section
6(c)(1)(C), the Commission limited the good faith exception in final
Rule 180.1 to the mistaken transmission of false or misleading or
inaccurate information to a price reporting service. The Commission
also makes clear that the scienter requirement of final Rule 180.1,
final Rule 180.2, and CEA section 9(a)(2) functions to ensure that
good-faith mistakes or negligence will not constitute a violation of
the final Rules under any circumstance. Thus, a person lacking the
requisite scienter cannot be found to have engaged in a manipulative or
deceptive device or contrivance within the meaning of CEA section
6(c)(1).
F. The Required Scienter for a Violation of Final Rule 180.1
1. Comments
Several commenters asked the Commission to clarify the standard of
scienter under proposed Rule 180.1.
Senator Levin recommends that the Commission shift the burden of
proof with respect to intent to market participants, which would
require them to show that their conduct was not manipulative.\72\
---------------------------------------------------------------------------
\72\ Senator Levin at page 4.
---------------------------------------------------------------------------
API and NPRA state that the Commission should clarify that scienter
may not be premised on the collective knowledge of an entire company,
but instead must be based on the knowledge of the person participating
in the deceptive or fraudulent conduct.\73\
---------------------------------------------------------------------------
\73\ API and NPRA at page 18.
---------------------------------------------------------------------------
The ABA Derivatives Committee, CEF, MFA, API and NPRA disagree with
the Commission's proposal to adopt recklessness as the scienter
requirement, believing instead that the language of the statute
supports a specific intent standard.\74\ In the alternative, API and
NPRA, CMC, Edison Electric Institute (``EEI''), MFA, and the
Associations propose a standard of ``extreme recklessness.'' \75\
Additionally, commenter COPE states that the Commission should make
clear that the type of recklessness contemplated is not recklessness in
a tort sense, but rather a business activity that diverges so greatly
from rational market behavior as to indicate a fraudulent intent.\76\
---------------------------------------------------------------------------
\74\ ABA Derivatives Committee at pages 11-13; CEF at page 5;
MFA at pages 6-7; API and NPRA at pages 12-16. API and NPRA also
believe that a recklessness standard may be appropriate in the
highly regulated securities context with its fiduciary duties and
strict disclosure requirements, but a recklessness standard in this
context would increase the costs of complying with a market
manipulation rule and deter market participants from disclosing
relevant information that helps markets to function more
efficiently.
\75\ API and NPRA at page 17; CMC at page 2; EEI Comment Letter
at page 4; MFA at page 6; Associations at pages 2 and 6-9.
\76\ COPE at page 7.
---------------------------------------------------------------------------
The ABA Derivatives Committee requests that in cases alleging
manipulation under final Rule 180.1, the Commission must show a
specific intent to cause an artificial price to satisfy the scienter
requirement.\77\
---------------------------------------------------------------------------
\77\ ABA Derivatives Committee at pages 11-15.
---------------------------------------------------------------------------
CEF requests that if a recklessness standard is adopted, it should
not extend to violations arising under CEA section 9(a)(2).\78\ In
addition, CEF suggests that the Commission confirm that it will not
adopt a scienter requirement ``that creates an implied presumption that
sophisticated traders understand and are aware of the effects of their
actions taken in the normal course of business on other commodity or
securities markets.'' \79\
---------------------------------------------------------------------------
\78\ CEF at page 7.
\79\ CEF at page 7. Rather, CEF believes that the CFTC should
evaluate alleged manipulation on a case-by-case basis, taking into
consideration the facts and circumstances of each case.
---------------------------------------------------------------------------
PMAA supports and encourages the Commission to adopt
``recklessness'' as the level of scienter, particularly when evaluating
issues relating to algorithmic market manipulation.\80\ According to
PMAA, the Commission's adoption of a ``recklessness'' standard in CEA
section 4c(a)(7) and proposed Rules 180.1 and 180.2 should impose
enhanced duties of diligence on those using or employing automated
trading systems.\81\
---------------------------------------------------------------------------
\80\ PMAA at page 2.
\81\ PMAA at page 2.
---------------------------------------------------------------------------
Mr. Clarence Townsend (``Townsend'') believes the standard of
scienter should be strengthened to ``reckless manipulation.'' \82\
---------------------------------------------------------------------------
\82\ Townsend Comment Letter at page 1.
---------------------------------------------------------------------------
Professor Greenberger states that section 6(c)(1) lowers the
standard of manipulation from ``knowingly'' to ``reckless.'' \83\
Professor Greenberger states that CEA section 6(c)(1) was designed to
empower the Commission with ``the same anti-manipulation standard
employed by the [SEC] for more than 75 years, which has been upheld and
defined in many court cases, including the Supreme Court.'' \84\
---------------------------------------------------------------------------
\83\ Professor Greenberger at page 2.
\84\ Professor Greenberger at page 2 (internal quotation marks
and citation omitted). Professor Greenberger states that the
Commission correctly proposes that judicial precedent interpreting
and applying Exchange Act Section 10(b) and SEC Rule 10b-5 in the
context of the securities markets should guide application of the
scienter standard relevant to proposed Rule 180.1 given that
proposed Rule 180.1 is modeled on SEC Rule 10b-5. Id. In Professor
Greenberger's view, such judicial precedent ``will provide
regulatory certainty and will not disrupt the market function.'' Id.
---------------------------------------------------------------------------
The Air Transport Association (``ATA'') believes that the scienter
standard should enable the Commission to police and punish a broader
array of potentially manipulative conduct than is reachable under the
CEA section 9(a)(2) anti-manipulation provision.\85\
---------------------------------------------------------------------------
\85\ ATA Comment Letter at page 4.
---------------------------------------------------------------------------
2. Commission Determination
Upon consideration of all the comments in this rulemaking record,
the Commission clarifies that a showing of recklessness is, at a
minimum, necessary to prove the scienter element of final Rule
180.1.\86\ Consistent with long-standing precedent under the
commodities and securities laws, the Commission defines recklessness as
an act or omission 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.'' \87\ Proof of knowledge, however, is not
required.\88\ Certain commenter requests for a scienter standard of
``specific intent'' would unduly limit the scope of final Rule 180.1.
Likewise,
[[Page 41405]]
in response to comments calling for a bifurcated approach to scienter
under 6(c)(1) and final Rule 180.1, that is, specific intent to effect
a price or price trend that does not reflect legitimate forces of
supply and demand for non-fraud based manipulations, and ``extreme
recklessness'' in fraud-based manipulations, the Commission states, as
it did in the NOPR, that it will be guided, but not controlled by,
judicial precedent interpreting and applying scienter under Exchange
Act section 10(b) and SEC Rule 10b-5.\89\ At the same time, the
Commission makes clear that final Rule 180.1 does not reach inadvertent
mistakes or negligence. Final Rule 180.1 will not affect market
participants engaged in legitimate market activity undertaken in good
faith.\90\ Under final Rule 180.1, the plaintiff bears the burden of
proving the violation by a preponderance of the evidence.\91\
---------------------------------------------------------------------------
\86\ See, e.g., SEC v. U.S. Envtl., Inc., 155 F.3d 107, 111 (2d
Cir. 1998) (finding allegation of reckless participation in a market
manipulation sufficient to state a claim of violation of Exchange
Act section 10(b)).
\87\ Drexel Burnham Lambert Inc. v. CFTC, 850 F.2d 742, 748 (DC
Cir. 1988); 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).
\88\ See, e.g. Hollinger, v. Titan Capital Corp., 914 F.2d 1564,
1568-96 (9th Cir. 1990) (en banc), cert. denied, 111 S. Ct. 1621
(1991).
\89\ 75 FR at 67659.
\90\ Consistent with the Supreme Court's interpretation of
Exchange Act section 10(b) in Ernst & Ernst v. Hochfelder, 425 U.S.
185, 206 (1976), the Commission finds no indication in CEA section
6(c)(1) that Congress intended anyone to be made liable for a
violation of final Rule 180.1 unless he or she acted other than in
good faith.
\91\ See, e.g., Herman & Maclean v. Huddleston, 459 U.S. 375,
387-90 (1983), citing SEC v. C. M. Joiner Leasing Corp., 320 U.S.
344, 355 (1943).
---------------------------------------------------------------------------
With respect to comments requesting clarification that scienter may
not be premised on the collective knowledge of an entire company, the
Commission notes that there is disagreement among the circuits on the
collective knowledge theory--that is, the courts disagree on whether
the conduct of one corporate agent can be aggregated with another
corporate agent's state of mind in holding a corporation liable for
fraud.\92\ The judicial decisions on the applicability of the
collective knowledge theory under Exchange Act section 10(b) involve
only private securities litigation; the Commission is unaware of any
judicial decision applying the so-called collective knowledge theory
under Exchange Act section 10(b) where the government is the plaintiff.
Further, the Supreme Court has not spoken to the issue under Exchange
Act section 10(b) or any other similar fraud-based prohibition.
---------------------------------------------------------------------------
\92\ Compare, e.g., United States v. Bank of New England, N.A.,
821 F.2d 844, 856 (1st Cir. 1987) (holding in a corporate criminal
liability action arising under the Currency Transaction Reporting
Act, that ``[c]orporations compartmentalize knowledge, subdividing
the elements of specific duties and operations into smaller
components. The aggregate of those components constitutes the
corporation's knowledge of a particular operation * * * [and the]
corporation cannot plead innocence by asserting that the information
obtained by several employees was not acquired by any one individual
who then would have comprehended its full import''); City of Monroe
Employees Retirement System v. Bridgestone Corp., 387 F.3d 468, 690
(6th Cir. 2004) (finding that plaintiffs adequately pleaded
securities fraud claims against a corporate defendant even though
the complaint failed to allege that the corporate agent whose
scienter was imputed to the corporation ``played any role in
drafting, reviewing, or approving'' the allegedly false
representations or ``that he was, as a matter of practice, or by job
description, typically involved in the creation of such
documents''); with Nordstrom Inc. v. Chubb & Son Inc., 54 F. 3d
1424, 1435 (9th Cir. 1995) (``there is no case law supporting an
independent `collective scienter' theory,'' i.e., the theory ``that
a corporation's scienter could be different from that of an
individual director or officer''); Southland Sec. Corp. v. INSpire
Ins. Solutions Inc., 365 F.3d 353, 364-65 (5th Cir. 2004) (quoting
In re Apple Computer Inc., 243 F. Supp. 2d 1012, 1023 (N.D. Cal.
2002)) (`` `A defendant corporation is deemed to have the requisite
scienter for fraud only if the individual corporate officer making
the statement has the requisite level of scienter * * * at the time
he or she makes the statement' * * * [T]he required state of mind
must actually exist in the individual making the misrepresentation
and may not simply be imputed to that individual on general
principles of agency''), cited with approval in Makor Issues &
Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 708 (7th Cir. 2008);
United States v. Sci. Applications Int'l Corp., 626 F.3d 1257, 1274-
75 (DC Cir. 2010) (holding a ``collective knowledge'' jury
instruction inconsistent with the scienter requirement under the
False Claims Act and expressing doubt, in dicta, regarding the use
of ``collective knowledge'' to establish corporate scienter in non-
FCA cases).
---------------------------------------------------------------------------
Given that the collective knowledge theory of alleging and proving
scienter against corporate defendants is permissible in certain
circuits, and because the Commission finds the policy rationale
underlying the theory to be in the public interest (i.e., that it
creates incentives for the corporate entity to create and maintain
effective internal communications and controls to prevent wrongful and
harmful conduct), the Commission declines to adopt comments requesting
that the Commission foreclose the collective knowledge theory in any
case. Rather, the Commission intends to follow the law of the various
circuits and, in all cases, consider the totality of the facts and
circumstances of a particular case before deciding whether enforcement
action is appropriate and in the public interest.
G. The Scope of the Phrase ``In Connection With''
1. Comments
In response to the NOPR, Better Markets requested the Commission
interpret the ``in connection with'' language of Proposed Rule 180.1
broadly to include not only the transaction giving rise to a swap
agreement, but also all of the continuing performance obligations under
such agreement.\93\
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\93\ Better Markets at page 2. Better Markets notes that the SEC
employed the language in connection with the ``offer, purchase or
sale'' of any security-based swap, and also targeted a specific
characteristic of swaps--the ongoing payments or deliveries between
the parties throughout the life of the security-based swap in
accordance with their rights and obligations.
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CME Group states that the Commission should interpret the ``in
connection with'' standard to require a ``nexus'' between transactions
(or offers to transact) subject to CFTC jurisdiction and prohibited
fraudulent or deceptive conduct.\94\ CEF expressed concern that a broad
interpretation of the phrase ``in connection with'' may result in
conflicting or duplicative regulation with other agencies, including
the Federal Energy Regulatory Commission (``FERC''), SEC, Federal Trade
Commission (``FTC'') and the Public Utility Commission of Texas.\95\
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\94\ CME Group at pages 9-10.
\95\ CEF at pages 3-4.
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Senator Levin believes the Commission should employ its new
authority under CEA section 6(c) to prevent manipulative and disruptive
activities even where the impacts may only be felt in other markets--
including markets regulated by the SEC.\96\ Senator Levin expresses
concern that, as currently drafted, the proposed rules may not allow
the CFTC to effectively regulate market activity that is intended to or
actually does artificially change prices in another market or
product.\97\
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\96\ Senator Levin at pages 5-6.
\97\ Senator Levin at pages 5-6.
\98\ SEC v. Zandford, 535 U.S. 813 (2002).
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2. Commission Determination
Upon careful consideration of the entire rulemaking record, the
Commission finds it unnecessary to alter the text of final Rule 180.1.
The Commission interprets the words ``in connection with'' broadly, not
technically or restrictively. Section 6(c)(1) and final Rule 180.1
reach all manipulative or deceptive conduct in connection with the
purchase, sale, solicitation, execution, pendency, or termination of
any swap, or contract of sale of any commodity in interstate commerce,
or contract for future delivery on or subject to the rules of any
registered entity. Accordingly, final Rule 180.1 covers conduct
including, but not limited to, all of the payment and other obligations
arising under a swap.
While broad, the elasticity of the ``in connection with'' language
is not limitless. In this regard, the Commission finds the Supreme
Court's decision in Zandford interpreting SEC Rule 10b-5's ``in
connection with'' language particularly instructive.\98\ In its
opinion, the Court gave the following example to
[[Page 41406]]
highlight the limits of SEC Rule 10b-5 applicability:
If * * * a broker embezzles cash from a client's account or
takes advantage of the fiduciary relationship to induce his client
into a fraudulent real estate transaction, then the fraud would not
include the requisite connection to a purchase or sale of
securities. Likewise if the broker told his client he was stealing
the client's assets, that breach of fiduciary duty might be in
connection with a sale of securities, but it would not involve a
deceptive device or fraud.\99\
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\99\ Id. at 825 n. 4. The holding of Zandford is consistent with
judicial interpretations of the phrase ``in or in connection with''
in the anti-fraud provisions of the CEA, particularly section 4b(a),
which prohibits any person from defrauding another person ``in or in
connection with'' a commodity futures transaction. For example, in R
& W Tech. Servs. Ltd., v. CFTC, 205 F.3d 165 (5th Cir. 2000), cert.
denied, 531 U.S. 817 (2000), the Fifth Circuit, in affirming the
liability of a defendant for defrauding another person, refused to
construe ``in or in connection with'' and 4b(a) narrowly. Id. at
171-74. Rather, the court endorsed the Commission's position that
fraud in the sale of investment advice will be ``in connection
with'' the sale of a commodities futures contract ``if the fraud
relates to'' the risk of trading and the primary purpose of the
advice is to execute trades. Id. at 172-73. As a general matter, the
Supreme Court has stated that anti-fraud and anti-manipulation
provisions of the CEA are to be construed broadly. See, e.g., CFTC
v. Schor, 478 U.S. 833, 836 (1986) (``The CEA broadly prohibits
fraudulent and manipulative conduct in connection with commodity
futures transactions.'').
The Commission intends to be guided by this and other precedent
interpreting the words ``in connection with'' in the securities
context.\100\
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\100\ Zandford, 535 U.S. 813 (2002); see also Merrill Lynch,
Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 85 (2006)
(holding that the ``in connection with'' language of SEC Rule 10b-5
requires a nexus between fraudulent conduct and a securities
transaction).
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As to comments regarding cross-market manipulation, the Commission
intends to apply final Rule 180.1 to the fullest extent allowed by law
when determining whether conduct in one market is ``in connection
with'' an activity or product subject to the jurisdiction of the
Commission. Further, where the Commission's jurisdiction is not
exclusive,\101\ the Commission will, to the extent practicable and
consistent with its longstanding practice, coordinate its enforcement
efforts with other federal or state law enforcement authorities.
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\101\ 7 U.S.C. 2(a)(1)(A).
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H. Penalty, Procedure, Effect on Automated Trading Systems, and a
Proposal To Define Manipulation
1. Comments
With regard to the penalty for violating final Rule 180.1, API and
NPRA state that if the Commission chooses to promulgate a catch-all
anti-fraud rule without regard to whether the conduct had a
manipulative purpose or effect (a proposal that API and NPRA submit
would exceed the Commission's authority), then the Commission should
clarify that the enhanced sanctions in section 753 of the Dodd-Frank
Act apply only to cases of manipulation or attempted manipulation, and
not to every alleged violation of the rule.\102\ CEF seeks
clarification that, in a case of a false reporting violation under CEA
section 6(c)(1)(A), the Commission is not permitted to impose a penalty
of an amount equal to the greater of $1 million or treble damages
pursuant to CEA section 6(c)(10)(C)(ii).\103\
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\102\ API and NPRA at pages 10-11.
\103\ CEF at page 8.
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On the subject of implementation, API and NPRA ask that any final
rule adopt a 180-day effective date to enable the industry to design
and implement comprehensive compliance programs.\104\ EEI and CEF
recommend that the CFTC implement its new authority in a cooperative
manner with FERC and further recommend that it hold a workshop, before
the final Rule is issued, on a variety of subjects related to
interpretation and application of the final Rule.\105\ Professor
Greenberger believes that the Commission correctly states in the NOPR
that market participants should already have constructed and
implemented procedures to guard against their employees' and agents'
attempts at manipulation. As such, Professor Greenberger believes that
there should not be any additional cost to the existing market
participants.\106\
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\104\ API and NPRA at page 27.
\105\ EEI at pages 2-4; CEF at pages 4-5.
\106\ Greenberger at page 4.
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On the issue of use or employment of algorithmic or automated
trading systems, the PMAA requests that the Commission establish
standards governing the use of algorithmic trading technology by
requiring internal controls such as logs and specific notification
protocols, directed to the trading entity, when significant code
modification of its algorithm takes place, including interpretation by
the algorithm of digitized news and social networking sources.\107\
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\107\ PMAA at pages 1-2.
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Finally, the Brattle Group economists state that the Commission
should adopt its proposed definition of manipulation: ``Manipulation is
engaging in anomalous price-making behavior intended to alter a price
in order to profit in affected price-taking transactions.'' \108\ The
Brattle Group economists contend that manipulation thus defined can be
interpreted as a form of fraud whereby anomalous behavior (non-
economic, stand-alone transactions for the actor) injects false or
misleading information into a market and consequently impairs its
integrity.\109\
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\108\ Brattle Group economists Comment Letter at page 6.
\109\ Brattle Group economists at pages 6-7.
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2. Commission Determination
With respect to penalties, the Commission will follow CEA section
6(c)(10)(C)(ii), which states that the Commission may assess ``in any
case of manipulation or attempted manipulation in violation of [CEA
section 6(c)] or section 9(a)(2), a civil penalty of not more than an
amount equal to the greater of--(I) $1,000,000; or (II) triple the
monetary gain to the person for each such violation.'' CEF's request
that the penalties for manipulation not apply to violations of CEA
section 6(c)(1)(A) is declined because such an outcome would conflict
with the plain language of the statute. False or misleading or
inaccurate reporting is a type of unlawful manipulation specifically
prohibited by CEA section 6(c)(1)(A). Accordingly, where section
6(c)(1)(A) applies, the Commission may assess a penalty of an amount
equal to the greater of $1 million or treble damages under CEA section
6(c)(10)(C)(ii) for each such violation.
The Commission declines to adopt comments recommending that it
conduct further technical conferences on this rulemaking. The
Commission has provided notice and opportunity to comment and has met
with numerous groups to discuss this rulemaking.\110\ Further, as noted
above, there is extensive case law interpreting SEC Rule 10b-5 upon
which final Rule 180.1 is modeled.\111\
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\110\ A list of all external meetings held on Dodd-Frank Act
section 753 is available at: http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm.
\111\ Similarly, the Commission has ample experience enforcing
the predecessor provisions of final Rule 180.2.
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The Commission declines to adopt comments requesting heightened
supervision of algorithmic and automated trading systems as beyond the
scope of this rulemaking. Nevertheless, as a general matter, a
supervisory failure may be one of the facts and circumstances that the
Commission considers in determining whether a violation of the final
Rule exists.
The Commission declines to adopt comments proposing a new
economics-based definition of manipulation. Instead, as stated above,
all relevant
[[Page 41407]]
facts and circumstances must be considered in determining whether a
violation of final Rule 180.1 exists.
V. Discussion of CEA Section 6(c)(3) and Final Rule 180.2
The Commission proposed Rule 180.2 under its general rulemaking
authority, CEA section 8a(5) and its statutory authority to prohibit
manipulation under new CEA section 6(c)(3). Proposed Rule 180.2 mirrors
the text of new CEA section 6(c)(3), by stating that ``[i]t shall be
unlawful for any person, directly or indirectly, to manipulate or
attempt to manipulate the price of any swap, or of any commodity in
interstate commerce, or for future delivery on or subject to the rules
of any registered entity.'' In the NOPR, the Commission proposed to
continue ``interpreting the prohibition on price manipulation and
attempted price manipulation to encompass every effort to improperly
influence the price of a swap, commodity, or commodity futures
contract.'' \112\
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\112\ 75 FR at 67658.
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A. Comments
The CME Group believes that the Commission should employ a bright-
line test under final Rule 180.2 that distinguishes prohibited
manipulative conduct from legitimate competitive trading activities. To
that end, CME Group urges the Commission to clarify what factors or
types of activity the Commission considers to be ``intended to
interfere with the legitimate forces of supply and demand.'' \113\ The
CME Group believes the Commission's statement in the NOPR that ``an
illegal effect on price can often be conclusively presumed from the
nature of the conduct in question and other factual circumstances not
requiring expert economic analysis'' \114\ is tantamount to a ``we-
know-it-when-we-see-it-approach'' that impermissibly collapses the
third and fourth elements of the traditional framework for manipulation
outlined in Cox.\115\
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\113\ CME Group at page 11. CME Group states that the Commission
also should clarify how to determine whether a price has been
affected by illegitimate factors. CME Group at pages 11-12.
\114\ 75 FR at 67660-61.
\115\ In the Matter of Cox, [1986-1987 Transfer Binder] Comm.
Fut. L. Rep. (CCH) P 23,786 at 34,060-61 (CFTC July 15, 1987).
---------------------------------------------------------------------------
COPE and EEI believe that the provisions in proposed Rule 180.1 are
the same as proposed Rule 180.2 and thus the latter should be
deleted.\116\ EEI recommends that if the Commission chooses not to
delete proposed Rule 180.2, it should carve this section out of the
current rulemaking initiative and issue a separate and more detailed
NOPR for public comment.\117\
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\116\ COPE at pages 6-7; EEI at page 6.
\117\ EEI at page 6.
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EEI requests that the Commission affirm in regulatory text that the
scienter requirement for proposed Rule 180.2 is specific intent under
the Commission's four-prong test.\118\ This four-part test is described
in subsection B below. Likewise, the Associations believe that the
Commission should not use CEA section 6(c)(3) as a mechanism to lower
the specific intent standard traditionally required in manipulation
cases. Instead, the Commission should issue clarifying guidance that
conforms to the traditional framework of enforcement, including the
theory of liability set forth in the Di Placido matter.\119\
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\118\ EEI at page 7.
\119\ Associations at page 10 referring to In re Di Placido,
2008 WL 4831204 (CFTC 2008), affd in pertinent part, Di Placido v.
CFTC, 364 Fed Appx. 657, 2009 WL 3326624 (2d Cir. 2009), cert.
denied, 130 S. Ct. 1883 (Mar. 22, 2010).
---------------------------------------------------------------------------
With respect to the scope of application of proposed Rule 180.2,
CMC recommends the Commission clarify that CEA section 6(c)(3) does not
confer any additional enforcement authority beyond the holding in the
Di Placido matter.\120\
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\120\ CMC at pages 2-3.
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CMC and MFA recommend that the Commission make clear that proposed
Rule 180.2 does not create a presumption that a price is artificial
merely because one or more isolated transactions are deemed uneconomic
without proof of a specific intent to move prices.\121\ The
Associations and MFA believe that the Commission's statement in the
NOPR ``that prices [are] affected by a factor not consistent with
normal forces of supply and demand will often follow inescapably from
proof of the actions of the alleged manipulator'' is an overly
aggressive reading of judicial precedent like Di Placido. \122\ MFA
believes that the Commission should not create a ``conclusive
presumption'' that a price is artificial without proof of specific
intent to move prices.\123\
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\121\ CMC at pages 2-3; MFA at pages 7-8.
\122\ Associations at page 11; MFA at pages 7-8.
\123\ MFA at pages 7-8.
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Professor Greenberger states that although the Commission has
already interpreted the ``prohibition on price manipulation and
attempted price manipulation to encompass every effort to influence the
price of a swap, commodity, or commodity futures contract that is
intended to interfere with the legitimate forces of supply and demand
in the marketplace,'' it is important to reaffirm the relevance of that
legal interpretation.\124\ Professor Greenberger believes that
Commission precedent supports the position that illegal effect on price
can often be conclusively presumed from the nature of the conduct in
question and other factual circumstances not requiring expert economic
analysis.\125\
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\124\ Professor Greenberger at page 4.
\125\ Professor Greenberger at page 4.
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ATA believes that the Commission should consider whether its
complete reliance on past precedent in interpreting manipulation under
proposed Rule 180.2 needlessly narrows the potential reach of the
amended anti-manipulation provision of section 6(c)(3), anchoring its
interpretation to a past standard that has proven remarkably difficult
to enforce.\126\ ATA notes that section 6(c)(3) as amended is broader
than both its prior version and section 9(a)(2) by its inclusion of the
word ``indirectly,'' making it unlawful to indirectly manipulate or
attempt to manipulate prices.\127\
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\126\ ATA at page 1.
\127\ ATA at page 4.
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B. Commission Determination
In response to the comments received regarding this matter, the
Commission reiterates that, in applying final Rule 180.2, it will be
guided by the traditional four-part test for manipulation that has
developed in case law arising under 6(c) and 9(a)(2): (1) That the
accused had the ability to influence market prices; (2) that the
accused specifically intended to create or effect a price or price
trend that does not reflect legitimate forces of supply and demand;
\128\ (3) that artificial prices existed; and (4) that the accused
caused the artificial prices.\129\
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\128\ In re Indiana Farm Bureau Cooperative Assn., Inc., [1982-
1984 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 21,796 (CFTC Dec.
17, 1982), citing Volkart Bros., Inc. v. Freeman, 311 F.2d 52 (5th
Cir. 1962); In re Hohenberg Bros. Co., [1975-1977 Transfer Binder]
Comm. Fut. L. Rep. (CCH) ] 20,271 (CFTC Feb. 18, 1977).
\129\ In re Cox [1986-1987 Transfer Binder], Comm. Fut. L. Rep.
(CCH) ] 23,786, 1987 CFTC LEXIS 325, at *9, 1987 WL 106879, at *3
(CFTC July 15, 1987). In cases of attempted manipulation under
section 9(a)(2), the CFTC is required to show: (1) An intent to
affect the market price; and (2) some overt act in furtherance of
that intent. See In re Hohenberg Bros. Co., ] 20,271 at 21,477.
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The Commission reaffirms the requirement under final Rule 180.2
that a person must act with the requisite specific intent. In other
words, recklessness will not suffice under final Rule 180.2 as it will
under final Rule 180.1. The Commission finds this level of intent
necessary to ensure that legitimate conduct is not captured by final
Rule 180.2, which covers non-fraud based manipulation. Given the
[[Page 41408]]
differences in scope of application between the final Rules, the
Commission declines requests to consolidate them.
The Commission declines requests to limit the application of final
Rule 180.2 to the circumstances set forth in the commenters' analysis
of particular cases, including the Di Placido matter. Likewise, the
Commission's statement in the NOPR that an artificial price may be
``conclusively presumed'' under certain facts and circumstances does
not mean that an artificial price may be conclusively presumed in all
cases. For example, where, as in Di Placido, a trader violates bids and
offers in order to influence the volume-weighted average settlement
price, an artificial price will be a ``reasonably probable
consequence'' of the trader's intentional misconduct. Moreover, the
Commission in the proposed Rule did not say that an artificial price
will be conclusively presumed in the absence of any evidence, only that
``extensive economic analysis may not be necessary'' to prove that an
artificial price existed.\130\ To be clear, in some cases the
conclusion that prices were affected by a factor not consistent with
normal forces of supply and demand will require economic analysis, but
in other cases, such a showing may, as the Commission stated in the
proposed Rule, ``follow inescapably from proof of the actions of the
alleged manipulator.'' \131\ This is unsurprising given the fact and
circumstance specific nature of manipulation cases. Accordingly, the
Commission is not, as some commenters state, collapsing the third and
fourth elements of the traditional four-part test for manipulation
under section 6(c)(3) and final Rule 180.2.
---------------------------------------------------------------------------
\130\ 75 FR at 67660 (emphasis added).
\131\ 75 FR at 67660.
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The Commission interprets the terms ``directly or indirectly'' as
describing the level of involvement necessary to establish a violation
of final Rule 180.2. In this context, the Commission interprets
``indirectly'' to include the circumstance where a person uses a third
party (e.g., an executing broker) to execute trades designed to
manipulate, so it will be no defense that the person did not himself
execute the transaction.
Notwithstanding the fact that final Rule 180.2 mirrors the text of
CEA section 6(c)(3), the Commission deems it appropriate and in the
public interest to promulgate this rule and, in so doing, provide the
above clarifications to the manner in which the Commission interprets
and intends to apply final Rule 180.2.
V. Administrative Compliance and Cost-Benefit Considerations
CEA section 15(a) \132\ requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA. By its terms, CEA section 15(a) does not require the
Commission to quantify the costs and benefits of a rule or to determine
whether the benefits of the regulation outweigh its costs; rather, it
requires the Commission to ``consider'' the costs and benefits of its
actions. CEA section 15(a) further specifies that the costs and
benefits shall be evaluated in light of five broad areas of market and
public concern: (1) Protection of market participants and the public;
(2) efficiency, competitiveness and financial integrity of futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. The Commission may in its
discretion give greater weight to any one of the five enumerated areas
and could in its discretion determine that, notwithstanding its costs,
a particular rule is necessary or appropriate to protect the public
interest or to effectuate any of the provisions or accomplish any of
the purposes of the CEA.
---------------------------------------------------------------------------
\132\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
In the NOPR, the Commission stated that the proposed rules would
enhance the authority of the Commission to ensure fair and equitable
markets, and that market participants and the public will substantially
benefit from such enhanced prevention and deterrence of manipulation.
With respect to costs, the Commission also stated that participants in
the markets should already have policies and procedures in place to
ensure that their employees, affiliates and agents will refrain from
attempting to manipulate the markets. The Commission invited public
comment on its cost-benefit considerations.\133\ Below, we summarize
and respond to those comments.\134\ Both in the response to comments
and in the preamble, we address the areas of market and public concern
for consideration of costs and benefits under CEA section 15(a).
---------------------------------------------------------------------------
\133\ 75 FR at 67661.
\134\ See note 2 for access to public comment file.
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API and NPRA commented that the potentially significant compliance
costs and legal uncertainty must be weighed against the limited
benefits of the proposed rules. Specifically, API and NPRA believe that
it is problematic to expand the scope of the Commission's enforcement
authority to cover routine cash market transactions in all areas of the
economy, as it would potentially create inconsistencies with existing
statutory and common law standards and would place a tremendous burden
on the Commission's resources.\135\ Further, API and NPRA comment that
the risk of inconsistent standards with federal and state enforcement
authorities may exacerbate market participants' regulatory and
compliance risk and burden.\136\ API and NPRA also believe that a
recklessness standard under Section 753 would increase the costs of
complying with a market manipulation rule and deter market participants
from engaging in legitimate business activities and disclosing relevant
information that helps markets to function more efficiently as price
discovery venues.\137\ API and NPRA contend that where market
participants seek to comply with an omissions rule by disclosing more
information, companies will have an incentive to exercise great caution
to ensure that no affirmative statement may be subjectively considered
misleading through any omission.\138\
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\135\ API and NPRA at pages 4 and 8.
\136\ API and NPRA at page 8.
\137\ API and NPRA at pages 12-17.
\138\ API and NPRA at page 22.
---------------------------------------------------------------------------
MFA is concerned that ambiguity with respect to legal standards
would increase transaction costs and chill legitimate trading
practices, in turn decreasing market depth and liquidity.\139\ The
Associations state that no new duties of disclosure, inquiry, or
diligence should be imposed between two sophisticated parties to a
bilateral transaction. Any such new duties may discourage legitimate
trading activities, increase transaction costs, and, as a result,
reduce liquidity and market depth.\140\ CME and Argus make similar
comments as to the potential effects on markets as a whole, but do not
express their concerns in terms of costs. The CME comments that the
Commission must provide greater clarity as to the scope of prohibited
conduct to maintain and promote fair and efficient markets and to
protect market liquidity, price discovery, and the risk management
functions of futures markets.\141\ Argus states that absent
clarification from the Commission, the proposed rules may unnecessarily
chill the voluntary submission of transaction related data by market
participants to compilers of price indices which, in turn, hinders the
Dodd-Frank Act's goal of market transparency.\142\ CEF comments that
[[Page 41409]]
market participants will face substantially more uncertainty with
respect to their activities in energy markets and significant costs in
attempting to comply with multiple regulatory regimes, thereby likely
reducing participation in energy markets.\143\ CEF also comments that
jurisdictional overlap of agencies will result in increased litigation
costs, depletion of scarce resources, and uncertainty for both the
Commission and market participants.\144\ CEF states the false reporting
provision will place a heavy burden on all market participants as they
attempt to comply with the new reporting requirements proposed by the
Commission pursuant to the Act.\145\
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\139\ MFA at pages 3-4.
\140\ Associations at pages 1 and 4.
\141\ CME at page 3.
\142\ Argus at page 1.
\143\ CEF at pages 2-3.
\144\ CEF at page 4.
\145\ CEF at page 7.
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In contrast, Barnard believes the implementation costs of the
proposed rules should be minimal.\146\ Professor Greenberger believes
that the Commission correctly states that market participants should
already have constructed and implemented procedures to guard against
their employees' and agents' attempts at market manipulation. As such,
Professor Greenberger believes that there should not be any additional
costs to existing market participants.\147\
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\146\ Barnard at page 2.
\147\ Professor Greenberger at page 4.
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The Commission has carefully considered the concerns expressed by
some of the commenters that the final Rules could substantially
increase costs on market participants, reduce market liquidity or chill
legitimate market activity. However, commenters provide no
quantification of the potential costs or reliable data as a basis for
conclusions that substantial costs will be incurred as a result of the
final Rules. Furthermore, commenters have not shown how such rules have
negatively impacted comparable markets that trade comparable
instruments and operate under comparable anti-manipulation rules.
Specifically, regarding the comments received by API, NPRA, MFA,
CME, Argus, and the Associations as to how the new rules may directly
increase transaction costs, reduce market liquidity and depth, and
hinder risk management functions of markets subject to the Commission's
jurisdiction, the Commission notes that final Rule 180.1 is modeled on
SEC Rule 10b-5. Many derivatives products in securities markets are
traded on national securities exchanges under SEC regulation (e.g.,
equity options, stock index options, and stock index exchange-traded
funds (``ETFs'')) and are therefore subject to the SEC anti-
manipulation rule.
Many of these SEC-regulated derivatives products exhibit high and
growing volumes, narrow bid-ask spreads, and high levels of market
depth. SEC-regulated stock index ETFs and stock-index options are
economically similar to CFTC-regulated stock index futures and options
on those futures and, like these CFTC-regulated derivatives, serve
primarily as risk-shifting instruments rather than instruments for
capital formation. Any argument that the SEC's anti-fraud and anti-
manipulation regime has negatively affected the growth of SEC-regulated
derivatives lacks a basis in fact and contradicts the generally
accepted purpose of the SEC's anti-fraud and anti-manipulation rules,
which is to protect investors and to promote market integrity.\148\
Moreover, the FERC also promulgated a rule modeled on SEC Rule 10b-5
for FERC-jurisdictional markets in natural gas and electricity
following the enactment of the Energy Policy Act of 2005. The FTC
promulgated a comparable prohibition for petroleum markets. In the
absence of any facts that anti-fraud and anti-manipulation rules
negatively affect markets, the Commission does not find such assertions
persuasive.
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\148\ See, e.g., Chemical Bank v. Arthur Andersen & Co., 726
F.2d 930, 943 (2d Cir. 1984) (``The purpose of Sec. 10(b) and Rule
10b-5 is to protect persons who are deceived in securities
transactions--to make sure that buyers of securities get what they
think they are getting * * *.'') (Friendly, J.); Laird v. Integrated
Res., 897 F.2d 826, 831 at n.10 (5th Cir. 1990), quoting 3 Fletcher
Cyclopedia of Corporations, section 900.3 (perm. ed. 1986) (``The
general purpose and intent of the broad anti-fraud provisions of
Section 10(b) and Rule 10b-5 is to protect investors, to prevent
inequitable and unfair practices and to insure fairness in
securities transactions generally * * *'').
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As to the concerns of API and NPRA regarding increased costs from
the Commission's purported expansion of its authority to cover a
plethora of routine cash market transactions in all areas of the
economy, with respect to the scope of final Rule 180.1, as discussed
above, the Commission intends to exercise its authority under 6(c)(1)
to cover transactions related to the futures or swaps markets, or
prices of commodities in interstate commerce, or where the fraud or
manipulation has the potential to affect cash commodities, futures, or
swaps markets or participants in these markets. Thus, concerns about
purported increased costs are misplaced in that they rest on an
incorrect assumption about the scope of the Commission's expanded
authority.
In response to comments from CEF, the Commission re-iterates that
the final Rules do not contain any requirement to create, retain,
submit, or disclose any information. The final Rules impose no
recordkeeping or related data retention or disclosure requirements on
any person, including small businesses. Given that the final Rules
impose no affirmative duties, it is unlikely that the final Rules will
impose any additional ongoing costs beyond the existing costs
associated with ensuring that behavior and statements are not
fraudulent or manipulative. In that regard, the Commission believes
that it will not be necessary for firms that currently have adequate
compliance programs to hire additional staff or significantly upgrade
their systems to comply with the new Rules. Firms may incur some one-
time costs such as costs associated with training traders and staff in
the new Rules.
The Commission believes the comments from API, NPRA, and CEF
regarding increased costs pertaining to compliance, litigation, and
uncertainty with respect to inconsistent standards with other
regulatory agencies are misplaced. To the contrary, the Commission
believes that market participants and the public will benefit from
enhanced regulatory certainty that will arise from the Commission's
adoption of an anti-manipulation rule that is more harmonized with
existing anti-manipulation rules of the SEC, FERC, and FTC.
In the NOPR, the Commission stated, and re-iterates here, that with
respect to benefits, the proposed rules would enhance the authority of
the Commission to ensure fair and equitable markets. The Commission
stated, inter alia, that market participants and the public will
benefit substantially from enhanced prevention and deterrence of
manipulation. In light of public considerations under CEA section 15(a)
in promulgating this rule, the Commission concludes that market
participants and the public will benefit substantially from increased
protection through the prevention and deterrence of fraud and
manipulation. The final Rules will help ensure the efficiency,
competitiveness, and financial integrity of derivatives markets.
Markets free from fraud and manipulation function better as venues for
price discovery and risk management.
A. Paperwork Reduction Act
As discussed above, the provisions of Commission Regulations Part
180 would not result in new recordkeeping
[[Page 41410]]
requirements within the meaning of the Paperwork Reduction Act of 1995.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act \149\ requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting such impact.\150\
The final Rules will not have a significant economic impact on a
substantial number of small entities. As explained above, legitimate
market participants should already have procedures in place to prevent
their employees and agents from manipulating the markets. The Chairman,
on behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.
605(b), that the final Rules will not have a significant impact on a
substantial number of small entities.
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\149\ 5 U.S.C. 601.
\150\ Id.
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C. Effective Date
API and NPRA ask the Commission to adopt a 180-day delay in the
effective date of the final Rules to enable the industry to design and
implement comprehensive compliance programs.\151\ The Commission
declines this request. A 180-day delayed effective date would unduly
limit the Agency's responsibility to protect market participants and
promote the integrity of the markets. Rather, consistent with Dodd-
Frank Act section 753(d) and Administrative Procedure Act section
553(d), 5 U.S.C. 553(d), the final Rules will take effect 30 days after
they are published in the Federal Register.
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\151\ API and NPRA at page 27.
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List of Subjects in 17 CFR Part 180
Commodity futures.
Authority and Issuance
For the reasons stated in the preamble, the Commodity Futures
Trading Commission adds a new 17 CFR Part 180 as set forth below:
PART 180--PROHIBITION AGAINST MANIPULATION
Sec.
180.1 Prohibition on the employment, or attempted employment, of
manipulative and deceptive devices.
180.2 Prohibition on price manipulation.
Authority: 7 U.S.C. 6c(a), 9, 12(a)(5) and 15, as amended by
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010); 5 U.S.C. 552
and 552(b), unless otherwise noted.
Sec. 180.1 Prohibition on the employment, or attempted employment, of
manipulative and deceptive devices.
(a) It shall be unlawful for any person, directly or indirectly, in
connection with any swap, or contract of sale of any commodity in
interstate commerce, or contract for future delivery on or subject to
the rules of any registered entity, to intentionally or recklessly:
(1) Use or employ, or attempt to use or employ, any manipulative
device, scheme, or artifice to defraud;
(2) Make, or attempt to make, any untrue or misleading statement of
a material fact or to omit to state a material fact necessary in order
to make the statements made not untrue or misleading;
(3) Engage, or attempt to engage, in any act, practice, or course
of business, which operates or would operate as a fraud or deceit upon
any person; or,
(4) Deliver or cause to be delivered, or attempt to deliver or
cause to be delivered, for transmission through the mails or interstate
commerce, by any means of communication whatsoever, a false or
misleading or inaccurate report concerning crop or market information
or conditions that affect or tend to affect the price of any commodity
in interstate commerce, knowing, or acting in reckless disregard of the
fact that such report is false, misleading or inaccurate.
Notwithstanding the foregoing, no violation of this subsection shall
exist where the person mistakenly transmits, in good faith, false or
misleading or inaccurate information to a price reporting service.
(b) Nothing in this section shall be construed to require any
person to disclose to another person nonpublic information that may be
material to the market price, rate, or level of the commodity
transaction, except as necessary to make any statement made to the
other person in or in connection with the transaction not misleading in
any material respect.
(c) Nothing in this section shall affect, or be construed to
affect, the applicability of Commodity Exchange Act section 9(a)(2).
Sec. 180.2 Prohibition on price manipulation.
It shall be unlawful for any person, directly or indirectly, to
manipulate or attempt to manipulate the price of any swap, or of any
commodity in interstate commerce, or for future delivery on or subject
to the rules of any registered entity.
Issued in Washington, DC, on July 7, 2011, by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Prohibition on the Employment, or Attempted Employment,
of Manipulative and Deceptive Devices; Prohibition on Price
Manipulation--Commission Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn,
Sommers, O'Malia and Chilton voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the final rulemaking to enhance the Commission's
ability to protect against manipulation. Effective regulation
requires an effective enforcement program. The Dodd-Frank Act
enhances the Commission's enforcement authorities in the futures
markets and expands them to the swaps markets. This rule implements
new Dodd-Frank authorities to police against fraud and fraud-based
manipulative schemes, based upon similar authority that the
Securities and Exchange Commission, Federal Energy Regulatory
Commission and Federal Trade Commission have for securities and
certain energy commodities.
In the past, the CFTC had the ability to prosecute manipulation,
but to prevail, it had to prove the specific intent of the accused
to create an artificial price. Under the new law and one of the
rules before us today, the Commission's anti-manipulation reach is
extended to prohibit the reckless use of fraud-based manipulative
schemes. This closes a significant gap, as it will broaden the types
of cases we can pursue and improve the chances of prevailing over
wrongdoers.
The rule also implements the Dodd-Frank Act's price-based
manipulation authority to police against corners and squeezes. These
new authorities expand the CFTC's arsenal of enforcement tools and
strengthen the Commission's ability to effectively deal with threats
to market integrity. We will use these tools to be a more effective
cop on the beat, to promote market integrity and to protect market
participants.
I thank Senator Maria Cantwell for her work to secure this
important authority for the CFTC. As Senator Cantwell explained in
proposing that this authority be included in the Commodity Exchange
Act, ``It is a strong and clear legal standard that allows
regulators to successfully go after reckless and manipulative
behavior.''
Attachment A
Parties filing comments:
Air Transport Association (ATA)
[[Page 41411]]
American Bar Association, Derivatives and Futures Law Committee,
Business Law Section (ABA Derivatives Committee)
American Petroleum Institute (API) and National Petrochemical and
Refiners Association (NPRA)
Argus Media, Inc. (Argus)
Barnard, Chris (Barnard)
Better Markets
Brattle Group Economists (Brattle Group)
Carini, Peter*
CME Group, Inc. (CME Group)
Coalition of Physical Energy Companies (COPE)
Commodity Markets Council (CMC)
Council of Institutional Investors (Council)
Edison Electric Institute (EEI)
Freddie Mac
Futures Industry Association, International Swaps and Derivatives
Association, Inc. (ISDA) and Securities Industry and Financial
Markets Association (SIFMA) (together, the Associations)
Managed Funds Association (MFA)
Pen Fern Oil Co., Inc.*
Petroleum Marketers Association of America (PMAA)
Platts
Scullin Oil Co.*
Townsend, Clarence (Townsend)
U.S. Senator Carl Levin (Senator Levin)
University of Maryland School of Law, Professor Michael Greenberger
(Professor Greenberger)
Weir, Bix
West Virginia Oil Marketers & Grocers Association (OMEGA)*
Working Group of Commercial Energy Firms (CEF)
Zwack, Joseph
* Denotes commenters filing identical comments which were
consolidated.
[FR Doc. 2011-17549 Filed 7-13-11; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: July 14, 2011