[Federal Register Volume 76, Number 53 (Friday, March 18, 2011)]
[Notices]
[Pages 14943-14948]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-6398]


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COMMODITY FUTURES TRADING COMMISSION


Antidisruptive Practices Authority

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed Interpretive Order.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing this interpretive order to provide interpretive 
guidance regarding the three statutory disruptive practices set forth 
in new section 4c(a)(5) of the Commodity Exchange Act (``CEA'') 
pursuant to section 747 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank Act''). The Commission requests 
comment on all aspects of the proposed interpretive order.

DATES: Comments must be received on or before May 17, 2011.

ADDRESSES: Comments, identified by RIN number, may be sent by any of 
the following methods:
    <bullet> Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
    <bullet> Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581.
    <bullet> Hand Delivery/Courier: Same as mail above.
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.

FOR FURTHER INFORMATION CONTACT: Robert Pease, Counsel to the Director 
of Enforcement, 202-418-5863, <a href="/cdn-cgi/l/email-protection#80f2f0e5e1f3e5c0e3e6f4e3aee7eff6"><span class="__cf_email__" data-cfemail="56242633372533163530223578313920">[email protected]</span></a>; Steven E. Seitz, 
Attorney, Office of the General Counsel, 202-418-5615, <a href="/cdn-cgi/l/email-protection#95e6e6f0fce1efd5f6f3e1f6bbf2fae3"><span class="__cf_email__" data-cfemail="bac9c9dfd3cec0fad9dcced994ddd5cc">[email protected]</span></a>; 
or Mark D. Higgins, Counsel to the Director of Enforcement, 202-418-
5864, <a href="/cdn-cgi/l/email-protection#0d6065646a6a64637e4d6e6b796e236a627b"><span class="__cf_email__" data-cfemail="9df0f5f4fafaf4f3eeddfefbe9feb3faf2eb">[email protected]</span></a>, Commodity Futures Trading Commission, Three 
Lafayette

[[Page 14944]]

Centre, 1151 21st Street, NW., Washington, DC 20581.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
http://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that may be exempt from disclosure under the Freedom of 
Information Act (``FOIA''),\1\ a petition for confidential treatment of 
the exempt information may be submitted according to the established 
procedures in Sec.  145.9 of the CFTC's regulations.\2\ The Commission 
reserves the right, but shall have no obligation, to review, prescreen 
filter, redact, refuse, or remove any or all of your submission from 
http://www.cftc.gov that it may deem to be inappropriate for 
publication, such as obscene language. All submissions that have been 
redacted or removed that contain comments on the merits of the 
rulemaking will be retained in the public comment file and will be 
considered as required under the Administrative Procedure Act and other 
applicable laws, and may be accessible under FOIA.
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    \1\ 5 U.S.C. 552.
    \2\ 17 CFR 145.9.

SUPPLEMENTARY INFORMATION:

Prohibition of Disruptive Practices

I. Statutory and Regulatory Authorities

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act'').\3\ Title VII 
of the Dodd-Frank Act \4\ amended the Commodity Exchange Act (``CEA'') 
\5\ to establish a comprehensive new regulatory framework for swaps and 
security-based swaps. The legislation was enacted to reduce risk, 
increase transparency, and promote market integrity within the 
financial system by, among other things: (1) Providing for the 
registration and comprehensive regulation of swap dealers and major 
swap participants; (2) imposing clearing and trade execution 
requirements on standardized derivative products; (3) creating robust 
recordkeeping and real-time reporting regimes; and (4) enhancing the 
Commission's rulemaking and enforcement authorities with respect to, 
among others, all registered entities and intermediaries subject to the 
Commission's oversight.
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    \3\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act of 2010, Public Law 111-203, 124 Stat. 1376 (2010). The text of 
the Dodd-Frank Act may be accessed at http://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
    \4\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may 
be cited as the ``Wall Street Transparency and Accountability Act of 
2010.''
    \5\ 7 U.S.C. 1 et seq.
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    Section 747 of the Dodd-Frank Act amends section 4c(a) of the CEA 
to add a new section entitled ``Disruptive Practices.'' New CEA section 
4c(a)(5) makes it unlawful for any person to engage in any trading, 
practice, or conduct on or subject to the rules of a registered entity 
that--
    (A) Violates bids or offers;
    (B) Demonstrates intentional or reckless disregard for the orderly 
execution of transactions during the closing period; or
    (C) Is, is of the character of, or is commonly known to the trade 
as, ``spoofing'' (bidding or offering with the intent to cancel the bid 
or offer before execution).
    Dodd-Frank Act section 747 also amends section 4c(a) by granting 
the Commission authority under new CEA section 4c(a)(6) to promulgate 
such ``rules and regulations as, in the judgment of the Commission, are 
reasonably necessary to prohibit the trading practices'' enumerated 
therein ``and any other trading practice that is disruptive of fair and 
equitable trading.''
    The Commission is issuing this proposed interpretive order to 
provide market participants and the public with guidance on the scope 
of the statutory prohibitions set forth in section 4c(a)(5). The 
Commission requests comment on all aspects of this proposed 
interpretive order, as well as comment on the specific provisions and 
issues highlighted below.

II. Background

    On November 2, 2010, the Commission issued an advance notice of 
proposed rulemaking (``ANPR'') asking for public comment on all aspects 
of Dodd-Frank Act section 747.\6\ When the ANPR was issued, the 
Commission was considering whether to adopt regulations regarding the 
disruptive practices set forth in new CEA section 4c(a)(5). After 
reviewing the ANPR comments, the Commission determined that it was 
appropriate to address the statutory disruptive practices through a 
proposed interpretive order. Accordingly, a Commission document 
terminating the ANPR is being published elsewhere in the Proposed Rules 
section of this issue of the Federal Register. Notwithstanding that 
termination, the Commission considered all of the ANPR commentary in 
developing this proposed interpretive order.
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    \6\ 75 FR 67301, Nov. 2, 2010.
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    In the ANPR, commenters were encouraged to address the nineteen 
specific questions posed by the Commission in the ANPR.\7\ The ANPR 
requested, among other things, comment on section 747(A) (``violating 
bids and offers''), section 747(B) (``the disorderly execution of 
transactions around the closing period''), section 747(C) 
(``spoofing''), the role of executing brokers, and the regulation of 
algorithmic and automated trading systems.\8\ The questions in the ANPR 
also formed the basis for a December 2, 2010, roundtable held by 
Commission staff in Washington, DC.\9\ The full-day roundtable 
consisted of three panels \10\ that addressed the ANPR questions, the 
role of exchanges in CFTC-regulated markets, and whether there are 
other potential disruptive trading practices that the Commission should 
prohibit. The ANPR set a deadline of January 3, 2011, by which comments 
had to be submitted.\11\ In response to the ANPR, the Commission 
received 28 comments from interested parties,\12\ including industry 
members, trade associations, consumer groups, exchanges, one member of 
the U.S. Congress, and other interested members of the public.\13\ The 
Commission has carefully considered all of the ANPR comments, as well 
as the roundtable discussion, in proposing this interpretive order.
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    \7\ The ANPR may be accessed through: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=893.
    \8\ 75 FR 67302, Nov. 2, 2010.
    \9\ See Appendix III for a list of roundtable participants and 
discussion panels. A verbatim transcript of the disruptive trading 
practices roundtable may be accessed at http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission24_120210-transcri.pdf.
    \10\ Note that citations to statements by the panelists at the 
public roundtable will be cited as [Panelist name at page X of 
roundtable transcript].
    \11\ 75 FR 67301, Nov. 2, 2010.
    \12\ See Appendix IV for a list of parties submitting comment 
letters in response to the ANPR.
    \13\ The comment letters received by the Commission in response 
to the ANPR may be accessed through: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=893.
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    Throughout the roundtable discussion and comment letters, there was 
widespread support for the Commission's goal of preventing disruptive 
trading practices and ensuring fair and equitable markets.\14\ Several 
themes emerged from the roundtable discussion and the comment

[[Page 14945]]

letters, which are discussed below in the following sections.
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    \14\ Liam Connell at 40 (``Allston Trading supports the mission 
of the CFTC to maintain orderly markets and to prohibit deceptive 
practices and manipulative trading.''); Rajiv Fernando at 17 (``I 
support the CFTC's effort to ensure that markets operate in an 
orderly way that's fair for all participants.''); Argus at 1 
(``Argus supports the important goal of preventing disruptive trade 
practices in CFTC jurisdictional markets.'').
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a. Market Participants Request Additional Guidance Regarding the Scope 
and Application of Section 747's Provisions

    Throughout the Commission roundtable, panelists stated that the 
provisions of section 747 were vague \15\ and did not provide market 
participants with adequate notice of the type of trading, practices, 
and conduct that is prohibited by section 4c(a)(5).\16\ Several comment 
letters also raised concerns about vagueness and believed that Dodd-
Frank Section 747 was susceptible to constitutional challenge.\17\ 
Comment letters requested that the Commission provide additional 
guidance concerning the conduct and trading practices that constitute 
violations under the statute.\18\ During the roundtable discussion, 
panelists also requested additional clarity and refinement in the 
definition of terms such as ``the orderly execution of transactions,'' 
\19\ ``closing period,'' \20\ and ``spoofing.'' \21\ The comment 
letters reiterated this concern and expressed the need for the 
Commission to define these terms and other concepts such as violating 
bids and offers.\22\
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    \15\ See. e.g., Gary DeWaal at 57 (``This is an incredibly vague 
provision.''); Greg Mocek at 170 (``There are a lot of issues on 
vagueness.'').
    \16\ See, e.g., Adam Nunes at 20 (``Additional guidance * * * is 
going to be necessary.''); Ike Gibbs at 157 (``We would really 
prefer to see a scenario where the Commission is not overly 
prescriptive [and] we're given guidance as to what's appropriate and 
what's not appropriate.'').
    \17\ See, e.g., Managed Funds Association at 4 (``Dodd-Frank Act 
Section 747 as written is vague and particularly vulnerable to 
constitutional challenge by market participants.''); CME Group at 2 
(``As written, Section 747 is vague and susceptible to 
constitutional challenge.'').
    \18\ See, e.g., American Petroleum Institute at 2 (``The 
Commission should provide specific guidance regarding the scope of 
the trading practices listed in 747.''); Investment Company 
Institute at 2 (Recommending that the ``Commission provide 
additional guidance as to the types of conduct that would constitute 
violations under the statute.''); HETCO at 4 (``The Commission 
should resolve the ambiguity in Section 4c(a)(5) by articulating the 
specific types of disruptive practices that prompted it to request 
the new enforcement authority in Section 747.'').
    \19\ See, e.g., Adam Nunes at 26 (``When we look at disruptive 
trading practices and the intentional reckless disregard for orderly 
execution that is going to be very difficult to define.'').
    \20\ See, e.g., Don Wilson at 46 (``The definition of those 
rules around what is and is not acceptable in the closing period 
needs to be carefully considered.'').
    \21\ See, e.g., Gary DeWaal at 64 (``I'm not sure the definition 
of spoofing can be agreed upon by the ten people around this 
table.''); John J. Lothian at 82 (Referring to `spoofing' as a 
``very undefined type of term within the industry.'').
    \22\ See, e.g., Futures Industry Association at 3 (``Definitions 
such as `orderly execution,' `violates bids or offers' and 
`spoofing' in Sections 4c(a)(5)(A), (B) and (C), respectively, 
require refinement and clarification by the Commission.'').
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    Panelists and commenters also sought clarity on whether scienter is 
required for each of the enumerated practices of section 4c(a)(5), and 
if so, specificity as to the degree of intent required. Roundtable 
panelists \23\ and commenters \24\ stated that a showing of bad intent 
should be necessary to distinguish prohibited conduct from legitimate 
trading activities. Panelists further stressed that any evaluation of 
trading behavior must consider the historical trading patterns and 
practices of market participants.\25\
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    \23\ See, e.g., Adam Nunes at 36 (``The intent to manipulate * * 
* [is] critically important.''); Cameron Smith at 37 (``What really 
needs to be there in my mind is some notions of intent or phrases 
like ``for the purpose of.''); Don Wilson at 47 (``I think it really 
comes down to intent.''); Mark Fabian at 163 (``I think everyone has 
agreed that intent is something that is required.'').
    \24\ See, e.g., Chopper Trading at 3 (``Any definition of 
spoofing must include an element of an intent to manipulate the 
market.''); FIA at 4 (``The Commission should clarify that 
manipulative intent to create an artificial price is required to 
violate 5(A)'s prohibition on violating bids or offers * * * [and] 
that manipulative intent is necessary under 5(B)'s prohibition.''); 
International Swaps and Derivatives Association at 3 (``Manipulative 
intent is a necessary element of `manipulative' or `disruptive' 
conduct.'').
    \25\ See, e.g., Adam Nunes at 94 (``[I]t's really a pattern and 
practice of activity.''); John Hyland at 147 (``It's patterns and 
practices, facts and circumstances.''); Mark Fabian at 163 (``A 
pattern is also required.'').
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    In response to these comments, the Commission is proposing this 
Interpretive Order to provide additional guidance to market 
participants and the public on the types of trading, conduct, and 
practices that will constitute violations of section 4c(a)(5). This 
proposed interpretive order addresses the concerns expressed by the 
commenters regarding market uncertainty by clarifying how the 
Commission will interpret and implement the provisions of section 
4c(a)(5). By the terms of the statute, 4c(a)(5) applies to trading, 
practices or conduct on or subject to the rules of a registered entity: 
a designated contract market or a swap execution facility 
(``SEF'').\26\ The Commission interprets that section 4c(a)(5) will not 
apply to block trades or exchanges for related positions (``EFRPs'') 
transacted in accordance with the rules of a designated contract market 
or SEF or bilaterally negotiated swap transactions.
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    \26\ The Commission does not believe that a trade becomes 
subject to 4c(a)(5) solely because it is reported on a swap data 
repository, even though a swap data repository is a registered 
entity.
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    The Commission stresses the important role and unique position of 
exchanges and self-regulatory organizations to ensure that markets 
operate in a fair and equitable manner without disruptive trading 
practices.\27\ The Commission agrees with commenters and panelists that 
a multi-layered, coordinated approach is required to prevent disruptive 
trading practices and ensure fair and equitable trading through 
enforcement of these provisions.\28\
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    \27\ See, e.g., CME Group Rule 432B.2 (``It shall be an offense 
* * * to engage in conduct or proceedings inconsistent with just and 
equitable principles of trade.'').
    \28\ See, e.g., FIA at 10 (``FIA strongly believes that a multi-
layered enforcement approach, which implements policies and 
procedures at the firm, exchange and clearing level, will most 
effectively mitigate the risk of market disruptions.'').
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i. Violating Bids and Offers
1. Comments From ANPR and Roundtable
    During the roundtable discussion, panelists questioned how the 
concept of violating bids and offers applies across various trading 
platforms and markets.\29\ Commenters expressed a similar concern \30\ 
and requested that the Commission clarify how the prohibition against 
violating bids and offers applies to swaps,\31\ open outcry pits,\32\ 
infrequently traded over-the-counter products,\33\ and electronic 
trading venues where the best bid and offer are matched automatically 
by algorithm.\34\
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    \29\ See, e.g., Greg Mocek at 173 (``There's more practical 
issues to think about in the context of the concepts themselves and 
how the industry is structured, like violating a bid and an 
offer.''); Ken Raisler at 176 (generally asking how the concept of 
violating bids and offers applies to over-the-counter markets, swap 
execution facilities, and block trades).
    \30\ See, e.g., CME Group at 4 (``The Commission should make 
clear that the prohibition on violating bids or offers is not 
intended to create a best execution standard across venues as any 
such standard would be operationally and practically untenable.'').
    \31\ See, e.g., ISDA at 2 (``The phrase `violating bids and 
offers' simply has no meaning in most if not all swaps markets. The 
pricing and trading of many swaps involves a variety of factors 
(e.g., size, credit risk) which, taken together, render the concept 
of ``violating bids or offers'' as inapposite.'').
    \32\ See, e.g., CME Group at 4 (generally discussing how the 
concept of violating bids and offers applies to open outcry trading 
environments).
    \33\ See, e.g., FIA at 4 (``The Commission should clarify that 
the prohibition on violating bids or offers does not apply in the 
over-the-counter markets.'').
    \34\ See, e.g., CME Group at 4 (``Order matching algorithms on 
electronic platforms preclude bids and offers from being 
violated.''); FIA at 4 (``Matching engines make it impossible to 
sell or buy except at the best available quote.''); MFA at 5 (``The 
term `violate bids or offers' * * * has virtually no application to 
electronic trading where systems buy or sell at the best available 
quote.'').
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2. Commission Guidance
    The Commission interprets section 4c(a)(5)(A) as prohibiting any 
person from buying a contract at a price that is

[[Page 14946]]

higher than the lowest available offer price and/or selling a contract 
at a price that is lower than the highest available bid price. Such 
conduct, regardless of intent, disrupts the normal forces of supply and 
demand that are the foundation of fair and equitable trading. This 
proposed interpretive order is consistent with exchange rules that 
prohibit the violation of bids and offers.\35\ Notably, Congress did 
not include an intent requirement in section 4c(a)(5)(A) as it did in 
both sections 4c(a)(5)(B) and (C). Accordingly, the Commission 
interprets section 4c(a)(5)(A) as a per se offense, that is, the 
Commission is not required to show that a person violating bids or 
offers did so with any intent to disrupt fair and equitable trading.
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    \35\ See, e.g., New York Mercantile Exchange Rule 514.A.3; 
Minneapolis Grain Exchange Rule 731.00.
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    The Commission agrees that section 4c(a)(5)(A) does not apply where 
a person is unable to violate a bid or offer--i.e. when a person is 
utilizing an electronic trading system where algorithms automatically 
match the best bid and offer.\36\ Section 4c(a)(5)(A) will operate in 
any trading environment where a person exercises some control over the 
selection of the bids or offers against which they transact, including 
in an automated trading system which operates without pre-determined 
matching algorithms. The Commission recognizes that at any particular 
time the bid-ask spread in one trading environment may differ from the 
bid-ask spread in another trading environment. Accordingly, in the view 
of the Commission, section 4c(a)(5)(A) does not create any sort of best 
execution standard across multiple trading platforms and markets; 
rather, a person's obligation to not violate bids or offers is confined 
to the specific trading venue which he or she is utilizing at a 
particular time. Finally, section 4c(a)(5)(A) does not apply where an 
individual is ``buying the board''--that is, executing a sequences of 
trades to buy all available bids or offers on that order book in 
accordance with the rules of the facility on which the trades were 
executed.
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    \36\ See, e.g., CME Group at 4 (``Order matching algorithms on 
electronic platforms preclude bids and offers from being 
violated.'').
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ii. Orderly Execution of Transactions During the Closing Period
1. Comments From ANPR and Roundtable
    Roundtable panelists expressed the view that additional clarity was 
needed for the definitions incorporated in section 747(B), in 
particular, terms such as ``closing period.'' \37\ Commenters also 
requested clarification on the definition of closing period and 
requested Commission guidance on whether the prohibition on disorderly 
execution of transactions extends to conduct occurring outside the 
closing period.\38\ More specifically, some commenters requested that 
the prohibitions in section 747(B) be limited to manipulative conduct 
such as ``banging'' or ``marking the close.'' \39\
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    \37\ See, e.g., Greg Mocek at 173 (``It's easy to define the 
term `closing period' presumably in a designated contract market. 
Are you planning on defining that period in a SEF?'').
    \38\ See, e.g., API at 12 (``Trading practices or conduct 
outside the closing period are not relevant to determine whether 
conduct inside the closing period is deemed `orderly'.''); HETCO at 
7 (``HETCO urges the Commission to refrain from applying the 
prohibition against disorderly trading to an overly broad trading 
time period.''); CEF at 6 (``The Commission should refrain from 
looking at trading practices outside of the closing period.'').
    \39\ See, e.g., FIA at 5 (``The Commission should clarify that 
traditionally accepted types of market manipulation, such as 
`banging the close,' `marking the close' and pricing window 
manipulation fall under the prohibition of 5(B).'').
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2. Commission Guidance
    New CEA section 4c(a)(5)(B) prohibits any trading, practices, or 
conduct on or subject to the rules of a registered entity that 
``demonstrates intentional or reckless disregard for the orderly 
execution of transactions during the closing period.'' In the view of 
the Commission, Congress's inclusion of a scienter requirement means 
that accidental, or even negligent, trading conduct and practices will 
not suffice for a claim under section 4c(a)(5)(B); rather a market 
participant must at least act recklessly.\40\ Accordingly, section 
4c(a)(5)(B) will not capture legitimate trading behavior and is not ``a 
trap for those who act in good faith.'' \41\
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    \40\ See, e.g., Hammond v. Smith Barney, Harris Upham & Company, 
Inc., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 24,617 
(CFTC Mar. 1, 1990) (scienter requires proof that a defendant 
committed the alleged wrongful acts ``intentionally or with reckless 
disregard for his duties under the Act''); Drexel Burnham Lambert, 
Inc. v. CFTC, 850 F.2d 742, 748 (DC Cir. 1988) (holding that 
recklessness is sufficient to satisfy scienter requirement and that 
a reckless act is one where there is so little care that it is 
``difficult to believe the [actor] was not aware of what he was 
doing'') (quoting First Commodity Corp. v. CFTC, 676 F.2d 1, 7 (1st 
Cir. 1982)).
    \41\ United States v. Ragen, 314 U.S. 513, 524 (1942).
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    The Commission interprets the closing period to be generally 
defined as the period in the contract or trade when the daily 
settlement price is determined under the rules of that trading 
facility.\42\ While the Commission interprets the prohibition in 
section 4c(a)(5)(B) to encompass any trading, conduct, or practices 
occurring inside the closing period that affects the orderly execution 
of transactions during the closing period, potential disruptive conduct 
outside that period may nevertheless form the basis for an 
investigation of potential violations under this section and other 
sections under the Act. With respect to swaps executed on a SEF, a swap 
will be subject to the provisions of section 4c(a)(5)(B) if a closing 
period or daily settlement price exists for the particular swap. 
Additionally, section 4c(a)(5)(B) violations will include executed 
orders as well as any bids and offers submitted by individuals for the 
purposes of disrupting fair and equitable trading.
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    \42\ Closing periods may include the time period in which a 
daily settlement price is determined, the expiration day for a 
futures contract, and any period of time in which the cash-market 
transaction prices for a physical commodity are used in establishing 
a settlement price for a futures contract, option, or swap (as 
defined by the CEA).
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    Similar to other intent-based violations of the CEA, the Commission 
will consider all of the relevant facts and circumstances in 
determining whether a person violated section 4c(a)(5)(B). The 
Commission will evaluate the facts and circumstances as of the time the 
person engaged in the relevant trading, practices, or conduct (i.e. the 
Commission will consider what the person knew, or should have known, at 
the time he or she was engaging in the conduct at issue). The 
Commission will use existing concepts of orderliness of markets when 
assessing whether trades are executed, or orders are submitted, in an 
orderly fashion in the time periods prior to and during the closing 
period. In the view of the Commission, an orderly market may be 
characterized by, among other things, parameters such as a rational 
relationship between consecutive prices, a strong correlation between 
price changes and the volume of trades, levels of volatility that do 
not materially reduce liquidity, accurate relationships between the 
price of a derivative and the underlying such as a physical commodity 
or financial instrument, and reasonable spreads between contracts for 
near months and for remote months.\43\ Participants and regulators in

[[Page 14947]]

the commodity and securities markets are already familiar with these 
assessments of orderliness in connection with issues of market 
manipulation \44\ and risk mitigation. The Commission believes that 
market participants should assess market conditions and consider how 
their trading practices and conduct affect the orderly execution of 
transactions during the closing period.\45\
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    \43\ Concepts applicable to the securities markets are useful in 
analyzing commodity markets because of similarities between the two 
areas. Concerning orderliness of markets, see, e.g., In re NYSE 
Specialists Securities Litigation, 503 F.3d 89 (2d Cir. 2007) 
(discussing role of specialists in maintaining orderly market and 
various circumventions of that role); Last Atlantis Partners, LLC v. 
AGS Specialist Partners, 533 F.Supp. 2d 828 (N.D. Ill. 2008) 
(allegation that trading specialists disengaged automated order 
execution mechanism to discriminate against customers having direct 
access to markets); LaBranche & Co., NYSE AMEX Hearing Board 
Decisions 09-AMEX-28, -29, and -30 (Oct. 2009) and NYSE Member 
Education Bulletin 2006-19 (discussing the proper design and use of 
specialist algorithms to avoid taking liquidity from the market at 
and surrounding the prevailing market price).
    \44\ See, e.g., Cargill, Inc. v. Hardin, 452 F.2d 1154, 1170-71 
(8th Cir. 1971) (market disruption through ``squeeze'' of shorts 
characterized by extraordinary price fluctuations, with little 
relationship to basic supply and demand factors for wheat; other 
markets not similarly affected; long employed unusual mechanism to 
liquidate position).
    \45\ For example, absent an intentional or reckless disregard 
for the orderly execution of transactions during the closing period, 
a person would not be liable under 4c(a)(5)(B) upon executing an 
order during the closing period simply because the transactions had 
a substantial effect on the settlement price.
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iii. Spoofing
1. Comments From ANPR and Roundtable
    Roundtable panelists commented that there is no commonly-accepted 
definition of ``spoofing'' throughout the industry.\46\ Some commenters 
expressed a similar concern \47\ and requested additional Commission 
guidance that any definition of ``spoofing'' set forth in section 
4c(a)(5)(C) would not capture legitimate trading behavior.\48\ In 
particular, several comment letters also expressed views on whether 
partial fills should be exempt from the definition of ``spoofing.'' 
\49\
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    \46\ See, e.g., John J. Lothian at 82 (referring to spoofing as 
``a very undefined type of term within the industry'').
    \47\ See, e.g., Chopper Trading at 3 (``The Commission must 
consider that spoofing does not have a generally understood 
definition in the futures markets.'').
    \48\ See, e.g., CME Group at 8 (``The statute's definition of 
`spoofing' as `bidding or offering with the intent to cancel the bid 
or offer before execution,' is too broad and does not differentiate 
legitimate market conduct from manipulative conduct that should be 
prohibited. The distinguishing characteristic between `spoofing' 
that should be covered by paragraph (C) and the legitimate 
cancellation of other unfilled or partially filled orders is that 
`spoofing' involves the intent to enter non bona fide orders for the 
purpose of misleading market participants and exploiting that 
deception.''); HETCO at 7 (``The Commission should describe, with 
specificity, what trade practices constitute spoofing, particularly 
where this is not a concept familiar to the markets for commodities 
and derivatives.''); ICE at 8 (generally discussing the practice of 
``spoofing'' as defined in paragraph (C) of Section 747 may capture 
legitimate trading behavior).
    \49\ See, e.g., API at 14 (``The Commission has requested 
comment on whether a ``partial fill of an order * * * necessarily 
exempts that activity from being defined as `spoofing.' The answer 
is yes.''); HETCO at 8 (``A partial fill of an order or series of 
orders should not exempt the activity described above from being 
defined as `spoofing'.'').
---------------------------------------------------------------------------

2. Commission Guidance
    New CEA section 4c(a)(5)(C) prohibits any trading, practice, or 
conduct that ``is, is of the character of, or is commonly known to the 
trade as, ``spoofing'' (bidding or offering with the intent to cancel 
the bid or offer before execution).'' To violate section 4c(a)(5)(C), a 
market participant must act with some degree of intent, or scienter, to 
engage in the ``spoofing'' trading practices prohibited by section 
4c(a)(5)(C). In the view of the Commission, a 4c(a)(5)(C) ``spoofing'' 
violation requires that a person intend to cancel a bid or offer before 
execution; therefore, the Commission believes that reckless trading, 
conduct, or practices will not result in violations of section 
4c(a)(5)(C).\50\ Furthermore, orders, modifications, or cancellations 
will not be classified as ``spoofing'' if they were submitted as part 
of a legitimate, good-faith attempt to consummate a trade. Thus, the 
legitimate, good-faith cancellation of partially filled orders would 
not violate section 4c(a)(5)(C). However, a partial fill does not 
automatically exempt activity from being classified as ``spoofing.'' 
When distinguishing between legitimate trading involving partial 
executions and ``spoofing'' behavior, the Commission will evaluate the 
market context, the person's pattern of trading activity (including 
fill characteristics), and other relevant facts and circumstances. For 
example, if a person's intent when placing a bid or offer was to cancel 
the entire bid or offer prior to execution, regardless of whether such 
bid or offer was subsequently filled, that conduct may violate section 
4c(a)(5)(C). Accordingly, under this interpretation, section 
4c(a)(5)(C) will not capture legitimate trading.
---------------------------------------------------------------------------

    \50\ Similar to violations under section 4c(a)(5)(B), accidental 
or negligent trading, practices, and conduct will not constitute 
violations of section 4c(a)(5)(C).
---------------------------------------------------------------------------

    This ``spoofing'' prohibition covers bid and offer activity on all 
registered entities, including all regulated futures, options, and swap 
execution facilities, including all bids and offers in pre-open periods 
or during other exchange-controlled trading halts. ``Spoofing'' also 
includes, but is not limited to: (i) Submitting or cancelling bids or 
offers to overload the quotation system of a registered entity, (ii) 
submitting or cancelling bids or offers to delay another person's 
execution of trades; and (iii) submitting or cancelling multiple bids 
or offers to create an appearance of false market depth.\51\ However, 
the ``spoofing'' provision is not intended to cover non-executable 
market communications such as requests for quotes and other authorized 
pre-trade communications.
---------------------------------------------------------------------------

    \51\ See, e.g., Trillium Brokerage Services, LLC, Letter of 
Acceptance, Waiver and Consent, No. 2007007678201, from the 
Financial Industry Regulatory Authority (``FINRA'') (issued 
September 12, 2010) for a discussion of a ``spoofing'' case 
involving an illicit high frequency trading strategy. Under their 
``spoofing'' strategy, Trillium entered numerous layered, non-bona 
fide market moving orders to generate selling or buying interest in 
specific stocks. By entering the non-bona fide orders, often in 
substantial size relative to a stock's overall legitimate pending 
order volume, Trillium traders created a false appearance of buy- or 
sell-side pressure. This trading strategy induced other market 
participants to enter orders to execute against limit orders 
previously entered by the Trillium traders. Once their orders were 
filled, the Trillium traders would then immediately cancel orders 
that had only been designed to create the false appearance of market 
activity. The Letter of Acceptance, Waiver and Consent and 
accompanying press release from FINRA can be accessed at http://www.finra.org/Newsroom/NewsReleases/2010/P12195.
---------------------------------------------------------------------------

    As with other intent-based violations, the Commission distinguishes 
between legitimate trading and ``spoofing'' by evaluating all of the 
facts and circumstances of each particular case, including a person's 
trading practices and patterns. Notably, a section 4c(a)(5)(C) 
violation does not require a pattern of activity, even a single 
instance of trading activity can be disruptive of fair and equitable 
trading.

    Issued in Washington, DC, on February 24, 2011 by the 
Commission.
David A. Stawick,
Secretary of the Commission.

Appendices to Antidisruptive Practices Authority--Commission Voting 
Summary; Statements of Commissioners; List of Roundtable Participants 
and Commenters

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn, Chilton 
and O'Malia voted in the affirmative; Commissioner Sommers voted in 
the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed interpretive order regarding disruptive 
practices on designated contract markets or swap execution 
facilities. Congress expressly prohibited three trading practices 
that it deemed were disruptive of fair and equitable trading. 
Today's order provides additional guidance to market participants 
and the public on the trading, practices and conduct that violate 
these statutory provisions. The order also addresses comments 
received by the Commission at the December 2nd roundtable and in 
response to the Advanced Notice of

[[Page 14948]]

Proposed Rulemaking on disruptive trading practices. The order 
addresses the comments by clarifying how the Commission will 
interpret and implement the provisions of Section 747. I look 
forward to hearing from the public in response to this proposed 
interpretive order. The comment letters and staff roundtable were 
extremely helpful in formulating this proposed order.

Appendix III

December 2, 2010 CFTC Staff Roundtable on Disruptive Trading Practices

I. Panel One: Opportunities and Challenges to Fair and Equitable 
Trading

i. Ensuring Fair and Equitable Trading at the Close

ii. Exploring ``the character of'' Spoofing

    a. Panelists: John Hyland--U.S. Natural Gas Fund; Rajiv 
Fernando--Chopper Trading LLC; Adam Nunes--Hudson River Trading 
Group; Cameron Smith--Quantlab Financial, LLC; Liam Connell--Allston 
Trading, LLC; Don Wilson--DRW Trading Group; Joel Hasbrouck--New 
York University; Gary DeWaal--Newedge USA, LLC; Mark Fisher--MBF 
Clearing Corp; John Lothian--John J. Lothian & Company.

II. Panel Two: Rules ``Reasonably Necessary'' To Prohibit Disruptive 
Trading

    a. Panelists: Tom Gira--Financial Industry Regulatory Authority; 
Chris Heymeyer--National Futures Association; Ike Gibbs--
ConocoPhillips; Dean Payton--Chicago Mercantile Exchange; Mark 
Fabian--IntercontinentalExchange; Joe Mecane--New York Stock 
Exchange; Greg Mocek--McDermott Will & Emery; Ken Raisler on behalf 
of Futures Industry Association--Sullivan and Cromwell LLP; Micah 
Green--Patton Boggs LLP; Tyson Slocum--Public Citizen; Andrew Lo--
Massachusetts Institute of Technology.

III. Panel Three: Exchange Perspectives on Disruptive Trading; 
Potential New Disruptive Trading Practices

    a. Panelists: Tom Gira--Financial Industry Regulatory Authority; 
Chris Heymeyer--National Futures Association; Dean Payton--Chicago 
Mercantile Exchange; Mark Fabian--IntercontinentalExchange; Joe 
Mecane--New York Stock Exchange; Andrew Lo--Massachusetts Institute 
of Technology.

Appendix IV

Parties Submitting Comment Letters in Response to Disruptive Trading 
Practices ANPR

A. Flachman
American Petroleum Institute (API)
Argus Media, Inc. (Argus)
Better Markets (BM)
Bix Weir
Chopper Trading, LLC (Chopper Trading)
CME Group, Inc. (CME Group)
Commodity Markets Council (CMC)
David S. Nichols
DeWitt Brown
Edison Electric Institute (EEI)
Emilie Lauran
Futures Industry Association (FIA)
Hess Energy Trading Company, LLC (HETCO)
IntercontinentalExchange, Inc., and ICE Futures U.S., Inc. 
(collectively, ICE)
International Swaps and Derivatives Association, Inc. (ISDA)
Investment Company Institute (ICI)
Managed Funds Association (MFA)
Minneapolis Grain Exchange, Inc. (MGEX)
Newedge USA, LLC (Newedge USA)
Nicole Provo
Peter J. Carini
Petroleum Marketers Association of America (PMAA)
Rebecca Washington
Securities Industry and Financial Markets Association (SIFMA)
U.S. Senator Carl Levin
West Virginia Oil Marketers & Grocers Association (OMEGA)
Working Group of Commercial Energy Firms (CEF)

[FR Doc. 2011-6398 Filed 3-17-11; 8:45 am]
BILLING CODE 6351-01-P


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