UNITED STATES OF AMERICA 

 COMMODITY FUTURES TRADING COMMISSION 

 STAFF ROUNDTABLE ON DISRUPTIVE TRADING PRACTICES 

 Washington, D.C. 

 Thursday, December 2, 2010 
 2 

 1 PARTICIPANTS: 

 2 CFTC Staff: 

 3 ROBERT PEASE, Co-Chair 

 4 MARK HIGGINS, Co-Chair 

 5 ANDREI KIRILENKO 

 6 JEREMY CUSIMANO 

 7 STEVEN SEITZ 

 8 STEPHEN SHERROD 

 9 Panel One: 

 10 JOHN HYLAND 

 U.S. Natural Gas Fund 

 11 

 RAJIV FERNANDO 

 12 Chopper Trading, LLC 

 13 ADAM NUNES 

 Hudson River Trading Group 

 14 

 CAMERON SMITH 

 15 Quantlab Financial, LLC 

 16 LIAM CONNELL 

 Allston Trading, LLC 

 17 

 DON WILSON 

 18 DRW Trading Group 

 19 JOEL HASBROUCK 

 New York University 

 20 

 GARY DeWAAL 

 21 Newedge USA, LLC 

 22 MARK FISHER 

 MBF Clearing Corp 
 3 

 1 PARTICIPANTS (CONT'D): 

 2 JOHN LOTHIAN 

 John J. Lothian & Company 

 3 

 Panel Two: 

 4 

 TOM GIRA 

 5 Financial Industry Regulatory Authority 

 6 CHRIS HEYMEYER 

 National Futures Association 

 7 

 IKE GIBBS 

 8 ConocoPhillips 

 9 DEAN PAYTON 

 Chicago Mercantile Exchange 

 10 

 MARK FABIAN 

 11 IntercontinentalExchange 

 12 JOE MECANE 

 New York Stock Exchange 

 13 

 GREG MOCEK 

 14 McDermott Will & Emery 

 15 KEN RAISLER 

 Futures Industry Association 

 16 Sullivan & Cromwell, LLP 

 17 MICAH GREEN 

 Patton Boggs, LLP 

 18 

 TYSON SLOCUM 

 19 Public Citizen 

 20 ANDREW LO 

 Massachusetts Institute of Technology 

 21 

 22 
 4 

 1 PARTICIPANTS (CONT'D): 

 2 Panel Three: 

 3 TOM GIRA 

 Financial Industry Regulatory Authority 

 4 

 CHRIS HEYMEYER 

 5 National Futures Association 

 6 DEAN PAYTON 

 Chicago Mercantile Exchange 

 7 

 MARK FABIAN 

 8 IntercontinentalExchange 

 9 JOE MECANE 

 New York Stock Exchange 

 10 

 ANDREW LO 

 11 Massachusetts Institute of Technology 

 12 

 13 * * * * * 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 5 

 1 P R O C E E D I N G S 

 2 (9:31 a.m.) 

 3 MR. PEASE: Good morning and welcome to 

 4 CFTC's roundtable discussion on disruptive 

 5 trading. My name is Robert Pease. I'm counsel to 

 6 the director of Enforcement. With me today are 

 7 Mark Higgins, also counsel to the Director of 

 8 Enforcement; Jeremy Cusimano, economic advisor to 

 9 the Director of Enforcement; Steve Seitz, attorney 

 10 from the Office of the General Counsel; and our 

 11 moderators for the morning session, Steve Sherrod, 

 12 the director of Market Surveillance; and Andre 

 13 Kirilenko, a senior financial economist from the 

 14 Office of the Chief Economist. 

 15 In Dodd-Frank, Congress specifically 

 16 enumerated three practices as being disruptive of 

 17 commodity markets. Section 747 of Dodd-Frank 

 18 states that "it shall be unlawful for any person 

 19 to engage in any trading, practice or conduct on 

 20 or subject to the rules of a registered entity 

 21 that violates bids or offers, demonstrates 

 22 intentional or reckless disregard for the orderly 
 6 

 1 execution of transactions during the closing 

 2 period, is, is of the character of, is commonly 

 3 known, as spoofing," and spoofing is defined as 

 4 bidding or offering with the intent to cancel the 

 5 bid or offer before execution. 

 6 In addition, Congress gave the 

 7 Commission the authority to make and promulgate 

 8 such "rules and regulations as in the judgment of 

 9 the Commission are reasonably necessary to 

 10 prohibit the trading practices" enumerated in the 

 11 statute and "any other trading practices that are 

 12 disruptive of fair and equitable trading." 

 13 On October 26th of this year, the 

 14 Commission approved an Advanced Notice of Proposed 

 15 Rulemaking on disruptive trading practices. In 

 16 that ANOPR, the Commission asked 19 questions and 

 17 invited comments from the public on each of the 

 18 issues raised by the ANOPR. This roundtable is 

 19 one effort to seek comments on the questions posed 

 20 by the ANOPR. We invite all of today's panelists, 

 21 as well as those attending today, to send their 

 22 comments on disruptive trading practices to 
 7 

 1 disruptivetrading@cftc.gov. 

 2 I want to thank our distinguished 

 3 panelists for agreeing to appear today and to 

 4 share with us their insights and thoughts on 

 5 disruptive trading practices. Our first panel 

 6 consists of experienced market participants who 

 7 have faced many of the issues that we will discuss 

 8 today. We want to thank the panelists not only 

 9 for their time, but in this budget crisis period, 

 10 also having paid their own way to this roundtable. 

 11 We're broke. Our panelists are John 

 12 Hyland from the U.S. 

 13 Natural Gas Fund, Rajiv Fernando from 

 14 Chopper Trading; Adam Nunes from Hudson River 

 15 Trading Group; Cameron Smith from Quantlab 

 16 Financial; Liam Connell of Allston Trading; Don 

 17 Wilson from DRW Trading Group; Joel Hasbrouck from 

 18 NYU; Gary DeWaal of Newedge; Mark Fisher of MBF 

 19 Clearing; and John Lothian of John J. Lothian & 

 20 Company. 

 21 Before we begin, there are a few 

 22 housekeeping issues. This event is being 
 8 

 1 transcribed by a court reporter who will be taking 

 2 a verbatim transcript. This event is also being 

 3 listened to by members of the public via 

 4 listen-only teleconference. Because we are not 

 5 webcasting this conference, I ask that each 

 6 speaker state their name before they speak so that 

 7 those on the telephone will know who is speaking. 

 8 For the panelists, please turn your name 

 9 cards sideways if you want to speak so that the 

 10 moderator will know to call on you. We will have 

 11 a 15-minute break around 11:00 this morning. 

 12 A few other ones, as I said, the meeting 

 13 is being recorded. The microphones are 

 14 push-to-talk, please press your microphone and 

 15 speak directly into it. When your indicator light 

 16 appears red, your microphone is on. When you 

 17 finish talking, please press the microphone again 

 18 to turn it off. Please refrain from putting your 

 19 BlackBerry or cell phone on the table as they will 

 20 cause audio interference. 

 21 We will not have opening presentations, 

 22 instead we will go right to the questions posed by 
 9 

 1 the ANOPR. With that, I will turn it over to our 

 2 two moderators, Steve Sherrod and Andrei 

 3 Kirilenko. Thank you. 

 4 MR. SHERROD: Okay, I'm having technical 

 5 problems now. 

 6 Good morning. Thanks for being with us. 

 7 We have a lot of questions to cover in the morning 

 8 panel and we have a lot of interesting people that 

 9 we want to hear from, so as a suggestion -- and 

 10 it's only my suggestion because I'm just a 

 11 moderator -- I'd like to group our questions, and 

 12 we're passing around a copy of the questions out 

 13 of the Advanced Notice of Proposed Rulemaking, and 

 14 I would like us to group our thoughts around 

 15 different groups of the questions. 

 16 So, roughly speaking, maybe the first 

 17 six questions that we could handle together, then 

 18 question seven separately, eight through 11, and 

 19 then probably the next three questions, 12, 13, 

 20 14, separately, and 15 through 19 as a block. 

 21 That might help us manage our time just a little 

 22 bit better, but we want to make sure we hear from 
 10 

 1 each of you, so don't hesitate to raise your hand, 

 2 put your card on end, to chime in, because we are 

 3 really interested in hearing your opinions. 

 4 MR. HIGGINS: And Steve, just for 

 5 housekeeping, for the people on the telephone, the 

 6 numbers that you referenced also correspond to the 

 7 ANOPR question numbers, correct? 

 8 MR. SHERROD: That's correct. All 

 9 right, so I'm going to start, I guess, with John 

 10 Hyland on my left and we'll work our way around 

 11 and we'll work our way back in the other 

 12 direction. So, with that, John, I'd be very 

 13 interested to know your views on the first set of 

 14 questions. 

 15 And if you don't have any views, that's 

 16 okay, too. We can wait until you do. 

 17 MR. HYLAND: We're dealing with 

 18 questions one through -- which did you say? 

 19 MR. SHERROD: One through six. 

 20 MR. HYLAND: One through six. 

 21 MR. SHERROD: So, these are the general 

 22 questions at the beginning. 
 11 

 1 I apologize if we didn't get organized 

 2 this way. 

 3 MR. HYLAND: When you were telling us 

 4 what questions we were going to be following I 

 5 didn't have the question -- they hadn't made it 

 6 around, so I wasn't able to mark them up 

 7 appropriately. 

 8 This is John Hyland. I'm with the United 

 9 States Natural Gas Fund, or more specifically, I'm 

 10 with the United States Commodity Funds, which is 

 11 an operator of a number of different exchange 

 12 traded commodity funds of which United States 

 13 Natural Gas is one. 

 14 Looking around the panel I probably 

 15 represent a slightly different viewpoint than many 

 16 of the other participants here in that I probably 

 17 am representing the viewpoint not just of passive 

 18 commodity index funds, which my group certainly 

 19 is, and there are a number of others like that in 

 20 the United States, but also looking around I'm 

 21 probably representing what I would describe as the 

 22 natural longs and the natural shorts in the 
 12 

 1 marketplace -- large players who are not intraday 

 2 players, who are not liquidity providers, who are 

 3 not market makers, who are not looking to make, 

 4 you know, a small amount of -- you know, a 

 5 fractional share 1,000 times an hour, but instead 

 6 are typically taking large positions that extend 

 7 over days, weeks, months, and who are therefore -- 

 8 many of the topics that we're discussing today -- 

 9 spoofing, others -- simply don't fit into -- or 

 10 even algorithmic trading -- don't fit into the 

 11 profile of the kind of trading that gets done by 

 12 players like ourselves or others, therefore our 

 13 comments -- or my comments and, as I said, sort of 

 14 acting as a representative for the passive index 

 15 world generally or for the natural longs and 

 16 natural shorts generally -- our comments are, you 

 17 know, we are totally in favor of cracking down on 

 18 manipulative behavior, we're totally in favor of 

 19 cracking down on disruptive trading practices. We 

 20 have two concerns; concern number one is that in 

 21 attempting to take action against those who engage 

 22 in some of these practices, most of which appear, 
 13 

 1 looking at the questions, to be ones that are 

 2 being executed intraday at a very high speed, in 

 3 cracking down on them we have a concern that this 

 4 could lead to an overall reduction in liquidity, 

 5 which would certainly affect those of us who are 

 6 not involved in the trenches intraday -- interday, 

 7 but who do have to, you know, move in and out as 

 8 liquidity demands if you're the passive indexers 

 9 or if you're the natural short who's the hedger as 

 10 your physical book changes. 

 11 So, we have a concern that the 

 12 unintended consequence would be for the liquidity 

 13 to be driven off so you throw out -- in driving 

 14 out the bad practices, you're also going to drive 

 15 out good practices, we'll see a reduction in 

 16 liquidity. 

 17 Our other concern is that there could be 

 18 a view here that somebody who is a, you know, 

 19 natural short, so somebody hedging 10,000 

 20 contracts of crude oil because they're, you know, 

 21 long a bunch of physical, and who's matching up 

 22 with somebody who wants to be a natural long, 
 14 

 1 which in this case would be the passive index fund 

 2 because essentially if you listen to Gorton and 

 3 Rouwenhorst, we're in a business of selling price 

 4 assurance to the physical hedgers. The mere fact 

 5 -- where we're concerned is that in talking about 

 6 disruptive practices, particularly around the 

 7 closing period, that if PG&E or Chevron wants to 

 8 sell 10,000 contracts at the close and I want to 

 9 buy 10,000 contracts at the close, that somehow 

 10 the mere size of the trade that we're doing could 

 11 be described as disruptive, even though from an 

 12 economic standpoint they're a natural seller and 

 13 I'm a natural buyer, and so we have a concern that 

 14 -- not only that in the case of the liquidity 

 15 issue, that the baby gets thrown out with the 

 16 bathwater, but also that this could be -- that the 

 17 final conclusion here could be sufficiently vague 

 18 enough that the -- that you could take what would 

 19 normally be considered perfectly acceptable trades 

 20 without the slightest hint that there's anything 

 21 manipulative or disruptive about them and simply, 

 22 because it's politically convenient, describe them 
 15 

 1 as being, uh, that's too large a trade. We don't 

 2 really want Chevron selling 10,000 oil contracts 

 3 to United States Oil. 

 4 So, those are our two concerns. Looking 

 5 at this -- 

 6 MR. PEASE: How do you think we can 

 7 provide clarity, particularly with the -- this is 

 8 Bob Pease -- with the issue that you just raised 

 9 about large trades during the closing period? 

 10 MR. HYLAND: Well, you do specifically 

 11 reference a practice in here dealing with closing 

 12 -- you know, the matching up of closing prices -- 

 13 or buyers and sellers at the close which is buying 

 14 the board, which is certainly not something that I 

 15 think likely lends itself to misinterpretation 

 16 but, you know, when you start talking about 

 17 orderly execution I think, you know, you would 

 18 have to specifically state that size by itself is 

 19 not a factor in determining whether trades at the 

 20 close are disruptive. 

 21 If you naturally have -- you know, if 

 22 Chevron wants to roll 10,000 contracts short 
 16 

 1 because they're long, the physical, and we're the 

 2 other side of that trade, the fact that it's 

 3 10,000 is 10,000. You would simply have to say 

 4 that size by itself is not a factor. It would 

 5 have to be other facts and circumstances, you 

 6 know, buying the board or spoofing or what have 

 7 you, that creates the -- that crosses the line and 

 8 allows it to be described as being disruptive. 

 9 Otherwise I can tell you, you know, all the large, 

 10 physical hedges are going to be really cranky with 

 11 you. 

 12 So, I mean, I think that -- from our 

 13 standpoint, that's a factor. Within these other 

 14 things, I mean, when you are somebody in our 

 15 situation, if there is spoofing going on and to 

 16 the extent that it -- you know, we don't trade 

 17 during the day. I don't care what the price is at 

 18 11:00 or 12:00 or 1:00, I care what the prices is 

 19 at 2:30, but to the extent that spoofing or these 

 20 other practices do in fact ultimately affect the 

 21 2:30 price, we are probably the loser and 

 22 therefore we're all in favor of cracking down on 
 17 

 1 these, but once again I'll just leave it with the 

 2 comment, we're worried that you will drive out the 

 3 good with the bad, that we'll lose liquidity, and 

 4 in seeking to eliminate disruptive trading 

 5 practices, you'll do that, but you'll buy greater 

 6 market volatility because the pool will be thinner 

 7 -- will be shallower, and as we all know from 

 8 growing up as children, that it's more dangerous 

 9 to jump into a swimming pool that doesn't have a 

 10 lot of water in it than it is to jump into a 

 11 swimming pool that does have a lot of water in it. 

 12 MR. FERNANDO: Hi, I'm Raj Fernando, CEO 

 13 of Chopper Trading. We trade several asset 

 14 classes, cash and futures. We do some high 

 15 frequency trading, some algo trading, some longer 

 16 term trading going to days and even weeks. I 

 17 support the CFTC's effort to ensure that markets 

 18 operate in an orderly way that's fair for all 

 19 participants. I think I have basically three main 

 20 points to get across today. That's one of them. 

 21 Second, it's imperative for there to be 

 22 a multilayered, coordinated approach with risk 
 18 

 1 controls and market checks to ensure market 

 2 stability. And third, any trading practices with 

 3 the intent or reckless intent to manipulate 

 4 markets and disrupt fair and equitable trading 

 5 should be prohibited. Anyone in violation should 

 6 be held accountable. 

 7 I think it's important to note that our 

 8 markets, for the most part, are incredible 

 9 efficient right now, incredibly liquid right now, 

 10 and the bid-offer spreads are incredibly tight 

 11 right now, and whatever regulations that are put 

 12 forward, we do not want to hurt that part of the 

 13 market. 

 14 MR. SHERROD: Do you want us to -- tell 

 15 us -- this is Steve again -- tell us a little bit 

 16 more what you mean by the multiple levels of 

 17 checks. Is it your obligation as a trader? Or -- 

 18 we're kind of bleeding over into another question 

 19 about what pre-trade risk check should be your 

 20 responsibility and what should be the executing 

 21 brokers responsibility if you're using one of 

 22 those? 
 19 

 1 MR. FERNANDO: Well, I'll speak for my 

 2 firm. We have several layers and redundant risk 

 3 checks all up and down our whole company. As the 

 4 nature of proprietary trading, this is our money, 

 5 we have no investors, and we are going to be very 

 6 careful to make sure that nothing goes wrong. 

 7 If after it goes from our firm, the 

 8 clearinghouse is left making sure that we are 

 9 being responsible and anything that we don't pick 

 10 up, the clearinghouse will have to pick up. From 

 11 there it goes to the exchange and the exchange is 

 12 going to make sure the clearinghouse is doing 

 13 their duty to make sure that these risk checks are 

 14 in place all the way down the line. 

 15 MR. SHERROD: Any particular pre-trade 

 16 risk management checks that you rely upon? 

 17 MR. FERNANDO: We have dozens and we are 

 18 very -- they are very thorough and we're very 

 19 diligent about it and we have dozens of people in 

 20 our company that do nothing but keep track of 

 21 this. 

 22 MR. NUNES: Hi, I'm Adam Nunes from 
 20 

 1 Hudson River Trading. Thanks for having me here 

 2 to share our views on these topics. 

 3 So, I just want to start out, and it's 

 4 something that John touched on, just as far as, 

 5 you know, putting in these and kind of throwing 

 6 out good practices with bad, you know, I think the 

 7 first thing to lay out is eliminating bad 

 8 practices and disruptive practices is going to 

 9 make the market more liquid and more efficient 

 10 overall. It will allow legitimate practices to 

 11 occur without the risk of being manipulated and I 

 12 think overall that's going to be good for end 

 13 users and good for, you know, firms like those 

 14 around the table. 

 15 So, in getting into the questions, you 

 16 know, I think that first off, additional guidance, 

 17 you know, as laid out in the release, is going to 

 18 be necessary. The -- I think a few short 

 19 sentences on this is not going to be sufficient 

 20 to, you know, cover the activities that we need. 

 21 One of the things that is, I think, 

 22 critical, is just kind of looking at the 
 21 

 1 landscape. We have a number of exchanges across 

 2 futures and equities that have rules that, you 

 3 know, certainly cover, you know, C, which is the 

 4 spoofing aspect, that typically talk about bona 

 5 fide orders, bona fide quotes, and, you know, the 

 6 prohibition against submitting orders or quotes, 

 7 you know, with the intent of, you know, 

 8 effectively manipulating others to act in a way 

 9 that they otherwise wouldn't. So, you know, FINRA 

 10 Rule 5210, Section 9 of the SEC -- of the 

 11 Securities & Exchange Act, lay those out and there 

 12 are a number of other exchanges. I think it's 

 13 Rule 432 at the CME and CBOT, that lay out -- and 

 14 I think maybe 514 -- that lay out, you know, these 

 15 exact things and I think if you look at the way 

 16 that they describe, you know, what's described 

 17 here as spoofing, it does it in a manner that 

 18 isn't overly prescriptive. You know, we obviously 

 19 don't want to put ourselves in a position where 

 20 you can do something slightly different and it 

 21 doesn't meet the definition, you know, so there's 

 22 certainly kind of the intent aspect of this that's 
 22 

 1 important to cover, but when you get beyond that 

 2 having, you know, kind of having the rule that 

 3 lays out the overall activity, if there are 

 4 specific practices within that that can be 

 5 enumerated -- the FSA put out a release on 

 6 layering as an example where they didn't have to 

 7 change the rule, they just said, you know, we have 

 8 this rule, this type of behavior, we believe, is 

 9 covered by the rule -- it is extremely helpful to 

 10 market participants because, you know, it takes 

 11 something that, you know, perhaps was in a gray 

 12 area, maybe much closer to black than white, but 

 13 it makes it crystal clear and allows firms to put 

 14 in the, you know, the procedures and processes to 

 15 ensure that they're not engaging in activity that, 

 16 you know, that would have that character. 

 17 The other thing that I think is 

 18 important in looking at these things is looking at 

 19 a pattern in practice. There are likely to be 

 20 legitimate activities that can happen randomly and 

 21 not particularly often that could in that single 

 22 instance, look like something that could be, you 
 23 

 1 know, manipulative or spoofing or whatever it is, 

 2 but that, you know, just happened randomly as an 

 3 occurrence of firms sending a lot of orders into 

 4 the market, and that would differ quite a bit from 

 5 seeing that pattern, you know, happen, you know, 

 6 time and time again, day over day, so I think that 

 7 looking at things from that perspective, certainly 

 8 from a surveillance standpoint, is going to be 

 9 effective and, you know, I think if you look at 

 10 per se violations, if you do A, B, then C, you 

 11 know, then you've definitely violated versus 

 12 seeing the pattern in practice of that type of 

 13 activity is going to be more effective in, you 

 14 know, in kind of spending the Commission's 

 15 resources and, you know, finding people who are 

 16 breaking rules. 

 17 Just specifically to violating bids and 

 18 offers, that, you know, should generally be for 

 19 firms that trade, you know, electronically, 

 20 something that's going to be enforced by the 

 21 exchange. It raises a couple of topics in my 

 22 head, one is just the interaction between the 
 24 

 1 floor and the electronic market and how that 

 2 works. And the second would be in the instance 

 3 where you have products that are listed across 

 4 multiple exchanges, how that would be applied. 

 5 MR. HIGGINS: Adam, if I could 

 6 interrupt. Sorry, this is Mark Higgins. Could 

 7 you just describe the difference between markets, 

 8 as you speak, with the violating of bids and 

 9 offers? And then secondly, if you view that 

 10 prohibition in 747 of Dodd-Frank as being a per se 

 11 violation? Or are there facts and circumstances 

 12 that should be considered when looking at 

 13 violating bids and offers? 

 14 MR. NUNES: Yeah, I think the equities 

 15 markets provide a pretty good example where they 

 16 have Reg. NMS that governs trading across venues 

 17 that list the same -- you know, the same security 

 18 or the same contract and the options market have 

 19 something quite similar where they provide a 

 20 framework that, you know, basically says you must 

 21 have processes and procedures in place to 

 22 reasonably avoid trading through a displayed 
 25 

 1 better offer and then, you know, more or less a 

 2 sub-framework on that that lays out how one should 

 3 do that, and I think that that is definitely a 

 4 workable format from, you know, from a market 

 5 participant's perspective. It allows you to, you 

 6 know, set up a framework and set up a system that 

 7 will be compliant, but we're operating in a world 

 8 where it has a lot to do with technology and if 

 9 you drop a packet that contains a quote, you're 

 10 not going to see that quote, you know, until you 

 11 re-request it and get it back 100 milliseconds 

 12 later, and that's really a fact of the electronic 

 13 trading life. So, it's not going to be perfect, 

 14 but it can be extremely close to perfect. 

 15 So, I think having the processes and 

 16 procedures in place is the right approach. You 

 17 know, it seems hard to believe that a firm that's 

 18 99.999 percent compliant with, you know, never 

 19 trading through, drops a quote and that's a per se 

 20 violation and they're fined for that where they 

 21 have a system in place that, you know, is very 

 22 robust. 
 26 

 1 So, I guess moving on a little bit more, 

 2 I think the other thing here is, you know, when we 

 3 look at disruptive trading practices and the 

 4 intentional reckless disregard for orderly 

 5 execution, to me that is going to be a very 

 6 difficult one to define. It seems like it would 

 7 be very difficult and I think John hit on this 

 8 very well, to put a contract limit on orders 

 9 because there are large players who have a lot of 

 10 exposure to hedge. 

 11 Similarly, it's very difficult to put 

 12 all participants -- and this is not just, you 

 13 know, the trading firms, but end users, in a 

 14 position of being judged after the fact, you know, 

 15 when they put an order in that, you know, that 

 16 they put thought into, that they chose an 

 17 execution strategy that they thought was going to 

 18 be effective, and it just so turned out it didn't 

 19 work and that, you know, to me again just gets 

 20 into, you know, do you have appropriate policies 

 21 and procedures around what you're doing and how 

 22 you're doing it, and do you have effective 
 27 

 1 supervisory and controls around that where if you 

 2 do, then that should minimize the likelihood of 

 3 that happening, but I don't see how we can 

 4 eliminate it, and putting, you know, all users in 

 5 a position of being judged after the fact, I 

 6 think, puts them in a difficult position. 

 7 There was one that I -- question five -- 

 8 that I specifically wanted to address which I 

 9 think gets to -- I'm sorry, it was question six -- 

 10 just gets to order activity as opposed to 

 11 executions only where I think that from my 

 12 perspective it's pretty clear that we should be 

 13 looking at both orders and executions across, you 

 14 know, basically all of the things that -- well, I 

 15 guess violating bids and offers has to be an 

 16 execution, but you know, across intentional and 

 17 reckless disregard for orderly execution as well 

 18 as spoofing. I think that, you know, certainly 

 19 with spoofing it's often just going to be orders. 

 20 So, I think that looking at orders as well as 

 21 executions is appropriate. 

 22 MR. KIRILENKO: Adam, thank you. This 
 28 

 1 is Andrei Kirilenko. Thank you for those very 

 2 last comments that you made. I think that perhaps 

 3 to make things a little bit more general, sort of 

 4 some general comments, is that these disruptive 

 5 practices, in a way you could think of them as 

 6 extending the Commission's jurisdiction into the 

 7 area of orders rather than executions. Executions 

 8 typically have to do, you know, with when 

 9 manipulation is being looked at, attached to that 

 10 was executions, or as these specific areas are in 

 11 the area of sort of orders and order submission, 

 12 and there is a reason for that, and the reason for 

 13 that is being -- is that in anonymous electronic 

 14 markets, there is a lot -- you know, the market 

 15 participants communicate to each other and 

 16 communicate with the market by submitting, 

 17 cancelling, and modifying their orders, and 

 18 therefore, that's where the jurisdiction should 

 19 move into, and so one of the sort of broader 

 20 questions, to the extent that other participants 

 21 could comment on it, is where should that boundary 

 22 be? Where should that regulatory boundary be for 
 29 

 1 the Commission? And how well should it be 

 2 defined? Should it be defined very clearly or 

 3 should it be defined clearly in some areas and be 

 4 left in principle in other areas and some would be 

 5 (inaudible) circumstances? 

 6 I understand that as some of you have 

 7 already said, that the more clearly it is defined, 

 8 the better you can define policies and procedures 

 9 so that you don't overstep over these boundaries. 

 10 However, there might be some areas where that 

 11 boundary will be moving as the market is 

 12 developing, so to the extent that you and others 

 13 would like to comment on the sort of general terms 

 14 of where that boundary should be, would be very 

 15 useful. 

 16 MR. HIGGINS: Just before you speak, 

 17 Adam, I just want to recognize that Commissioner 

 18 O'Malia is here. He heads our Technology Advisory 

 19 Committee, and so we thank him for his 

 20 participation. 

 21 MR. HYLAND: This is a question -- this 

 22 is John Hyland. This is a question for Robert, 
 30 

 1 actually. If I make -- under current rules, if I 

 2 make a bid or an offer with the intent to cancel 

 3 the bid or offer before execution, let's ignore 

 4 how you're going to prove that in a court of law, 

 5 let's just say I do it, is that under current CFTC 

 6 regulations an acceptable practice, bearing in 

 7 mind that I'm not a securities lawyer? 

 8 MR. PEASE: Well, one of the things we 

 9 want to do today is put as much meat on the bones 

 10 as we can to what it means to cancel bids or 

 11 offers, what would be legitimate practices, what 

 12 would be reasons. That's why we want to hear from 

 13 you all today, as different types of practices. 

 14 What is a legitimate business purpose to be 

 15 canceling the orders before execution? Are there 

 16 such legitimate purposes or should there be an 

 17 automatic ban? When does it become disruptive to 

 18 the market? 

 19 So those are the issues that we actually 

 20 want to hear from you all on today. 

 21 MR. HIGGINS: And to that point, John, I 

 22 just want to echo that we're here to listen and to 
 31 

 1 the extent staff does say anything that sounds 

 2 like an opinion, it's just staff's opinion, not 

 3 the opinion of the Commission or any other staff 

 4 members. So, I just want to make that clear. 

 5 MR. NUNES: I have a question, hopefully 

 6 -- so, to Andrei's question, were you asking that 

 7 specific to question B? Or was that for, you 

 8 know, basically A, B, and C? 

 9 MR. KIRILENKO: I was asking it respect 

 10 to all A, B and C. 

 11 MR. NUNES: Yeah, so I think that, you 

 12 know, drawing a line between the Commission's 

 13 jurisdiction over orders versus execution, from my 

 14 perspective, the Commission does and should 

 15 clearly have jurisdiction over both, you know, 

 16 their activity taking place in commodities in the 

 17 U.S. and, you know, from my perspective, you can't 

 18 look at -- you know, you can't have an execution 

 19 without an order, so from my perspective I don't 

 20 understand why you would separate the two. 

 21 You know, getting to Robert's question, 

 22 just kind of more generally on the practice of 
 32 

 1 submitting orders and canceling them, you know, I 

 2 believe you should send orders because you want 

 3 them to be executed and that there's not really 

 4 another reason to legitimately send them to 

 5 market. But there are a number of legitimate 

 6 reasons why you may end up canceling them and 

 7 frankly why you may have a relatively high 

 8 proportion of them that are canceled. Some of 

 9 those are less in the futures market in the U.S. 

 10 just because there are fewer venues trading the 

 11 same product. But, you know, they're typically 

 12 going to just boil down to market conditions, you 

 13 know, whether related products have -- you know, 

 14 the price has moved or the price of that product 

 15 has moved, and then a firm's risk profile. So, I 

 16 may have taken a position in a related product 

 17 that led me to no longer want to buy the product 

 18 that I'm quoting, so, you know, the CME has limits 

 19 on what your order to execution ratio is and so 

 20 this is unlikely to be, you know, at present, a 

 21 major issue in the futures market. 

 22 On the equities market where you may be 
 33 

 1 trading across, you know, a dozen or well over 

 2 that venues, and you're layering the book to 

 3 provide liquidity across multiple venues, you 

 4 could have one hundred or hundreds of bids and 

 5 offers out and as you're adjusting your position 

 6 based on related products moving, based on that 

 7 product moving, based on your risk position, you 

 8 can end up with a relatively low order to 

 9 execution or a relatively high order to execution 

 10 ratio, you know, for legitimate reasons just 

 11 because you have a lot of risk out there and a lot 

 12 of orders out there because as a liquidity 

 13 provider, you don't know where the next order's 

 14 going. It could go to one of dozens of venues 

 15 that trade that product. 

 16 So, I think the issue in the futures 

 17 world is already a lot smaller just because you 

 18 don't have that, you know, but we're managing our 

 19 risk and we're trying to do that in a way that, 

 20 you know, we're sending orders that we want to 

 21 execute, but we can change our mind, you know, due 

 22 to risk factors, you know, in a short timeframe. 
 34 

 1 MR. PEASE: What would be a short 

 2 timeframe in your mind? 

 3 MR. NUNES: The timeframe could be 

 4 extremely short. I think that one area that you 

 5 can look at is, you know, does someone have a 

 6 pattern and practice of sending orders, like let's 

 7 pretend that an exchange can process an order, 

 8 send out the quote in one millisecond and then it 

 9 takes a millisecond for someone to respond to it. 

 10 In that world, like, if you're canceling an order 

 11 in less than two milliseconds, then no one 

 12 effectively has the chance to interact with it 

 13 unless it's by chance that they happen to be 

 14 sending an order. 

 15 Now, a firm can do that, you know, for 

 16 perfectly legitimate reasons because they sent an 

 17 order and, you know, immediately after sending it 

 18 got an execution they no longer wanted that risk, 

 19 but if you have a pattern and practice of doing 

 20 that, and you see that that's an activity that a 

 21 firm engages in, you know, that from my 

 22 perspective is certainly worth asking questions 
 35 

 1 about why that can be legitimate and what they're 

 2 trying to do with that activity. 

 3 But that just kind of to me gets back to 

 4 the per se versus pattern and practice approach to 

 5 this. 

 6 MR. FERNANDO: Can I make a quick 

 7 comment? This is Raj Fernando, Chopper Trading. 

 8 I could give a perfectly legitimate reason why I 

 9 would put in an order with no intent to have it 

 10 executed. Say I'm trading bond futures at the 

 11 Mercantile Exchange, the Board of Trade, and my 

 12 limits are set for 100 lot and I want to change it 

 13 to a 200 lot. So, I go through my risk procedures 

 14 and have it checked. I put 200 (inaudible) off 

 15 the market with an intent to cancel it just to 

 16 make sure my risk procedures went through 

 17 correctively. I have no intent for that trade to 

 18 ever be actionable. Is that a violation? I think 

 19 there's no reason that should be. 

 20 So, I think it is dangerous to be 

 21 getting pigeonholed with too many rules that could 

 22 open up a whole can of worms here. 
 36 

 1 MR. NUNES: I'm not going to comment on 

 2 that. But what -- from my perspective what does 

 3 matter and what you can add on to what Rajiv said 

 4 is, was there intent to manipulate someone else to 

 5 get someone else to do something? So, whether or 

 6 not that's legitimate, what is clearly not 

 7 legitimate would be sending in, you know, 1000 lot 

 8 because it's going to lead people to think there's 

 9 more demand, you know, in the market than there 

 10 truly is in order to get them to, you know, either 

 11 join the bid or in order to lift the offer. 

 12 So, you know, from that perspective -- 

 13 and that does get into the intent, not just to 

 14 cancel, which is laid out here, but the intent to 

 15 manipulate, which I think is also, you know, 

 16 critically important. 

 17 MR. SMITH: I'm Cameron Smith. I'm from 

 18 Quantlab and I don't know if it's fortunately or 

 19 unfortunately but I'm going after Adam who seems 

 20 to have a lot to say about a lot of this and stole 

 21 a lot of my lines, I think. But what I'll do is 

 22 I'll reiterate a few of, I think, the key points 
 37 

 1 there. 

 2 I do think, like Adam does, that we need 

 3 to elaborate on these -- these rules need to be 

 4 filled out a bit and there needs to be more 

 5 material and I think what really needs to be there 

 6 in my mind is some notions of intent or phrases 

 7 like "for the purpose of" to the extent that 

 8 quotes are entered or trades have an impact on the 

 9 market, they have to be done with a requisite 

 10 intent or -- and there's a lot in the equity 

 11 market, as Adam also mentioned. There's several 

 12 good examples of that. I think Section 9 of the 

 13 34 Act has some language like that. FINRA has a 

 14 few rules. There's the rule on quotations -- what 

 15 was that, 5210? And the CME also has -- so, I 

 16 think there's already rules out there. 

 17 My concern here is that these rules, 

 18 lacking that, can capture a lot of activity that 

 19 we -- I don't think that the intent is to capture 

 20 and I should note, I think John sort of brought 

 21 this out and maybe I'll say it more directly, and 

 22 that is, while I suspect a lot of these rules were 
 38 

 1 aimed at controlling automated trading, I think 

 2 when you really think about these practices and 

 3 think about what this says and apply it to what 

 4 really goes on in the market, natural buyers and 

 5 sellers are the ones who are actually trying to 

 6 avoid market impact. So, in a certain way you 

 7 could say that they're the most likely to engage 

 8 in practices that are intended in a certain way to 

 9 deceive, right, because they're trying to avoid -- 

 10 they're trying to do a lot of product. They don't 

 11 want the price to run away from them. So, they're 

 12 going to dribble it out, maybe they'll even, if 

 13 they're buying, maybe they'll put a sell order in 

 14 occasionally just to moderate that price move. 

 15 Who knows? I mean, but they're the ones that are 

 16 more likely to have price impact, and I'm sure 

 17 that's not the intent and that's why I think we've 

 18 got to be really careful with these rules and make 

 19 sure that there's an intent portion of them, 

 20 otherwise we are going to discourage legitimate, 

 21 important trading by end users, natural buyers and 

 22 sellers, and we certainly don't want to push that 
 39 

 1 off the exchange and in the OTC markets because if 

 2 there's some uncertainty as to whether or not 

 3 they're compliant. 

 4 So, I think that point may be kind of 

 5 missed because like I said, I do think that these 

 6 rules seem to be aimed at automated trading but 

 7 yet perversely, I think that it really actually 

 8 creates more concern for an institution because I 

 9 think they're the ones that are actually more 

 10 engaged in the things described here because of 

 11 the nature of their trading and the impact it has 

 12 on the market. 

 13 Automated traders typically trade in 

 14 relatively small sizes. We're not going to have 

 15 the same kind of market impact as an institution 

 16 or a big natural buyer and seller who has real 

 17 positions to hedge. 

 18 MR. CONNELL: My name is Liam Connell. 

 19 I work for Allston Trading, a proprietary 

 20 broker-dealer that trades in electronic markets, 

 21 in futures, and in equities. 

 22 I think a lot of my points have already 
 40 

 1 been covered. I think one point I'd like to make 

 2 is that, you know, Allston Trading supports the 

 3 mission of the CFTC to maintain orderly markets 

 4 and to prohibit deceptive practices and 

 5 manipulative trading. My concern is that, you 

 6 know, what might determine disruptive trading is 

 7 going to be dependent both on the venue and, you 

 8 know, the technology capabilities of that venue 

 9 and the specific market that that venue is 

 10 supporting. And, you know, I'm concerned that 

 11 very rigid rules will not take that into account. 

 12 My other concern is that some of the 

 13 wording about the illiquid markets, we want to 

 14 ensure that we don't drive liquidity away from 

 15 those illiquid markets. I think participants 

 16 should be allowed to take -- you know, to take 

 17 liquidity that's available in those illiquid 

 18 markets and if we lay down too many rules in 

 19 relation to that, we may drive liquidity away from 

 20 those illiquid markets when we really want to 

 21 encourage liquidity in those illiquid markets. 

 22 And then my concerns, and considering we 
 41 

 1 have 19 questions and these are the first six, I 

 2 will yield the floor. 

 3 MR. WILSON: This is Don Wilson. I'm 

 4 the founder and CEO of DRW Trading. 

 5 So, I think that one of the most 

 6 important things that we would like to see out of 

 7 this process is that the rules are clearly 

 8 defined. If rules are not clear, or if rules are 

 9 backward looking, in other words, an order, which 

 10 winds up moving the market a lot is after the fact 

 11 deemed to be disruptive merely because it moved 

 12 the market a lot, not because there was any intent 

 13 to move the market a lot, and if that then is 

 14 deemed to be a disruptive order and a violation, 

 15 the central marketplace will be significantly 

 16 harmed. Exactly the intent of the, you know, the 

 17 intent of Dodd-Frank was obviously to bring more 

 18 transparency to the marketplace and actually 

 19 exactly the opposite will be achieved. I think 

 20 that what will happen is that market participants 

 21 who have large orders to execute will conclude 

 22 that the regulatory risk of entering the large 
 42 

 1 orders into the marketplace are -- is too great 

 2 and they will instead execute the orders most 

 3 likely as block trades or some other privately 

 4 negotiated transaction so that they don't have to 

 5 take on that regulatory risk. 

 6 It would have obviously very adverse 

 7 effect on the central market place. 

 8 As far as some specific comments on the 

 9 first six questions, as far as violating bids and 

 10 offers, I think that it's important to 

 11 differentiate between the securities markets and 

 12 the futures markets. Adam, you know, describes 

 13 the way that the securities markets work and there 

 14 seems to be a pretty good system there, a 

 15 mechanism. 

 16 In the futures markets an identical 

 17 futures contract which -- contract specifications, 

 18 which is listed on two different exchanges and is 

 19 cleared at two different clearinghouses, will 

 20 frequently trade at different prices because 

 21 different market participants will have a desire 

 22 to be -- to buy one instead of another, maybe for 
 43 

 1 -- because they're offsetting a different risk at 

 2 different places. Frequently we see in the energy 

 3 markets the relationship between the ICE and NYMEX 

 4 trade at a spread merely because the order flow is 

 5 all one way and at some point people get tired of 

 6 buying one and selling the other, they run out of 

 7 capital, and so the spread tends to trade at a 

 8 premium or deficit. I don't think that there's 

 9 anything inherently wrong with that. That's just 

 10 the way that the market works and so I think it's 

 11 very important to differentiate between securities 

 12 and futures and understand that different futures 

 13 on different exchanges, or even a mini future and 

 14 a big future, both listed on the same exchange, 

 15 can trade for very good reasons at different 

 16 prices. I also think that, you know, a futures 

 17 contract which is traded in the pit may trade at a 

 18 different price than a futures contract traded on 

 19 the screen, and that's just market dynamics and 

 20 order flow. I don't think that that's -- you 

 21 know, that the CME generally treats those as 

 22 different ticker symbols even although ultimately 
 44 

 1 the contacts wind up in the same open interests. 

 2 So, I think that, you know, some careful 

 3 consideration needs to go into, you know, what is 

 4 expected to be caught in the violating bids and 

 5 offers framework. 

 6 As far as canceling orders and where you 

 7 draw the line, what's okay and what's not okay, 

 8 you know, my general thought is that somebody who 

 9 enters a large order, who really has no intent of 

 10 buying but actually wants to sell, you know, or 

 11 has no intent of selling but actually wants to 

 12 buy, so, is entering an order in the opposite 

 13 direction to what they actually want to do, and 

 14 demonstrates a repeated pattern of entering those 

 15 orders, getting other people to join them, pulling 

 16 them and then, you know, going the other way -- I 

 17 think that it's fair to say that that's an 

 18 unacceptable practice. 

 19 On the other hand, it's quite common for 

 20 people to enter orders that are larger than they 

 21 actually want to transact because, for instance, 

 22 the allocation algorithm is a pro rata algorithm. 
 45 

 1 The market participants generally believe that 

 2 that's an acceptable practice and I think it is 

 3 because at least the market participant is not 

 4 signaling intent -- an intent to buy when they 

 5 want to sell or sell when they want to buy. 

 6 Now, Cameron brings up an interesting 

 7 point which is that for large end users who are 

 8 trying to move large orders through the central 

 9 market may find it beneficial to occasionally, you 

 10 know, if they're buying, enter sell orders or if 

 11 they're selling, enter buy orders, in order to 

 12 make their activity a little bit less transparent 

 13 to the marketplace so that they can execute at 

 14 better prices. And I think that it's an 

 15 interesting question to ask whether the intent 

 16 would be to ban that type of behavior, which, from 

 17 the perspective of the person executing the large 

 18 order, really isn't intended to be manipulative, 

 19 it's merely intended to improve their execution. 

 20 I think that's a question that should be carefully 

 21 considered. 

 22 As far as disruptive trading on the 
 46 

 1 close, again I think that it's very important to 

 2 not put in place rules which prevent people from 

 3 executing orders in the closing period. Generally 

 4 there are lots of good reasons that people need to 

 5 execute large orders in the closing period that 

 6 have nothing to do with manipulating the closing 

 7 price. There are lots of reasons for taking off 

 8 risk at the end of the day. And so I think that 

 9 the definition of those rules around, you know, 

 10 what is and is not acceptable in the closing 

 11 period needs to be carefully considered. 

 12 Certainly an intent to manipulate the closing 

 13 settlement price by engaging in inefficient 

 14 execution is something that I think is 

 15 unacceptable, but merely entering a large order, 

 16 even if it winds up moving the closing price, is 

 17 -- should be an acceptable activity. 

 18 And then just one last comment, the 

 19 question about buying the board in an illiquid 

 20 market, you know, I think that people who have 

 21 hedges to execute or, you know, otherwise need to 

 22 enter large orders and move large amounts of risk 
 47 

 1 need to have the flexibility to do that in the 

 2 most efficient way possible and certainly buying 

 3 the board, which just means that you're 

 4 simultaneously buying several different contract 

 5 months, for instance, may be the most efficient 

 6 way and prudent way of executing that order and 

 7 reducing that risk. 

 8 So, I don't think that there's 

 9 inherently anything wrong with that. 

 10 MR. SHERROD: Don, would your opinion be 

 11 different if someone were adding risk rather than 

 12 reducing risk? 

 13 MR. WILSON: Well, I think that it 

 14 really comes down to intent. If somebody is, you 

 15 know, purposefully trying to -- you know, and I 

 16 think that there was an example cited somewhere of 

 17 somebody in the egg market, you know, purposefully 

 18 moving the price and, you know, after they bought 

 19 the board and bid up the price, then they, you 

 20 know, cleaned out the whole book and then they bid 

 21 a one lot significantly higher, I think that it's 

 22 fair to say that that activity, there was some 
 48 

 1 intent in that activity because they were 

 2 executing it as inefficiently as possible. 

 3 So, I think that that's really where I 

 4 draw the line, not so much whether it's risk 

 5 adding or risk reducing. 

 6 MR. PEASE: What type of clarity would 

 7 you suggest -- this is Bob Pease -- would you 

 8 suggest that we add if we go forward and define 

 9 these types of rules so that you can know more in 

 10 advance what would be prohibited rather than being 

 11 subject to an investigation after the fact? 

 12 MR. WILSON: Well, again, I think that 

 13 intent is a really helpful criteria to put in this 

 14 stuff and, yeah. 

 15 MR. HIGGINS: This is Mark Higgins. If 

 16 I could just jump in for a second. It seems that 

 17 a theme that is coming through so far is that 

 18 intent is the all-important determining factor. I 

 19 just had a question as we continued along the line 

 20 here. Are there certain practices that are so bad 

 21 that on their face you'd like to -- you think they 

 22 should be prohibited because they're disruptive of 
 49 

 1 fair and equitable trading, without having to go 

 2 into an assessment of the intent or the facts and 

 3 circumstances underlying a specific trade? And I 

 4 throw that open to the entire panel. I don't know 

 5 if anybody has a special view, but maybe Joel, if 

 6 you want to take that one. 

 7 MR. HASBROUCK: I'm Joel Hasbrouck. I'm 

 8 a professor at the Stern School at New York 

 9 University. And my area of specialty is mostly 

 10 empirical analysis of market data. 

 11 I've looked at an awful lot of high 

 12 frequency data, some from futures markets, but 

 13 mostly from equities markets. 

 14 My first point is that we're here today 

 15 because of, really, technology and it's important 

 16 to remember that this technology is not yet 

 17 mature. So, we're trying to hit a moving target 

 18 here and in this kind of regulatory environment, I 

 19 think it's better to be a little bit conservative, 

 20 leave markets room to evolve and then impose 

 21 regulation to address the worst excesses. 

 22 Now, this does not say, you know, we 
 50 

 1 shouldn't be concerned about another May 6th -- 

 2 circuit breakers, price limits, great, but I think 

 3 it's difficult to get definite rules in detail 

 4 about prohibitive bidding, offering, or trading 

 5 practices that aren't going to constrain the 

 6 efficient evolution of markets. 

 7 A couple of specifics, one, the process 

 8 at the close, we know from other markets that one 

 9 procedure seems to work pretty well which is a 

 10 single price call auction at the close. You have 

 11 a period where orders can be entered, an order and 

 12 balance is published, beyond a certain point, 

 13 submissions and cancellations that aggravate that 

 14 imbalance are prohibited, and then you have a 

 15 clearing in an orderly fashion. It seems to work 

 16 well in equities markets and some futures markets 

 17 and options markets abroad. 

 18 Another point, and Adam raised this 

 19 question about multiple markets trading 

 20 essentially the same thing, and he raised it in 

 21 connection with a violation of bids and offers, 

 22 that is trade-throughs. Now, Reg. NMS in the 
 51 

 1 equity markets did address that but it's important 

 2 to remember that that was contingent on markets 

 3 being "fast", that is, if you wanted your prices 

 4 to be protected, you had to be in a position to 

 5 respond pretty quickly. So, for example, Reg. NMS 

 6 would not apply in a situation like side- by-side 

 7 trading where you have a contract traded on Globex 

 8 and the pit, the pit being essentially a manual 

 9 open outcry market would be considered slow and 

 10 it's quotes would not be considered eligible for 

 11 protection. 

 12 Lastly, the question has come back again 

 13 and again to intent. I'm so leery of defining 

 14 rules or prohibiting practices based on intent 

 15 because as markets and strategies evolve, so many 

 16 things that look illegitimate at first, often very 

 17 rational and constructive rationale can be 

 18 attributed to it. For example, in equities data, 

 19 I have seen certainly extreme cases of somebody 

 20 changing the bid and offer maybe 84,000 times in 

 21 two or three minutes, and that, to my eye, is 

 22 spoofing and should probably be prohibited, but if 
 52 

 1 I look at the intent of a rapid cancellation and 

 2 resubmission, I think, you know, why do we change 

 3 our bids? Well, we change our bids and offers 

 4 because the information has changed somehow. And 

 5 well, how rapidly are we getting new information? 

 6 When it was a floor market, we'd get new 

 7 information, maybe one update ever ten seconds but 

 8 in an electronic market where we are continually 

 9 monitoring all the news feeds and all the market 

 10 prices from other securities, those updates are 

 11 essentially coming continuously. 

 12 I would put it out there that I could, I 

 13 think, justify practically -- for a person who 

 14 monitored those feeds, I think it would be very 

 15 difficult to establish an intent as opposed to a 

 16 legitimate purpose. 

 17 Thank you. 

 18 MR. KIRILENKO: Thank you, Professor 

 19 Hasbrouck. This is Andrei Kirilenko from the 

 20 CFTC. I have a question for you, perhaps, that 

 21 you can comment on. You said that -- you said 

 22 something very interesting, you said that the 
 53 

 1 rules have to take into account the evolving 

 2 technology in the marketplace and to that extent, 

 3 these rules, how would you try to put it into 

 4 these specific rules? What -- how would you 

 5 advise to put specific technology that is 

 6 available now, and evolving technology in the 

 7 future? 

 8 MR. HASBROUCK: First, I don't know -- I 

 9 think rules based on intent in evolving technology 

 10 are impractical. They can certainly be written, 

 11 but I think were any cases to be brought, I think 

 12 they'd be relatively easy to defend. 

 13 I don't do this work myself, but I know 

 14 people who do and of course, as do you, and it's 

 15 very easy to constructively come up with 

 16 alternative explanations for a given pattern of 

 17 behavior. 

 18 So, what would you do? First, I think a 

 19 rule that's directed specifically at spoofing is 

 20 probably too narrow. I recognize that that is in 

 21 the Dodd-Frank bill, but I think it's going to be 

 22 based on intent and I would not be in a position 
 54 

 1 of wanting to -- of having to define it. 

 2 If you think that the problem is bids 

 3 and offers that are being quoted too rapidly, then 

 4 you could do what at least one market has done 

 5 which is prohibit cancellations below a certain 

 6 time threshold. You want to put a bid out there, 

 7 it has to be good for at least 100 milliseconds. 

 8 Rules like that sort of get away from intent and 

 9 really address very narrowly the particular thing 

 10 at the moment that seems to concern us. So, I 

 11 would say that would be one example. 

 12 MR. FERNANDO: Can I comment on that? 

 13 MR. SHERROD: Sure, go ahead. 

 14 MR. FERNANDO: This is Raj Fernando, 

 15 Chopper Trading. If there was some kind of 

 16 minimal time limit to holding bids and offers, 

 17 I'll speak for my firm, if we're making markets in 

 18 the treasury complex and we had a certain amount 

 19 of timeframe we have to keep a bid in the 

 20 five-year future and we're trying to get a hedge 

 21 up from the five- year cache, all that will make 

 22 us do as a firm is widen out our bids and offers 
 55 

 1 which will provide less liquidity and the spreads 

 2 will all widen and it will be extremely 

 3 detrimental to this market. 

 4 MR. NUNES: This is Adam from Hudson 

 5 River Trading. Just one thing to add to that is 

 6 from my perspective rules should generally be 

 7 technology agnostic. You know, I've lived through 

 8 electronic trading since, you know, the late '90s 

 9 and 100 millisecond rule in 1999 would have been 

 10 somewhat absurd because it took seconds to get 

 11 orders executed whereas today, you know, that 

 12 would be over 100 times longer than the fastest, 

 13 you know, exchange can respond to something, so 

 14 codifying timeframes like that -- and if you look 

 15 at Reg. NMS, it's one second -- one second in the 

 16 equities world is a material delay at this point 

 17 whereas one second ten years ago would have been 

 18 really fast for a lot of markets. 

 19 So, from my perspective, unless there is 

 20 something specific to the use of technology, it's 

 21 agnostic. You know, firms are using technology to 

 22 do things that humans used to do and they're just 
 56 

 1 using, you know, the efficiency and leverage that 

 2 they get out of it. They're not necessarily doing 

 3 anything particularly different. 

 4 And I just wanted to add one thing to 

 5 what Don and Joel said on the Reg. NMS thing. One 

 6 of the other things Reg. NMS assumed is that the 

 7 product was fungible. So, you know, if you buy a 

 8 stock on one exchange you can get out of it in 

 9 another, where that's not present in the futures 

 10 market and that's, you know, kind of a fundamental 

 11 aspect to the violating bids and offers and I just 

 12 raised it as to me it raised issues that weren't 

 13 -- that were broader than, you know, when you're 

 14 greeted on its face, it's like electronic markets 

 15 take care of that, we don't need to worry about 

 16 it. It raised these other issues that are much 

 17 more thorny. 

 18 MR. SHERROD: Thanks, Adam. Can we turn 

 19 to Gary and then we'll get back to you? 

 20 MR. DEWAAL: Hi, Gary DeWaal here from 

 21 Newedge. And I think it's helpful as I prepared 

 22 for this -- first of all, for those who don't know 
 57 

 1 Newedge, we're a global broker and one thing that 

 2 we may be a bit different is that we look at 

 3 things holistically. We look at asset classes, we 

 4 do business, we broker financial assets, we don't 

 5 care really whether they're future securities or 

 6 cows walking in on the street, and that sort of 

 7 may permeate some other comments I make throughout 

 8 the day. 

 9 When I thought about these comments I 

 10 also thought about my own background. My own 

 11 background was I actually started in this industry 

 12 on your side of the table, I started as a CFTC 

 13 enforcement attorney. Obviously now I'm a general 

 14 counsel of this big global broker and when I was 

 15 in law school I supported myself by being a 

 16 stringer for the New York Times, so I think of 

 17 these things in terms of headlines and the 

 18 headlines I have on this are -- and some of this 

 19 is repetitive, but the first headline is, what 

 20 does this mean, okay? This is an incredibly vague 

 21 provision and I think what's somewhat misleading 

 22 is to look at this provision -- the provisions 
 58 

 1 that we're here to address today -- in isolation. 

 2 Well, they're not in isolation. This is 

 3 Section of what is Section 4(C)(a) of the 

 4 Commodity Exchange Act, and I think that in 

 5 analyzing this section, you've got to compare it 

 6 with some other sections. Okay? And that's what 

 7 makes it, to me, so confusing because I'm an old 

 8 guy and certainly I've been around for a long time 

 9 and the basic prohibitions of 4(C)(a), which were 

 10 considered the trade practice offenses -- and I'm 

 11 looking particularly at 4(C)(a)(2)(b) has a very 

 12 standard provision which basically says it's 

 13 illegal to cause prices to be recorded -- 

 14 registered or recorded that are not true or bona 

 15 fide. Okay? And in fact if you look at a lot of 

 16 the enforcement cases over the years, you'll 

 17 notice that whenever they charge someone with a 

 18 wash sale, when they charge someone with an 

 19 accommodation trade, this or that, they always 

 20 say, and non bona fide. So, it was always this 

 21 offense coupled with something else. 

 22 Now, what's also interesting about -- if 
 59 

 1 you look at this 4(C)(a), it sort of has a really 

 2 interesting preamble. It talks about, it's 

 3 unlawful for any person to offer to enter into, 

 4 enter into, confirm the execution of a 

 5 transaction. So, it very clearly takes the whole 

 6 framework from orders, execution, et cetera, and 

 7 then of course it goes to the offense. 

 8 You compare that to the physical 

 9 structure of the provision that we're looking at 

 10 today, which is 4(C)(a)(5) -- very, very confusing 

 11 because there's no parallelism. You have a 

 12 provision, as I said, that's been around for a 

 13 long, long time, and now you're talking about it's 

 14 unlawful to engage in any trading, practice, or 

 15 conduct. Okay. Right off the bat I don't know 

 16 which -- you know, trading I think I have an idea 

 17 of, practice, maybe, conduct, how do those three 

 18 things differ from each other? How do they differ 

 19 from entering into, offering to enter into, or 

 20 confirm the execution of a transaction? Whether 

 21 I'm from the CFTC side trying to prosecute a case 

 22 or I'm from my side trying to defend a case, words 
 60 

 1 have to have meanings, and it's not clear, even 

 2 before I get to the substance, what we're talking 

 3 about because the distinction between the 

 4 historical language of 4(C) and this new language 

 5 is so dramatic that I don't know what it means. 

 6 So, that's my first issue. The second 

 7 problem is, even the construct of this 4(C)(a)(5) 

 8 by itself is remarkable. Now, you know, I can't 

 9 -- my firm doesn't let me trade futures, but if I 

 10 just went through the plain language and I was a 

 11 retail investor buying gold futures who was a bit 

 12 lucky and was seeing the price rise and I was 

 13 making money every day and I tried to protect 

 14 myself by trailing it with stop orders. Well, and 

 15 I was hoping that my stops would never get elected 

 16 because that would mean that I was making money 

 17 every day. Well, now I realize I've just violated 

 18 the Commodity Exchange Act, because it says, it's 

 19 a violation for any trading -- okay, so 

 20 theoretically, one stop-order is any trading -- if 

 21 my intent is to cancel the bid or offer before 

 22 execution. Well, I really want to cancel that 
 61 

 1 stop order because it means my price has risen 

 2 higher and I can cancel that order and put in 

 3 another trailing stop order. 

 4 So, you know, to me that's the first 

 5 headline. This is just way too vague. Now, 

 6 again, you know, how can you fix it? And I think 

 7 that's one of the goals you hear, what can we do 

 8 to make it better? Well, I think, again, intent, 

 9 absolutely. I mean, you can't have incidental, 

 10 you can't have accidental, I'm not even sure you 

 11 want to have negligent, I'm not even sure how 

 12 recklessness fits into this although obviously 

 13 it's part of (5)(b), but it seems to me you need 

 14 actually two components because what we're talking 

 15 about is, as far as I think what's going on, and 

 16 again, maybe I'm wrong, maybe who knows, the 

 17 intent is to cause a non bona fide price. We're 

 18 back to that theme of non bona fide price because, 

 19 you know, the intent -- that's what the markets 

 20 are all about. We're all concerned about the 

 21 integrity of prices, okay, so all these things are 

 22 bad because at the end of the day somehow prices 
 62 

 1 are affected, and the most common prices, you 

 2 know, trumpers (inaudible) can play is back in 

 3 4(C)(a)(2)(b), non bona fide price. Okay? So now 

 4 I'm asking, well, if that's the thing we're 

 5 striving to prohibit, why am I even here? Why did 

 6 I need this provision? It seems to be completely 

 7 redundant of something that's been around for a 

 8 very, very long time, you know, tried and true, 

 9 and we still don't understand it. I mean, we know 

 10 that the intent to cause a non bona fide price is 

 11 a bad thing and it's something that's actionable 

 12 and the CFTC's got lots of cases on that. 

 13 So, it seems to me, ironically, the way 

 14 you fix this new provision 4(C)(a)(5) is basically 

 15 by going back to the old provision and applying 

 16 the standards that are there making this new 

 17 provision entirely redundant and unclear, but 

 18 unfortunately that's "not the way" that lawyers 

 19 handle something, because obviously if something 

 20 is here it's got to mean something different 

 21 because that's always what they teach you in law 

 22 school. If the language is here, it's something 
 63 

 1 different, it's got to mean something else, and 

 2 I've got to tell you, I don't know what it means 

 3 because I keep going back to the fix, the fix is 

 4 already there and this is something uncommon. 

 5 So, now where would I go from here? 

 6 Well, I do think the best thing that I have heard 

 7 is what Adam suggested, you know, I think -- and I 

 8 think Joel just suggested it also -- technology 

 9 changes dramatically and it's not -- we haven't 

 10 seen the end of this. I mean, you know, I'm going 

 11 back to, you know, my first days when I was in the 

 12 Commission and I literally sat -- I went down to 

 13 the floor of the COMEX and stood outside the gold 

 14 trading rink to watch what was going on and I 

 15 think of where life is today, it's just remarkable 

 16 and the one thing we know about technology is that 

 17 the speed of change collapses. So, the magnitude 

 18 of change that occurred over 20 years or 30 years, 

 19 will now occur over the next generation, will 

 20 occur over 15 and then it'll keep on -- and we 

 21 have no idea where it's going to go. 

 22 So, I do think that, you know, the way 
 64 

 1 to deal with it -- you know, I think it was a 

 2 mistake in the statute, frankly, to talk about 

 3 spoofing because I really don't know what spoofing 

 4 is except getting some kind of, you know, internet 

 5 solicitation that probably is meant to take my 

 6 money, and I'm not sure of the definition of 

 7 spoofing can be agreed upon by the ten people 

 8 around this table. And by the way, my mother used 

 9 to always tell me that whenever you put quotes 

 10 around a word, it's because you really don't know 

 11 what it means, so don't do that in a paper -- she 

 12 was an English teacher -- don't do it in a paper. 

 13 So, I do think what Adam suggested and 

 14 Joel implied is a better way, which is I think 

 15 that here I think that the exchanges probably are 

 16 in the best position to say what kind of specific 

 17 conduct, now and again, they think is problematic. 

 18 Okay. So, if there's something specific that is 

 19 bothersome, fine, then deal with it in a guidance, 

 20 deal with it in something so that folks like Don, 

 21 before they go out into the trading -- before they 

 22 go out onto the screens, know what they can't do 
 65 

 1 specifically, and then you'll have the flexibility 

 2 of withdrawing it and changing it as conditions 

 3 change along the line. 

 4 I've always been struck, to a certain 

 5 extent, that the clearinghouses and the exchanges 

 6 get to live in a world of principles-based 

 7 regulation and the rest of us are all micro 

 8 managed to death, and here I think there really is 

 9 a benefit for a principles-based regulation. I 

 10 mean, we're stuck with this provision of statute 

 11 which frankly is bad law, you know, to me it was 

 12 not necessary, and frankly confuses the situation, 

 13 and to me the only way to get out of it at this 

 14 point now is in fact to -- you know, for the 

 15 exchanges who I think are closest to it -- and by 

 16 the way, I think that the problems that we're 

 17 going to have are different from exchange to 

 18 exchange. I don't think that the kind of 

 19 problematic trading that may exist on one exchange 

 20 is necessarily replicated on all the exchanges. 

 21 Some things may be unique. I mean, obviously LME 

 22 is not in the United States, but the kind of 
 66 

 1 circumstances that are unique to the LME may have 

 2 no applicability to other exchanges because of the 

 3 nature of the trading there. And obviously some 

 4 of the exchanges still have open outcry pits 

 5 versus electronic. Some exchanges have mini 

 6 versus maxi contracts, and as Don has said, we 

 7 also have situations where you've got contracts 

 8 now which are traded on multiple facilities but 

 9 are basically the same contract. 

 10 So, it seems to me that you've got to 

 11 sort of get the exchanges get much more 

 12 involvement here. I think that, you know, to the 

 13 extent that they've got specific concerns, let 

 14 them issue specific guidance as to things that are 

 15 problematic and should be avoided. That gives the 

 16 guidance. But I've got to tell you, if it was 

 17 considered a technical correction, I would work on 

 18 repealing this provision which I just absolutely 

 19 think is unnecessary in light of 4(C)(a)(2)(b). 

 20 MR. SHERROD: Moving on to Mark Fisher. 

 21 MR. HYLAND: Gary, tell us how you 

 22 really feel. 
 67 

 1 MR. DEWAAL: I'm a little bashful about 

 2 expressing my true views, but -- 

 3 MR. SHERROD: I was going to stick with 

 4 Gary for just a minute. This is Steve Sherrod 

 5 again. So, what I hear you saying -- I just want 

 6 to make sure I've got it right -- besides all the 

 7 other commentary about congressional intent, you 

 8 suggest that perhaps we should adopt a 

 9 principles-based approach so that we require the 

 10 exchanges to address the concepts in 4(C)(a)(5)? 

 11 MR. DEWAAL: Yes. I think, again, I 

 12 think that at the end of the day, you know, the 

 13 specific issues are better within the jurisdiction 

 14 of the exchanges. I'm just -- and, again, I think 

 15 I'm going to defer to the guys who trade 

 16 day-to-day, I'm just looking at this more broadly 

 17 -- but it just seems to me that there are nuances 

 18 on each exchange, that that could get fouled up 

 19 with some kind of broad based provisions. 

 20 MR. SHERROD: Okay, thanks. Now we'll 

 21 move on to Mark. 

 22 MR. FISHER: Hi, I'm Mark Fisher from 
 68 

 1 MBF and I'm very happy that Gary went before me 

 2 because if you think Gary speaks his mind -- I 

 3 know some of you know me, you have no idea. 

 4 I'm sure also that half the people in 

 5 this room, when I get done in the next ten 

 6 minutes, are going to want to choke me, but, you 

 7 know what, it is what it is. 

 8 By way of background, I am a clearing 

 9 firm. I'm also (inaudible) firm, I'm also an 

 10 index creator, I also used to be in the dinosaur 

 11 days, probably the largest local in New York, and 

 12 I'm also an academic, so I basically cover the 

 13 background and I think what really, if I 

 14 understand the question here, is the Commission is 

 15 looking for specific answers, specific things, and 

 16 I'm going to put through a lot of specific points 

 17 that I'm sure half of you are not going to agree 

 18 with, but I figured if I got done here with -- I 

 19 might as well just speak really how I feel, and 

 20 I'm sorry if I offend anybody. 

 21 First of all, everyone -- the electronic 

 22 revolution that's taken place, the technology I'll 
 69 

 1 talk about, is based on one word: Speed. Call it 

 2 what you want, everybody in this room who's 

 3 trading is basically a speed merchant and what we 

 4 basically have to do is say, what type of 

 5 technology is it that's going ahead and who's 

 6 faster than who? Colocations, the amount of money 

 7 being spent on colocations, the amount of speed, 

 8 how quickly you can (inaudible) and everything 

 9 else, versus the technology that goes in and lets 

 10 you play chess better. If you're going to be a 

 11 bad chess player, if you're, you know, Jim Simons 

 12 from Renaissance and you're using your technology 

 13 to trade based on how you play chess, great. But 

 14 this is all based on speed. 

 15 I think the reason why all this is 

 16 taking place is because there's a fear that 

 17 (inaudible) in the marketplace is evaporating. 

 18 May 6th, the flash crash, you know, took away a 

 19 lot of people from the market trading, they're not 

 20 going to be back. They got stopped out on crazy 

 21 prices, filled to ridiculous levels, and there's 

 22 an easy solution that no one's going to like. I 
 70 

 1 don't know if any of you have been to NASCAR, but 

 2 if you go ahead and you're on a wet track or 

 3 there's an accident, okay, just slow everybody 

 4 down, everybody, you know, until you go ahead and 

 5 markets are -- go back to some type of normalcy. 

 6 And in terms of closes, the easy thing to do, and 

 7 the suggestion that Joel (inaudible) is the right 

 8 one. You know, come to a single price, but use 

 9 the motto where basically everything is 

 10 transparent, every single day at 3:40 in the 

 11 afternoon, I believe, they post every single 

 12 market imbalance and every single stock, so it's 

 13 completely transparent. Make everything 

 14 transparent and then slow everything down. If 

 15 you're concerned about closes, slow the closes 

 16 down. Slow it so that -- and the exchanges all 

 17 have the mechanism, it's called throttling. They 

 18 could do it whenever they wanted to. I think the 

 19 CFTC has the authority if they wanted to also 

 20 mandate throttling and in terms of market duress, 

 21 in terms of periods of, you know, when you know 

 22 things are going to get crazy, slow everything 
 71 

 1 down. 

 2 In terms of the indexes, I still don't 

 3 understand why an index is rolled over five days, 

 4 John. Why isn't it rolled over in four days, why 

 5 isn't it rolled over in 15 days? Because the 

 6 longer period of time that you roll an index, the 

 7 less impact you'll -- the less impact those rolls 

 8 have over the marketplace and the less important 

 9 closes become. 

 10 Why is a close the basis for any index 

 11 anyway? Why has the close become such an 

 12 important price for an index? Why shouldn't it be 

 13 a view-of over a period of a day so that you don't 

 14 have to target the close? And I don't mean just 

 15 you, I mean every index. And some of this would 

 16 go away. 

 17 The fact that, you know, canceling any 

 18 order with the intent to cancel, well, I don't 

 19 know of anyone who (inaudible), puts in orders in 

 20 the pre-market between 5:45 and 6:00, but every 

 21 that's there is canceling every order because it's 

 22 all just a speed game, how quickly I can get my 
 72 

 1 spreads in, so everyone bombs the exchange, for 

 2 lack of a better word, I don't mean -- you know, 

 3 bombs the exchange with speed, how fast is 

 4 someone's colocation, to go ahead and be the first 

 5 one on the gold spread, to be the first one on the 

 6 t-bond spread, to be the first one in the TAS 

 7 market, right, with the intent that if they don't 

 8 get -- if they're not first, second, fifth, sixth 

 9 in the queue, they cancel those orders. They're 

 10 all canceled before the market opens at 6:00, but 

 11 in that preopening window, every order is done 

 12 with the intent to cancel. 

 13 In terms of credit, okay, of all these 

 14 orders that are going directly without any credit 

 15 checks, I mean, my big concern is that we're going 

 16 to have another May 6th and it's all based on 

 17 speed, it's all going to be based on the fact of a 

 18 lack of accountability of credit checks. I think 

 19 the SEC is starting to address the problem now 

 20 with -- you know, in terms of who can actually go 

 21 direct and who actually has to be slowed down. I 

 22 haven't seen anything about that in the commodity 
 73 

 1 world. In the futures world I've seen that, in 

 2 terms of trading the close. Well, if I'm a roll 

 3 participant and I'm going ahead and I'm, you know, 

 4 trading the roll of the GSCI index or an AIG index 

 5 or whatever it may be, it's all transparent. All 

 6 the rolls should be transparent, not just the USO 

 7 rolls, not -- it should be that every roll is 

 8 completely transparent so everyone's on a level 

 9 playing field, and if you are the creator of an 

 10 index of a roll, you should not be able to go 

 11 ahead and in-house that roll yourself, you should 

 12 have to go ahead and have that roll executed in a 

 13 marketplace so that you can't have Bank A go 

 14 ahead, create an index, and Bank A's prop desk go 

 15 ahead and in-house that roll. Inherently, that's 

 16 insanity because it's very simple to see what 

 17 takes place in the close now versus TAS, or what 

 18 takes place in the close now versus a large order, 

 19 but until the OTC markets are integrated, which 

 20 now you have jurisdiction over, which is going to 

 21 take a number of years, a lot of the stuff that 

 22 takes place in the closes is because of stuff 
 74 

 1 that's completely, you know, non transparent right 

 2 now, you know, based on an OTC market, based on 

 3 knock outs, based on knock ins, based on things 

 4 that, you know, are not even -- that no one can 

 5 see. 

 6 If you go ahead and look at -- if you 

 7 look at what's worked, the CME stop price 

 8 mechanism, which slows you down, works. What does 

 9 it do? Slows everybody down. Okay? I think 

 10 that, yes, I mean, I'm not a lawyer, I'm not a 

 11 regulator, okay, but I've actually been everything 

 12 else in this industry. I talk way too much, but 

 13 the point being is, I've been there. Okay? 

 14 Basically all that's really happened is, you know, 

 15 technology has taken the local from the floor and 

 16 put it to you guys upstairs, but you know what, if 

 17 we don't go ahead and police our own markets in 

 18 terms of speed and allow the confidence in the 

 19 markets to stay (inaudible), you know what, so 

 20 everything slows down for five minutes in the 

 21 close, so there's no edge in that five minutes to 

 22 (inaudible) against a T-bond. Big deal. Okay? 
 75 

 1 But you go ahead and have a lot more people be -- 

 2 you know, the confidence of the markets will be 

 3 there. 

 4 The ECN model place should be there for 

 5 OTC markets, basically, you know, like with the 

 6 NASDAQ-ARCA model, you can place everything -- 

 7 place them, you can see all the bids and offers 

 8 (inaudible) and ECNs, whether it be ICAP, this 

 9 one, that one, you could see all the markets on 

 10 one screen, and in fact, everyone should be able 

 11 to trade every market. It shouldn't be that a 

 12 market participant who qualifies as an ECP, or 

 13 whatever it may be, should have to go ahead and go 

 14 through hoops to be able to go ahead and trade on 

 15 a market. You know, as long as you qualify, you 

 16 should not have to go -- you should be able to 

 17 trade in those markets to make tight enough 

 18 markets. There are some markets you can't even 

 19 trade on unless you get permission from the 

 20 exchange itself even if you do qualify. 

 21 The VWAPing of closes and the VWAPing of 

 22 (inaudible) and of trading (inaudible) and what I 
 76 

 1 call the non transparent (inaudible) which take 

 2 place if you're an index provider -- index creator 

 3 as well as an index liquidity provider to your own 

 4 index, you know, if everybody -- if every index 

 5 was as transparent as John's index, the amount of 

 6 volatility would go away a lot. The fact that you 

 7 have all these proprietary people -- traders at 

 8 different houses that go ahead and be able to 

 9 in-house their own rolls against their own -- 

 10 against what their sales force sold, for me, 

 11 without the marketplace being able to see, is a 

 12 humongous problem. And I think that whether 

 13 you're right about every single thing -- you know, 

 14 the rules are wrong or the rules shouldn't be 

 15 wrong or the rules are right but now they're wrong 

 16 -- I'm not really sure -- or all the rules are 

 17 wrong -- I'm not really sure what the question is. 

 18 The point being, you know, specific suggestions -- 

 19 if we're all down here, instead of just going 

 20 ahead and saying, yes, we all agree that 

 21 Dodd-Frank -- let's roll up our sleeves and give 

 22 the Commission specific suggestions to help them 
 77 

 1 make rules that are going to make sense. Intense, 

 2 very important, right? Obviously, right? But I 

 3 think that if we're here, let's have one committee 

 4 that actually says specific things, and if we get 

 5 ourselves into trouble we have lawyers to go ahead 

 6 and say, well, he really didn't mean it. You 

 7 know? Let's do that as opposed to just, you know, 

 8 just talking pie in the sky stuff. 

 9 MR. SHERROD: Hey, Mark. You're going 

 10 to have another shot, but I want to get around at 

 11 least once and let John have one shot before we 

 12 take a break and then we'll start back this way. 

 13 Thanks. 

 14 MR. LOTHIAN: Sure, I'm John Lothian. 

 15 I'm a futures broker, commodity trading advisor, 

 16 new media entrepreneur. I've been a prop trader, 

 17 I've done a lot of different things within the 

 18 markets and am a keen observer of all the markets. 

 19 You know, first off, futures markets are 

 20 about two things, they're about price discovery 

 21 and risk transfer, okay? The price discovery 

 22 process is an auction process. The futures 
 78 

 1 markets is different from the securities market in 

 2 that it's more of a request for quote type of 

 3 market. 

 4 I equate a lot of all of this to where 

 5 we came from in terms of open outcry markets, 

 6 okay, so for example, if I offer something in an 

 7 open outcry market, as soon as I drop my hands, 

 8 I'm off, the offer is no longer good, okay, and 

 9 quite frankly, I can't keep my hands up all day, 

 10 okay, even if I had an offer that was good for all 

 11 day long, okay, and was the market. So, there's 

 12 always going to be, you know, sell six at eight, 

 13 I'm off, okay, type of thing. So, what I'm trying 

 14 to do is I'm trying to discover where the price is 

 15 so 100 at 8, okay, well, quite frankly size 

 16 matters when somebody wants to come into the 

 17 market and they're going to pay more attention to 

 18 that size. 

 19 A lot of the orders and canceling and 

 20 stuff that we get as part of that price discovery 

 21 process is part of the noise in the market in 

 22 discovering where people are going to trade, and 
 79 

 1 quite frankly, there are practices that happen in 

 2 open outcry in terms of, you know, here's a noisy 

 3 pit, so guys are going to come, run over to that 

 4 pit to trade because they were attracted by that 

 5 noise. If you see trades in the electronic market 

 6 and size in the electronic market that's really 

 7 noise within the market, guess what, you're going 

 8 to run over there and you might trade or you might 

 9 be caused to trade because you see a particular 

 10 type of behavior or action. 

 11 All those things happen in open outcry, 

 12 they still happen in markets and it's perfectly 

 13 legal and acceptable. 

 14 John, all trading is algorithmic, okay, 

 15 whether you know it or not, okay. If you hand an 

 16 order to a broker and the broker's got 100 to buy 

 17 and he goes into a trading pit, he's going to go, 

 18 you know, two bid for 50, okay? He has 

 19 algorithmically decided to not impact the market 

 20 by splitting the order in half, and two guys are 

 21 going to go, sold, and he's going to go 50-50, 

 22 okay, and that was an algorithmic trade that the 
 80 

 1 broker executed on your behalf, okay? Electronic 

 2 algorithms do the same type of a thing. They are 

 3 hiding from the market volume so as opposed to 

 4 trying to influence the price by showing excessive 

 5 size, they're trying to influence the price by 

 6 showing minimal size. Okay? How is that any 

 7 different? 

 8 In terms of intent, short of water 

 9 boarding the developers of the systems, I'm not 

 10 sure how you get an answer as to what the intent 

 11 is. 

 12 MR. SHERROD: We can do that. 

 13 MR. LOTHIAN: Yeah, in terms of closing 

 14 ranges, you know, that is some of the most chaotic 

 15 trading in an open outcry environment that you 

 16 will see, okay? Short of prearranged trading, 

 17 short of something to make it more orderly, it's 

 18 going to be always chaotic in terms of the noise 

 19 coming out of the trading pit, the pitch -- the 

 20 open and the close are going to be the two most 

 21 disorderly times in terms of the amount of noise 

 22 coming out. There are some tools that are used, 
 81 

 1 as were pointed out, the TAS, or the trade at 

 2 settlement, where the settlement type of process 

 3 is important. That is a technique that can be 

 4 offered by exchanges in order to mitigate some of 

 5 the volatility on the close, and that in and of 

 6 itself is something that's traded during the day 

 7 where you can trade plus the settlement or minus 

 8 the settlement and take care of that, and that can 

 9 alleviate some of that, but it also takes away 

 10 from some of the, perhaps, natural price discovery 

 11 process. It's also a deterrent for continuation 

 12 of open outcry because a lot of the trade in some 

 13 of the open outcry pits that still exists, 

 14 revolves around the roll and revolves around those 

 15 closing prices during the roll and all of that, so 

 16 if you make it more electronic, you are going to 

 17 hurt those legacy markets. 

 18 You know, the recurring theme in terms 

 19 of spoofing that I hear is equating to the Potter 

 20 Stewart quote about pornography, and that is, I 

 21 don't know how to define it, but I know it when I 

 22 see it. I went on the internet last night, I 
 82 

 1 said, okay, what's spoofing, I looked it up. Now, 

 2 without being self-serving here, it shows up on 

 3 Wikipedia, you know, for a spoofing attack, 

 4 there's a list for spoof of 9 or 10 different 

 5 types of things on Wikipedia but none of them have 

 6 to do with trading, okay, so there's no definition 

 7 there. There is a definition on a page within 

 8 MarketsWiki which is in quotes, which means that 

 9 it's a little undefined and it's only got one 

 10 source of one story, okay, so it's a very 

 11 undefined type of a term within the industry. You 

 12 know, do guys in open outcry bid or offer more 

 13 than they are really willing to trade? Yes. Can 

 14 people hit them? Yes, if they get them before 

 15 their hands come down. 

 16 MR. SHERROD: That's probably a perfect 

 17 segue to a break if we could start back with you 

 18 at 11:15, and we'll start talking about spoofing. 

 19 That work? 

 20 MR. LOTHIAN: Sounds great. 

 21 MR. SHERROD: Thanks, so we'll start 

 22 back at 11:15, about 15 minutes. 
 83 

 1 MR. PEASE: For those who are here, 

 2 please make sure that you've signed in. We want 

 3 to keep a record of everybody who has attended 

 4 this roundtable today and there are sign-up sheets 

 5 out in the front. And we would like to get 

 6 started with the second half of our morning panel. 

 7 MR. SHERROD: I want to very quickly 

 8 thank everyone again, this is Steve Sherrod, and 

 9 give Cameron, kind of last shot at our first block 

 10 of questions because I skipped you earlier, and 

 11 then we're going to move on to other blocks. 

 12 MR. SMITH: Thanks. Yeah, I just wanted 

 13 to respond to a couple of the things that I had 

 14 heard coming around from the other side of the 

 15 table there. One was that a couple of the 

 16 gentlemen had mentioned that intent is difficult 

 17 to prove and therefore maybe we should dispense 

 18 with that requirement. I think it's absolutely 

 19 critical to have something in this rule that says 

 20 something to the effect of, you know, entering 

 21 quotes, or what have you, for the purpose of 

 22 creating a false appearance or to deceive or to 
 84 

 1 manipulate, and without that I think it's going to 

 2 lead to, again, as I talked about earlier, 

 3 uncertainty and actually, I think, reducing order 

 4 flow from the natural buyers and sellers. I don't 

 5 think it so much affects the automated traders. 

 6 So, that's one very important point. 

 7 The other point had to do with slowing down the 

 8 market, which I don't know how directly related 

 9 that is to the actual proposal, but, you know, to 

 10 the extent we have a concern of excessive use of 

 11 capacity, Joel mentioned 84,000 orders he saw, or 

 12 something, over some relatively short time period. 

 13 To me that's not a regulatory issue directly where 

 14 somebody needs to bring an action because they've 

 15 decided that that's too many orders. Again, I 

 16 think those have to be limited to instances where 

 17 they're doing it for the purpose of, that, again, 

 18 you need intent. And finally, I don't think it 

 19 should matter if it's difficult to prove intent. 

 20 Either you have a case and you can prove 

 21 somebody's doing it for a certain reason, or you 

 22 don't, and, you know, you can dispense with intent 
 85 

 1 and that would probably increase your conviction 

 2 rate, but I don't know that that's a healthy thing 

 3 to have a high conviction rate. I know I used to 

 4 live in Romania and they had a -- people told me 

 5 they had a very high confession rate there, but I 

 6 don't know if that is something that we want to 

 7 emulate. 

 8 But on the speed of the market, we know 

 9 by definition that slowing the market down has a 

 10 cost, right, because it makes the market less 

 11 efficient. Is it a huge cost? It's hard to say, 

 12 but we know it's greater than zero, and I would 

 13 just submit on that, what's the problem we're 

 14 trying to solve? What is the benefit? Are our 

 15 markets really as unhealthy as some people are 

 16 claiming? Every time I see studies, even Joel 

 17 recently did one, I'm not seeing anything that 

 18 leads me to believe that the markets have never 

 19 been more efficient, more healthy, and more 

 20 liquid, so to the extent we're trying to solve a 

 21 problem, I'm not sure what it is. There's just 

 22 some vague notion of investor confidence because 
 86 

 1 there's mutual fund outflows. 

 2 I was just at a conference the other 

 3 day, Dan Matheson from CFSB gave a great 

 4 presentation where he showed that in a historical 

 5 context mutual fund outflows are a blip, that 

 6 there are several other years going back to 2000 

 7 where there's much greater out flow, and that 

 8 actually a lot of what's going on is that people 

 9 are flowing into ETFs and out of mutual funds, so 

 10 there's this competition there. And that's being 

 11 missed. 

 12 So, I don't want to even accept this 

 13 premise that we have to restore investor 

 14 confidence by intentionally adding trading costs 

 15 to the market. I think that's just the wrong 

 16 direction to go in. Again, I don't know how 

 17 related that is, but I don't like to leave those 

 18 comments floating out there lest they gain some 

 19 legitimacy. Thank you. 

 20 MR. FISHER: Can I respond to that, 

 21 because obviously -- right? I mean -- 

 22 SPEAKER: Can I control you? 
 87 

 1 MR. FISHER: You could try. 

 2 MR. SMITH: Your comments on indexes 

 3 were pretty good, though. 

 4 MR. FISHER: Real quick. Okay? Looking 

 5 at the flash crash, right, the CME stop market 

 6 functionality actually helped that day, right? 

 7 What's the functionality of that stop logic? What 

 8 did they actually do? What did the market do? 

 9 They slowed the market down. No, no, real quick, 

 10 those are rhetorical questions. In fact, at the 

 11 CME conference a couple weeks ago, Naples, 

 12 Florida, Paul Jones put on a presentation that 

 13 said that the only reason -- one of the reasons 

 14 why the market came back after the crash is 

 15 because eventually CME shut the market all 

 16 together for a period of time. Is there a cost? 

 17 Sure there's a cost. But the market came back 

 18 from only because they shut the market. Okay? 

 19 And they stopped the market completely from 

 20 trading. 

 21 And so I would say to you, as much of an 

 22 algorithmic trader you are, I'm sure I'm nowhere 
 88 

 1 near in the league as you are, I'm just saying 

 2 investor confidence is the reason why all these 

 3 rules of Dodd-Frank have been passed, because if 

 4 investor confidence was higher, half the rules 

 5 that Gary was talking about wouldn't even have 

 6 gotten through. So, again, I think it's kind of 

 7 shortsighted just to say, protect speed, protect 

 8 speed. I think everything's on the table. That's 

 9 it. 

 10 MR. NUNES: Well, just to respond to 

 11 that quickly, and hopefully mediate a little bit. 

 12 I think it's the case that there's a difference 

 13 between having safeguards in place to make the 

 14 market more resilient, which is things like limit 

 15 up, limit down, stop spike logic, that I'm 

 16 guessing, by and large, automated traders agree 

 17 with and endorse, and frankly to the extent that 

 18 they work and are effective, they'll make the 

 19 market better because they -- you know, without 

 20 them, we're adding risk to the market it doesn't 

 21 need and reducing that risk will be good overall, 

 22 versus just the general notion of, slow everything 
 89 

 1 down, and I think to that point, you know, 

 2 Cameron's right, that unless there's some intent 

 3 or belief that that's going to improve price 

 4 discovery, trading costs and just overall market 

 5 quality, there's no reason to do that. So, I 

 6 think having the resiliency absolutely, and things 

 7 like limit up, limit down, and stop spike, make a 

 8 lot of sense, and we support them, but it's more 

 9 just a matter of kind of the blanket notion of, 

 10 it's too fast, slow it down, and that's where -- 

 11 like, why would we make the market worse if we 

 12 don't have to? 

 13 MR. SHERROD: And I'm going to get -- 

 14 I'm going to suggest a slightly different format 

 15 for our next hour or so. We're going to try to 

 16 cover a number of blocks of questions and we're 

 17 going to skip a few because the next question, 

 18 seven, will be dealt with by the second panel, so 

 19 the next topic I'd suggest is to discuss any input 

 20 you want to give us on spoofing, which are in 

 21 questions eight through 11, and if you want to 

 22 give your input just put your name card on end and 
 90 

 1 we'll get to you, and otherwise you can respond as 

 2 the people that have specific input, because we 

 3 have about three or four blocks of questions, and 

 4 if my math is correct, at the rate we're going, 

 5 we're not going to make it. 

 6 So, we do want to get a chance to get 

 7 specific input, if you have it, on spoofing. 

 8 MR. NUNES: So, I think I can be 

 9 reasonably quick on this. Adam Nunes from Hudson 

 10 River Trading. 

 11 So, I'm going to just focus in on 

 12 question nine and hit a few points there. So, 9A 

 13 deals with submitting and canceling bids or offers 

 14 to overload quotation systems. I know that 

 15 spoofing is in quotes and it's not well defined, 

 16 but I don't think that's what it is. That's some 

 17 different thing that, you know, doesn't seem like 

 18 a good practice and seems like it should be 

 19 prohibited if somebody's doing, you know, trying 

 20 to overload systems and somehow benefit from that. 

 21 But I don't know that it fits the character of 

 22 what we're describing as spoofing. 
 91 

 1 MR. SHERROD: Should we call it 

 2 something else, like denial of service? 

 3 MR. LOTHIAN: Quote stuffing. 

 4 MR. SHERROD: Quote stuffing? 

 5 MR. NUNES: Sure. From my perspective, 

 6 it's unclear to me how that can be effective. If 

 7 you overload a system it's unclear to me how you 

 8 can benefit from overloading the system, but if 

 9 someone's figured that out, we should find some 

 10 way to make that not happen. 

 11 MR. HIGGINS: Adam, if I could follow up 

 12 -- this is Mark Higgins. If you don't agree that 

 13 that is the definition of spoofing, what in your 

 14 view would be spoofing -- 

 15 MR. NUNES: Right, so -- 

 16 MR. HIGGINS: -- and are there other 

 17 specifically named practices in the trade that 

 18 you're aware of that you think should be 

 19 specifically enumerated? 

 20 MR. NUNES: Yeah, I think when you get 

 21 to B and C, and frankly, from my perspective, 

 22 spoofing is just a subset of a broader thing, and 
 92 

 1 if you look at this in the context of the rules 

 2 that it tends to be a part of, it tends to be a 

 3 part of rules that are much more broad and have to 

 4 do with, you know, sending out false crop reports, 

 5 right? So, it's basically just manipulating the 

 6 market in general and spoofing is, you know, kind 

 7 of one aspect of that but, you know, it's one very 

 8 narrow aspect of that, but it should be looked at 

 9 in the context of that, right. Price discovery on 

 10 exchanges is about incorporating information and 

 11 some of that information is going to be macro, 

 12 some of it's going to be things like crop reports 

 13 that are going to be specific, but some is going 

 14 to be supply and demand, so spoofing, you know, 

 15 tends to be specific to that portion, but it's 

 16 part of a bigger thing. 

 17 When you get into submitting and 

 18 canceling multiple bids or offers, in order to, 

 19 you know -- or for the purpose of what it says 

 20 here, causing a material price movement, I don't 

 21 know why materiality needs to be in there. If 

 22 you're manipulating the price by one or two ticks, 
 93 

 1 I don't know why that's okay, if it's not okay to 

 2 do it by six or seven ticks. So, I would just 

 3 argue, if you're entering bids or offers, if 

 4 you're executing at successively higher prices for 

 5 the purpose of, you know, manipulating others and 

 6 creating a false appearance in the market, it 

 7 shouldn't matter by how much you do that. You 

 8 know, I think Don spoke well about, you know, when 

 9 people are executing, they're trying to minimize 

 10 their price impact, you know. If you're executing 

 11 in order to maximize your price impact, then 

 12 there's likely some reason you're doing that, so I 

 13 think when you get to that, I don't know why 

 14 materiality matters, orders matter, executions 

 15 matter. It's really a matter of, you know, if 

 16 every time you bid for 1,000 contracts, why do you 

 17 end up selling five and not executing the 1,000? 

 18 So then, you know, clearly on C, which 

 19 is submitting and cancelling multiple bids or 

 20 offers to create an appearance of depth -- yes. I 

 21 think that makes sense to be a part of it and I 

 22 noted, you know, earlier, and Gary talked about 
 94 

 1 non bona fide prices, this all fits into that, 

 2 it's just describing that in a way that's -- you 

 3 know, provides more clarity. 

 4 So, I think that's one part. The other 

 5 part that I wanted to talk about is, you know, 

 6 question 10, which gets to, what if you get a 

 7 partial fill. Well, from my perspective, a 

 8 partial fill does not eliminate the activity, it's 

 9 really a pattern and practice of activity and, you 

 10 know, we kind of live in a trading environment 

 11 that's probabilistic, so if something works, you 

 12 know, a high proportion of the time where you're 

 13 able to manipulate the market and make money, 

 14 you're going to factor in, sometimes somebody's 

 15 going to hit my bid and I'm not going to make 

 16 money on that trade, but by and large, if you look 

 17 at the activity they're engaging in, the pattern 

 18 of activity would likely be profitable or they'd 

 19 stop, but, you know, saying, well look, it's a 

 20 firm bid, somebody could trade with it, and the 

 21 fact that somebody happens to, a small proportion 

 22 of the time, doesn't in my mind exempt that 
 95 

 1 activity. 

 2 MR. PEASE: Would it fall under the 

 3 definition -- this is Bob Pease -- Adam, of 

 4 spoofing, or does it get another label when you 

 5 have a partial fill? 

 6 MR. NUNES: Oh, I think it's -- it's the 

 7 same label, right, and, sorry but it does go to 

 8 the intent of that order. If you enter, you know, 

 9 a five contract sell with the inside market or 

 10 trade (inaudible) inside, then enter several 500 

 11 lots on the bid side with the intent of, you know, 

 12 manipulating someone to lift your offer because 

 13 you've given them the appearance that there's more 

 14 demand than there is, and, you know, after your 

 15 offer is filled, whatever happens, you wipe out 

 16 all those bids because you have obtained your 

 17 objective, it doesn't mean someone can't trade 

 18 with part or all of your bid, you're just looking 

 19 at, what's the probability they do that versus the 

 20 probability that they lift my offer. 

 21 So, from my perspective, when you see 

 22 that type of activity, they don't know what the 
 96 

 1 outcome is but they probably have a good idea of 

 2 the probabilities of the outcome, so they don't 

 3 control whether or not someone hits their bid or 

 4 not, they control the activity they engage in, so 

 5 from my perspective you can look at the pattern of 

 6 outcomes and you should be able to distinguish 

 7 that from legitimate activity and, you know, 

 8 typically if you see them do that where they enter 

 9 that on the bid side a few seconds later, maybe 

 10 they're entering it on the -- they're entering a 

 11 five lot on the bid and hundreds of contracts on 

 12 the offer to, you know, unwind the trade. 

 13 So, from my perspective, the outcome -- 

 14 I guess, the pattern of activity that they engage 

 15 in is what matters. They can't control who lifts 

 16 their offer, who hits their bid. So, I think 

 17 that's one aspect. 

 18 The other thing that I just want to 

 19 address is, there seems to be a notion that 

 20 somehow spoofing and the life of orders or the 

 21 speed with which they're entered and canceled, are 

 22 kind of tightly connected and I don't think that 
 97 

 1 that's necessarily the case. You could have those 

 2 orders sit out on the market for several seconds. 

 3 If they, you know, if they determine that the 

 4 product's not very volatile and there's an 

 5 extremely low likelihood of them being traded 

 6 with, it's not the case that, you know, they're 

 7 just entered and canceled, entered and canceled. 

 8 That's probably a less effective way to get 

 9 somebody to engage in the activity you're trying 

 10 to get them to engage in. 

 11 MR. SHERROD: I'm going to turn to Gary 

 12 and then Mark. 

 13 MR. DEWAAL: Yeah, I mean, I think that 

 14 intellectually we sit here and say, well, what is 

 15 spoofing. We all sort of think of it, well, it's 

 16 the bad placing of orders and pulling them back 

 17 real quickly, but I'm not sure where that gets you 

 18 as enforcement folks, I don't know where it gets 

 19 us as the industry, again, and I think Adam's 

 20 correct, I think that there's two things that have 

 21 to be done because, as I said before, this is a 

 22 bad statute. 
 98 

 1 I mean, I think clearly all these 

 2 offenses -- it's not just the issue of spoofing, I 

 3 think there does have to be an intent, there does 

 4 have to be a causation, and there has to be the 

 5 intent to cause either an artificial or a non bona 

 6 fide price. I think then what is also necessary 

 7 is to clearly define what's not within this 

 8 universe because the problem is, it's out there 

 9 right now, and again, it's got to mean something 

 10 because otherwise Congress wouldn't have written 

 11 it. I think it's very important that it be 

 12 defined to say that it's not meant to be 

 13 accidents, it's not meant to be negligence, it's 

 14 not meant to prohibit block trades, it's not meant 

 15 to require best execution, it's not meant to 

 16 prevent legitimate strategies to facilitate the 

 17 execution of bona fide orders, and it's not meant 

 18 to prevent price volatility or rises or falls in 

 19 prices, and I think that one of the problems that 

 20 you guys have that all agencies have, is that 

 21 you're reactive to things that happen in the 

 22 public sphere and obviously the politicians want 
 99 

 1 to respond to it and you get stuck with it, but I 

 2 think it's very, very important because of this 

 3 provision -- and I'm going to assume it's not 

 4 going to be repealed anytime soon -- that those 

 5 two elements are included -- what all these 

 6 elements must have, the intent, the causation, 

 7 artificial and non bona fide price, and what it's 

 8 not meant to prohibit. 

 9 MR. HIGGINS: Just a quick follow-up, 

 10 Gary, though by your formulation, it ceases to 

 11 become a disruptive trading practice. It starts 

 12 to look a lot more like a manipulation and that 

 13 may be a theme that I've heard, you know, quite a 

 14 bit this morning, but it seems to me that if 

 15 Congress put a manipulation prohibition and other 

 16 bad acts separate from disruptive trading 

 17 practices, and so, you're right, assuming that 

 18 Congress means what it says and does things 

 19 deliberately, this should mean something other 

 20 than what you've just formulated. 

 21 MR. DEWAAL: Sure, but then I'm going to 

 22 Joel, and since I see he wants to speak next, I've 
 100 

 1 never understood the difference between a price 

 2 that comes about -- the problem with the price 

 3 that comes about as a result of manipulation, 

 4 which is 6(c), and a non bona fide price under 

 5 4(c). Okay? I mean, again, that goes back to the 

 6 Commodity Exchange Act when it was first adopted. 

 7 It's out there, so there's clearly a problem, but 

 8 I think that we always speak in terms of an 

 9 artificial price and somehow an artificial price 

 10 is either the non bona fide price or a price comes 

 11 out as a result of manipulation. 

 12 MR. HIGGINS: My comment was actually 

 13 more of a question although it didn't probably 

 14 have a question mark at the end, and that is, 

 15 where does the line get drawn for you and for 

 16 others, perhaps, between disruptive trading 

 17 practices, which we had -- and manipulation? 

 18 MR. DEWAAL: I mean, I think -- again, I 

 19 think that in the end the answer is, there's not a 

 20 big fundamental difference because in the end, 

 21 both are meant to affect the price and the price 

 22 that results is an artificial price. I mean, 
 101 

 1 let's -- again, as I think John said very, very 

 2 eloquently, this is an auction market. Okay? The 

 3 only thing we care about at the end of the day is 

 4 the price, and there are the prices that come 

 5 about because of normal forces of supply and 

 6 demand, and then there's something else, and 

 7 again, you know, I wasn't around as far back as 

 8 the original adoption of the Commodity Exchange 

 9 Act, but, you know, there are different routes to 

 10 that artificial price, there's the route through 

 11 trade practice violations, the wash sales, the 

 12 accommodation trades, in the old days, you know, 

 13 the illegitimate cross trades, things like that, 

 14 and there's a route through manipulation. The 

 15 courts have, you know, come up with different 

 16 tests for the different elements, okay, so we know 

 17 that there are different characteristics, but in 

 18 the end we're speaking about a price that does not 

 19 come about through the normal forces of supply and 

 20 demand. 

 21 MR. SHERROD: Mark? 

 22 MR. FISHER: Real quick, I think one of 
 102 

 1 the things that should definitely be distinct from 

 2 spoofing is because what I described before about 

 3 the pre-market order flow, you know, whether 

 4 you're putting in spreads, whether you're putting 

 5 in TAS, whatever type of orders you're putting in, 

 6 limit orders, I would say that if you look at -- I 

 7 listen to the energy markets, 99 percent of those 

 8 orders are canceled, more than 99 percent are 

 9 canceled before the market even opens, so I think 

 10 that all those pre market orders, which would be 

 11 completely exempt from any type of spoofing 

 12 whatsoever. 

 13 The second thing I think that the 

 14 Commission should be aware of is, and it happens 

 15 more in the less liquid times of markets -- 

 16 overnight, 6:00 and on, you know, 4:00 to 5:00 in 

 17 the afternoon, is what I would call, you know -- 

 18 which is a kind of spoofing but not really, I 

 19 think, the way it's put out here, is there are 

 20 orders that are put out there, small orders, two 

 21 to sell, three to sell at a price, and what these 

 22 orderers have then done is, if a quantity is tried 
 103 

 1 to buy of say 50 or 100 or 200 or 500, these 

 2 orderers sniff out that there's a large order and 

 3 immediately they'll go ahead even though they sold 

 4 two, they'll take a loss and buy 20 at a higher 

 5 price thinking, okay, algorithmically that these 

 6 orders, they're basically racing these orders. 

 7 This doesn't typically happen as much during 

 8 highly liquid times, but this happens especially, 

 9 you know, from 6:00 at night to 2:00 -- until 

 10 London opens, there's a tremendous amount of 

 11 orders that are being put in, I'll sell two at 

 12 this price, if I can fill -- and I see the order 

 13 that's trying to buy it from me is a 50 lot order 

 14 that's unfilled, I'm immediately going out and 

 15 buying 20 lots and racing that order, hoping that 

 16 order is then going to come (inaudible). I don't 

 17 know if that's spoofing or not, but that's 

 18 probably, you know, some type of spoofing, 

 19 fishing, whatever you want to call it -- fishing 

 20 (inaudible), but some kind of a word along those 

 21 lines. 

 22 MR. SHERROD: Sniffing works for me. 
 104 

 1 Joel? 

 2 MR. HASBROUCK: Thank you. I was going 

 3 to say that spoofing was any practice with an 

 4 intent to deceive, but then I thought about the 

 5 last time I tried to buy a new car and I concluded 

 6 that both me and the dealer could have been 

 7 arrested. 

 8 Instead, let me just -- the first time 

 9 I've encountered the term spoofing was perhaps 

 10 about five years ago in connection with a case I'm 

 11 briefly going to describe the elements of and 

 12 because I think it generalizes. 

 13 In the equities market there is a 

 14 practice of retail brokers who will agree to 

 15 execute customer trades at the national best bid 

 16 or offer, so the trader in question was putting in 

 17 a limit order to change, when he really wanted to 

 18 sell, he put in a limit order to buy. He raised 

 19 the national best bid and then sent his order to 

 20 his broker forcing his broker to buy at the higher 

 21 price. 

 22 And when I think about the manipulation 
 105 

 1 cases -- and I don't think there's a big 

 2 difference -- they often involve a price that's 

 3 being used as a reference price for some other 

 4 transaction, for example, if you have a trade at 

 5 settlement and it's a large volume and you're 

 6 going to be buying, then I would perhaps want to 

 7 consider spoofing any activity that would try and 

 8 depress the settlement price because I'd be 

 9 putting in orders that would be against my 

 10 ostensible economic interest. 

 11 But beyond that I think it's difficult 

 12 to really pin this down, so I'd leave it there. 

 13 MR. FERNANDO: Raj Fernando, Chopper. I 

 14 think it's important to note that exchanges do 

 15 regulate all of these practices and it would 

 16 probably be important for the CFTC to work with 

 17 these exchanges but one of the functions of the 

 18 local, who is the ex-pit guy who's now gone 

 19 upstairs on the computer screen, is price 

 20 discovery and if somebody is showing a bid for 

 21 1,000, he might be flat, he might be showing a bid 

 22 for 1,000, or say he's long and he's hoping he can 
 106 

 1 sell the offer -- by showing the bid for 1,000 the 

 2 guy on the computer screen right next to him might 

 3 say, this guy's playing games, I'm going to hit 

 4 his bid and make him sell to me a tick lower, and 

 5 these are normal practices in the marketplace by 

 6 locals that are there to provide liquidity and 

 7 this is common market activity and I think it's 

 8 important to not box in with these specific rules 

 9 and more, work closely with the exchanges and see 

 10 what is and what is not manipulation and with 

 11 intent or reckless intent to harm these markets. 

 12 MR. SHERROD: John? 

 13 MR. LOTHIAN: I'm going to disagree with 

 14 Adam and agree a little bit with Raj there because 

 15 if I'm putting 500 lots into the market, those are 

 16 actionable orders, okay, and there are some 

 17 traders that are attracted by not only price, but 

 18 also size. So, if there are, you know, on steps 

 19 down -- on five steps down there's 500 lots, I 

 20 might go, you know what, I've got 2,500 to sell. 

 21 If I come into the market I know it's going to 

 22 move the market five ticks anyway because of the 
 107 

 1 way that they sniff out big orders, I'm just going 

 2 to go ahead and take it for an average of three 

 3 ticks worse. 

 4 As a trader, I might not even care what 

 5 is on either side other than just making sure that 

 6 there's adequate size to be able to handle my 

 7 order without it, you know, influencing it as 

 8 much. So, if it's an actionable order, it's an 

 9 actionable order, it's part of the price discovery 

 10 process, even if it's part of somebody's strategy 

 11 or game or whatever, it's a bona fide order within 

 12 the market. 

 13 There are some practices that I have 

 14 seen that I would describe as spoofing that are 

 15 similar to the one that Joel described in terms of 

 16 the stock example, okay, so we have price bands 

 17 within futures, you can't execute an order outside 

 18 of a price band of the last trade, okay, and so 

 19 let's say you have a gold order, the price band's 

 20 $10, there's a gold order in an off month, it's 

 21 off $10 -- it's off $15, okay? I go and I buy 

 22 that market $15 higher. I know that that order's 
 108 

 1 going to be busted because I'm going to call the 

 2 exchange and I'm going to say, hey, that order was 

 3 outside the $10 price band, okay, and so -- but 

 4 immediately after I did that order I go ahead and 

 5 I bid within the price band, you know, so here's 

 6 this guy who thinks he sold it at $15 and, you 

 7 know, and now he comes in and he's bidding for it 

 8 $5 lower or something like that, you know, because 

 9 he's trading, and I hit that. So now I've sold 

 10 something $10 higher and really the trade above is 

 11 going to be busted, and so now he's paid $10 

 12 higher. 

 13 So, gaming the system like that using 

 14 the rules and some of those bands, those types of 

 15 things I would qualify as spoofing. 

 16 MR. SHERROD: So, let me see if I can 

 17 repeat very quickly. So, a trader would enter an 

 18 order within the price band but outside the 

 19 no-bust range and then ask to have it busted -- 

 20 MR. LOTHIAN: Right. 

 21 MR. SHERROD: -- and then trade in the 

 22 other direction? 
 109 

 1 MR. LOTHIAN: Right. Right. 

 2 MR. SHERROD: Okay, got it. Cameron? 

 3 MR. SMITH: I just wanted to make a 

 4 couple quick observations. One, I think some of 

 5 the difficulty here when we discuss spoofing is it 

 6 is such a narrowly defined practice and I was just 

 7 going to suggest another bit of terminology. I 

 8 think just gaming is probably a better word 

 9 because it's more inclusive, so I don't know if 

 10 you could get Congress to change it, because it's 

 11 so narrow that you really do want to capture 

 12 executions and quote activity and a combination 

 13 thereof, and then folding that in with, of course, 

 14 intent and done for some purpose to mislead. 

 15 So, that's one observation. It's just, 

 16 I think that term is just very narrow and, I 

 17 think, unnecessarily restricts you and your 

 18 enforcement abilities. 

 19 The other one is just, to kind of point 

 20 out again, I guess to not be constructive in that 

 21 sense, that this is difficult. I started out in 

 22 the equity markets and one of the axiomatic things 
 110 

 1 that I always heard about when you were trading 

 2 equities is that -- and just to pick on Goldman 

 3 because I guess that's okay these days -- but they 

 4 go high bid, right, and then you would see a flood 

 5 of orders over SelectNet, Goldman selling, and you 

 6 could see it was Goldman, and that was, you know, 

 7 basically how you traded, and so when you think 

 8 about these common trading practices, at least 

 9 common in the equities markets back in early 2000, 

 10 you know, I don't know if there's a good analogue 

 11 here in the futures markets, I think, again, as I 

 12 said before, I think to some extent institutions 

 13 are going to try to limit their market impact 

 14 through something similar, that we need to 

 15 contemplate these things, which I think generally 

 16 people think, well, that's trading, and how do we 

 17 avoid capturing those things in here. Maybe we 

 18 want to capture them, but I don't think we do. 

 19 So, there's a really -- not a bright line between 

 20 what I would call old- fashioned trading, you 

 21 know, again, maybe to limit market impact, and 

 22 then where do you get into this -- well, I just 
 111 

 1 introduced the new term, gaming. I think it's a 

 2 real challenge. I wish I could give you a little 

 3 pithy definition that would capture it all, but 

 4 it's not easy. 

 5 MR. NUNES: If I can just raise one 

 6 thing. I think John raised an important point, 

 7 and having been around when the equities markets 

 8 went from being more manual to where it required, 

 9 effectively, human response, to where they went to 

 10 automatic execution, I think that there was a 

 11 general feeling that things like putting out 

 12 actionable orders that are automatically 

 13 executable would, you know, eliminate or at least, 

 14 you know, reduce dramatically, the ability to, I 

 15 don't know, spoof or whatever you want to call it, 

 16 and there's a fundamental question which is, if 

 17 you're putting orders out that are taking risk, 

 18 can you be defined as spoofing? And that's 

 19 important to answer. From my perspective, looking 

 20 at a pattern and practice of outcomes, where you 

 21 could see -- I think I said it earlier -- every 

 22 time you want to sell 1,000 you end up buying 5, 
 112 

 1 if that's your pattern and practice I would argue 

 2 that, you know, from a probability standpoint you 

 3 can do it in an electronic market and that it's 

 4 not just something that is, you know, more akin to 

 5 what you would have called backing away in the 

 6 manual days where you put something out that you 

 7 don't mean to honor it and when someone calls you 

 8 on it you say, oh, that's no good, I was in the 

 9 process of changing that. 

 10 MR. KIRILENKO: This is Andrei 

 11 Kirilenko. I have a question to those of you who 

 12 have trading algorithms that are actually trading 

 13 and I'd like to ask you if you have anything 

 14 embedded in your trading algorithms whether 

 15 there's automated execution or fast trading, high 

 16 frequency trading that looks at the imbalances of 

 17 the shape of the order book on the buy and the 

 18 sell side and reacts to it, and whether or not 

 19 you've been affected by -- whether you have 

 20 instances in your trading activity where your 

 21 algorithms reacted to an imbalance which may have 

 22 been caused by spoofing, maybe someone 
 113 

 1 particularly put a large order in so the buy and 

 2 the sell side now appear imbalanced, and that 

 3 triggered your trading and then caused something 

 4 -- caused you to trade without necessarily -- and 

 5 then you discovered that you probably may not need 

 6 it to. Have there been instances like that and do 

 7 your algorithms -- are actually designed to do 

 8 that? 

 9 MR. NUNES: So, I think one example of 

 10 that is FINRA recently had an enforcement case 

 11 that was settled where if you read through the 

 12 action -- and I think they kind of defined it as 

 13 layering, which seems to be another term that fits 

 14 the definition of what we're talking about, and I 

 15 believe in the -- whatever they call -- the notice 

 16 that they put out on that, they noted that the 

 17 activity, you know, either was designed to or 

 18 ended up capturing, you know, automated trading 

 19 systems through that type of activity. 

 20 MR. SHERROD: I want to move on then to 

 21 another question and if anyone wants to comment on 

 22 question 12, should the Commission specify an 
 114 

 1 additional disruptive trading practice beyond the 

 2 closing period for particularly large orders? 

 3 Don? 

 4 MR. WILSON: Yeah, this is something 

 5 that I talked about earlier a little bit but I 

 6 think it's really important to emphasize that 

 7 whether in the closing period or during the 

 8 regular trading day, if the framework is to kind 

 9 of look back and see whether or not an order wound 

 10 up moving the market a lot, if it moved the market 

 11 a lot, then clearly it was disorderly and to then 

 12 say, well, therefore you've broken a rule, it -- a 

 13 framework like that would have just a chilling 

 14 effect on the central order book and would 

 15 definitely cause people to avoid entering large 

 16 orders in the central order book and instead 

 17 entering -- and, you know, use the block trading 

 18 market, privately negotiate the trades, which 

 19 would just have a horrible impact on the quality 

 20 of markets as a whole. 

 21 MR. HYLAND: Let me jump on something -- 

 22 the mere fact that you enter in -- this is John 
 115 

 1 Hyland -- the mere fact that you enter in large 

 2 orders outside of the closing period and that it 

 3 ends up impacting the price I would have thought 

 4 would just be the normal result of supply and 

 5 demand and therefore would not in itself qualify 

 6 as disorderly execution. In this particular 

 7 context of question 12, I'm not exactly sure 

 8 therefore what disorderly is unless your, you 

 9 know, order shows up with tattoos and drunk or 

 10 something. I mean, what is disorderly execution 

 11 in this context? 

 12 MR. SHERROD: That's what we were hoping 

 13 you would shed some light on. 

 14 MR. HYLAND: Any time. 

 15 MR. CUSIMANO: This is Jeremy Cusimano. 

 16 Don, you mentioned a potential risk of migration 

 17 to block trades. In CME's rules they have a list 

 18 of market factors that you need to consider when 

 19 executing block trades that would kind of govern 

 20 orderly execution of block trades. Do you think 

 21 the CFTC should be prescriptive in that nature in 

 22 defining what an orderly or disorderly execution 
 116 

 1 would be? 

 2 MR. WILSON: Well, the CME gives kind of 

 3 general guidelines about, you know, reasonable 

 4 amount from -- you know, reasonable distance from 

 5 the current market, you know, recognizing the size 

 6 of the order and all this kind of stuff. I think 

 7 that, you know, if the CFTC -- I mean, an example 

 8 of the type of guidance that would be very 

 9 unhelpful would be the following: You know, if a 

 10 large order -- and you could define large order -- 

 11 if a large order moves the market by more than a 

 12 certain amount, then we deem it to be disorderly. 

 13 I mean, again, that would be just looking at 

 14 things after the fact and essentially trying to 

 15 intervene in the supply/demand, you know, or the 

 16 attempts of the market to find fair value and to 

 17 sort through the changing of the supply and demand 

 18 in the marketplace. 

 19 So, as I said earlier, I think it's very 

 20 important to define these rules clearly, so from 

 21 that perspective, you know, more definition is 

 22 better, but I could certainly envision some 
 117 

 1 prescriptive definitions that would be very 

 2 harmful. 

 3 MR. SHERROD: John? 

 4 MR. LOTHIAN: If there were prescriptive 

 5 rules for the block trades, I think that would 

 6 hurt innovation within the market in terms of 

 7 exchanges competing because that's one of the 

 8 areas where they have competed traditionally over 

 9 the years. 

 10 In terms of disorderly markets, you 

 11 know, when you talk about today versus 10 years 

 12 ago or something like that, with electronic 

 13 markets, it's really hard to say that you have a 

 14 disorderly market, it's just moving, okay? A 

 15 disorderly market, no offense, Mark, would have 

 16 been NYMEX when they went, you know, fast market, 

 17 not held for an entire month, you know, type of 

 18 thing while energy prices were all over the place. 

 19 Okay? So, you couldn't tell whether your orders 

 20 were good or not or whatever because the brokers 

 21 weren't being held. That was a disorderly market. 

 22 There are things that happen in the 
 118 

 1 marketplace that create disorderly outcomes in 

 2 terms of the prices moving. Sometimes those are 

 3 when a customer is being liquidated, okay? At the 

 4 point where, you know, a large position needs to 

 5 be liquidated in the market, and it may be in 

 6 illiquid markets, it may be a situation, like the 

 7 old saying, you know, you eat like a pigeon and 

 8 poop like an elephant, okay, that's going to have 

 9 some big market impact. 

 10 We -- you know, I was at a brokerage 

 11 firm in the early '90s, a broker got some 

 12 customers the wrong way in the middle of the 

 13 floods. In order to meet margin calls he spread 

 14 them up into the next year's crop, which was 

 15 really not reducing risk but adding -- but it 

 16 reduces margins, the accounts were debit, we 

 17 systematically worked with a member of the 

 18 clearinghouse -- or the clearing broker, to exit 

 19 the positions, but when you're in red (inaudible) 

 20 beans, you -- and there's not much out there, 

 21 you've got to work the order and we worked the 

 22 order, worked the order, we thought we were out of 
 119 

 1 everything, but the broker lied to the person from 

 2 the clearing firm about getting out of everything, 

 3 and Tuesday morning after Memorial Day, or 

 4 whenever, we ended up with stuff still on and the 

 5 floods were at their peak and the risk manager of 

 6 the clearing firm, somebody different now, said, 

 7 get me out. And the price discovery process was 

 8 you could call disorderly because the price of the 

 9 spreads moved a dollar and a half, but that was 

 10 the price discovery process and that was, you 

 11 know, the economic interest of the clearing firm 

 12 needing to be defined because it was no longer the 

 13 customer's position. 

 14 So, sometimes things happen within the 

 15 price discovery process that are not rational or, 

 16 you know, to a market maker or to a trader, it's 

 17 part of the chaos of the market. 

 18 MR. FISHER: Mark Fisher. I think one 

 19 of the issues with block trades that should be 

 20 looked at a little bit is when block trades -- 

 21 block orders are leaned on. Typically a broker 

 22 will come up and say, hey, (inaudible), blah, 
 120 

 1 blah, blah, and he says -- and the broker says, 

 2 well, I'm (inaudible) good for 500. You know, and 

 3 then someone works against that order and says, 

 4 are you still there, are you still there, and 

 5 they're basically using that order as an out for 

 6 that thing. 

 7 That practice which is obviously not 

 8 transparent to the marketplace in allowing one 

 9 person to use the market over everyone else as 

 10 opposed to saying, hey, make me a market -- 

 11 two-sided market (inaudible). It's different than 

 12 the OTC marketplace saying, I'm 60 (inaudible) and 

 13 allowing someone to work against that order. That 

 14 to me doesn't seem, for lack of a better word, 

 15 kosher. 

 16 MR. SHERROD: Joel, did you -- 

 17 MR. HASBROUCK: I think that the large 

 18 trade problem is in a sense going to go away like 

 19 it has in the equities markets. The size of 

 20 equity trades has dropped dramatically with the 

 21 rise of electronic trading. The New York Stock 

 22 Exchange used to define a block trade as 10,000 
 121 

 1 shares or more. There are virtually zero of those 

 2 now. It's not that people don't have large 

 3 trading needs, it's just that the technology and 

 4 using the technology intelligently, has worked in 

 5 the directions of people feeding these orders to 

 6 the price discovery process over time. 

 7 MR. SHERROD: So, Joel, just to follow 

 8 up, if someone is feeding a large order, they're 

 9 buying repetitively small amounts, at some point 

 10 does that become disorderly if they're buying 

 11 without regard to the price impact? 

 12 MR. HASBROUCK: Again, as an economist I 

 13 have to beg off trying to make a definition of 

 14 disorderly that's -- you know, certainly they will 

 15 be taking into account the price impact of their 

 16 trades but as John said, there are many situations 

 17 ranging from rational behavior to outright 

 18 stupidity where that would be their illegitimate 

 19 intent. 

 20 MR. CUSIMANO: Sorry, Jeremy Cusimano 

 21 again. I think we've heard a couple times from 

 22 different folks what would not be considered 
 122 

 1 disorderly, but is there a way that we can create 

 2 guidelines or at least a frame of reference that's 

 3 based on some type of market norms that would be 

 4 able to be used as a benchmark for what might be 

 5 orderly and what might be disorderly? 

 6 MR. WILSON: Since I answered the 

 7 question by telling you what you shouldn't do 

 8 before, let me take another stab at it. The -- 

 9 you know, I think that certainly somebody who 

 10 intentionally enters an order in a disorderly 

 11 manner, in order to maximize the price impact of 

 12 the order, that obviously has some kind of 

 13 manipulative intent to it, and I think we can all 

 14 agree that that activity should be banned. Now, I 

 15 think that it already is because in the process of 

 16 doing that somebody would, you know, move the 

 17 price to an artificial level and, you know, to an 

 18 inappropriate level, they would be doing so 

 19 intentionally by purposefully executing the order 

 20 as poorly as possible. You know, again, I think 

 21 that if you don't have that intent element there, 

 22 and you let the definition be, you know, and you 
 123 

 1 leave open the possibility that somebody who 

 2 nearly executes an order inefficiently, maybe 

 3 because they were nervous, they were panicked, 

 4 they felt that they needed to get the order done 

 5 quickly because they were about to -- you know, 

 6 some event was about to happen, whatever it is, I 

 7 think that if you leave open the possibility that 

 8 in doing that somebody is breaking a rule, you 

 9 really risk pushing them out of the central 

 10 market. You think you really risk saying to 

 11 people -- you know, you risk people making the 

 12 decision, you know what, I just don't want to take 

 13 the regulatory risk of executing this order in the 

 14 central market, I'm going to call up somebody and 

 15 get a block order done. 

 16 MR. NUNES: If I can just add on to what 

 17 Don said, you know, we all have incentives to 

 18 execute orders as efficiently as possible and to 

 19 limit the price impact, so typically, I think in 

 20 the example that he gave, there would be some 

 21 other interest in that product where, you know, 

 22 someone might hold 100,000 contracts of it and 
 124 

 1 have, you know, a settlement price or some event 

 2 that, you know, their execution is tied to, where 

 3 they say, well, I have 100,000 long on this and I 

 4 want to price it in a certain way, so if I 

 5 inefficiently execute 5,000 contracts, I may be 

 6 able to move the price, you know, in a way that 

 7 would advantage the other 95 I have. So, I think, 

 8 you know, typically we all have an incentive not 

 9 to execute orders in a way that maximizes the 

 10 price impact, so I think it's often going to be 

 11 the case that you would want to look at why it is 

 12 that they're doing it. In some examples they may 

 13 not be trying to maximize the price impact, but 

 14 they may be trying to get off a hedge where, you 

 15 know, they're neutral as to what the price is. As 

 16 long as they get the trade done, you know, they're 

 17 hedged and they don't have a true interest in that 

 18 price. It still doesn't mean that they're going 

 19 to do it in an inefficient way, but I think 

 20 typically when you see that type of behavior there 

 21 is some other reason that's worth understanding. 

 22 MR. SHERROD: So, Gary, give us that 
 125 

 1 specific list. 

 2 MR. DEWAAL: Well, I mean, I actually 

 3 sympathize with Don as a trader because, again, 

 4 and I'm just a practical guy, you've got to go 

 5 back to the statute that we have. It's bizarre. 

 6 Look at A, there's no reference to intent, there's 

 7 no reference to reckless. Look at B, which is the 

 8 one we're talking about, which is orderly 

 9 execution, it includes a standard of intent or 

 10 reckless. Then look at C, which talks about 

 11 spoofing, only deals with intent. Okay? So 

 12 you've got market -- you've got trade practice 

 13 offenses which are unclear and yet there's three 

 14 different standards right within the plain 

 15 language of the statutes. You have to say what 

 16 this is not, okay, because the problem is, the 

 17 standards are -- even just using the plain 

 18 language -- are so different for each sub-offense 

 19 that if you don't say what it's not, poor traders 

 20 will have no idea what they can or cannot do. 

 21 What is the difference when you say violates bids 

 22 or offers? Because it says intent or reckless in 
 126 

 1 B, or intent in C, it suggests that an accidental 

 2 violation of bid offer in A, could be an offense. 

 3 That can't be it. That will completely dry up 

 4 liquidity. If the traders think that an 

 5 accidental violation of a bid order offer could 

 6 cause a big problem, that's significant. 

 7 The statute that Congress has forced 

 8 you, unfortunately, to have to say what these 

 9 things are not or we're going to have problems, or 

 10 people are going to live with this knife over 

 11 their head. 

 12 Stop smiling, Mark. 

 13 MR. SHERROD: Raj? 

 14 MR. DEWAAL: You can't give your opinion 

 15 that way. 

 16 MR. HIGGINS: It doesn't get recorded in 

 17 the transcript. 

 18 MR. FERNANDO: I think -- this is Raj 

 19 Fernando. I think transparency is incredibly 

 20 important and we need to do everything we can to 

 21 bring more of these orders that are off the market 

 22 to the exchanges. This would alleviate the credit 
 127 

 1 default catastrophe that we had two years ago, but 

 2 one of the things that was just brought up could 

 3 be a slippery slope. If you're long to market and 

 4 the market is breaking and it's very liquid and 

 5 you get out very inefficiently, and it moves the 

 6 price even more, but if you're short the market 

 7 and you want to sell more and you sell more 

 8 inefficiently, that's bad? This is all a part of 

 9 the price discovery and I think as long as all 

 10 market participants have access to these markets, 

 11 we have to let price discovery take its course. 

 12 MR. SHERROD: Liam? 

 13 MR. CONNELL: I just want to make two 

 14 brief points. You mentioned basing rules on kind 

 15 of normative rules and normal market conditions. 

 16 I mean, isn't -- isn't it when the market isn't 

 17 performing normally that we have to be concerned 

 18 about? I mean, wasn't May 6th an example that 

 19 keeps on being brought up? And that's why I think 

 20 it's very dangerous to make very, very specific 

 21 rules that might really hurt you when you want 

 22 market participants to participate. And just a 
 128 

 1 second point is, we're talking about May 6th, when 

 2 the main criticism of a lot of trading firms is 

 3 that they didn't trade, not that they traded, and, 

 4 you know, again, I think we've got to take that 

 5 into account when we put rules together that we're 

 6 not discouraging people from trading in public 

 7 markets when perhaps they're most needed. That's 

 8 just the point I wanted to make. 

 9 MR. LOTHIAN: I agree with the 

 10 transparency issue. I mean, one of the biggest 

 11 things about the translation of many of these 

 12 practices from an open outcry environment into an 

 13 electronic is that the anonymity of the electronic 

 14 market allows things to occur that in an open 

 15 outcry environment would have been self-policed by 

 16 the pit, by the pit committee, by the exchange 

 17 themselves. If somebody is repeatedly offering 

 18 something and they're offering it above their 

 19 size, the pit knows that they're not going to 

 20 trade that big and they're going to ignore them 

 21 and they're going to not trade with them. In an 

 22 electronic market where there's surety of trade 
 129 

 1 and anonymity, you don't have that, and so I think 

 2 the surveillance issue at the exchange is really, 

 3 really important because those are the people that 

 4 can actually really dig down deep into that data 

 5 and to look at that. 

 6 You know, the issue of disorderly 

 7 trading, to me, disorderly trading would be when a 

 8 high degree of orders -- of executed trades, are 

 9 being canceled, okay, are being, you know, ignored 

 10 or, you know, canceled so that people don't know 

 11 what trades that they have on. Okay? To me that 

 12 is -- because that's when I'm going to withdraw 

 13 from the market if I'm a market maker or 

 14 participant because I need to know what I have on, 

 15 and if you look at May 6th why people pulled out 

 16 of the market, it's because they couldn't depend 

 17 upon the quotes and the markets had moved so much 

 18 that they weren't sure what trades that were going 

 19 to stand or not, and, you know, we had disorderly 

 20 markets back in 1999 in the gold market when it 

 21 first went over $1,000 and it traded for a few 

 22 days and we -- this again was an open outcry 
 130 

 1 environment, but you didn't know whether you were 

 2 filled or not. Orders were unable, you know, 

 3 there were technological reasons why all of that 

 4 occurred and all of that, but when you don't have, 

 5 you know, an acknowledgment of a filled order or a 

 6 cancellation of a trade in an efficient manner, 

 7 then that would create what I would consider a 

 8 disorderly market. 

 9 MR. SHERROD: Andrei? 

 10 MR. KIRILENKO: Since a number of you 

 11 mentioned the flash crash, I have a question that 

 12 some of you may be interested in commenting on, 

 13 and that is, should there be -- what do you think 

 14 is the role of executing broker and should we sort 

 15 of revisit the role of executing brokers in 

 16 automated execution of large trades above and 

 17 beyond the role of -- 

 18 MR. SHERROD: How about we do that on 

 19 the next panel? 

 20 MR. KIRILENKO: Sounds good. 

 21 MR. SHERROD: Okay. We're going to do 

 22 that on the next panel because we have about 15, 
 131 

 1 20 minutes for this panel and we're going to have 

 2 the panel talk about question seven, the role of 

 3 executing brokers, right after this, but let's 

 4 turn to the last block of questions, 15 through 

 5 19, and talk about what role the Commission should 

 6 play in promulgating rules for algorithmic 

 7 trading, automated trading systems, so if anyone 

 8 would like to comment on our questions 15 through 

 9 19. John? 

 10 MR. HYLAND: Let me jump in as probably 

 11 one of the people here who, notwithstanding John's 

 12 definition, does not engage in algorithmic 

 13 trading, but I think what would be helpful is if 

 14 we defined algorithmic trading, because if we use 

 15 John's, then we're all doing it, but if we're 

 16 talking about electronic trading done with a 

 17 computer program that is allowed within certain 

 18 parameters of it's programming to pick and choose 

 19 what it buys, when it buys, how it bids, how it 

 20 lists offers, et cetera, if that's algorithmic 

 21 trading, then, you know, we don't do that, but I 

 22 just want to make sure that's what we're talking 
 132 

 1 about as opposed to John's much broader definition 

 2 of what it was. 

 3 MR. PEASE: Why don't we accept that 

 4 definition for the purposes of this discussion? 

 5 MR. SHERROD: Joel. 

 6 MR. HASBROUCK: I'm glad we got that 

 7 clarification because otherwise the alternative to 

 8 algorithmic trading would be random trading. 

 9 But I'd like to -- I think concerns 

 10 about algorithmic trading are ultimately going to 

 11 come down to the point that Mark raised earlier 

 12 which is speed, in that a slow algorithm, I don't 

 13 think would concern anybody at this table, but a 

 14 very, very fast one might and in this connection, 

 15 I think it is worthwhile for the commission to 

 16 consider, and I concur with Mark on this, steps to 

 17 slow the market down. And the reason is, 

 18 technology is generating more and more rapid 

 19 speeds of trading, of course, and lower latencies, 

 20 but I think it's important to realize that this is 

 21 ultimately an arms race. Nobody really cares 

 22 whether their order gets in with, you know, 50 
 133 

 1 milliseconds or 5 milliseconds, as long as they're 

 2 first. And a race to be first is ultimately much 

 3 more unstable than simply people trying to be fast 

 4 because they deliver more value to their 

 5 customers. 

 6 So, I think that given a particular 

 7 state of technology, it makes sense to consider 

 8 rules that are based on time and would slow the 

 9 market down. 

 10 MR. PEASE: And which rules would you 

 11 propose? 

 12 MR. HASBROUCK: I was afraid I'd be 

 13 pinned down to specifics. Basically -- I will 

 14 give you some examples of some things that have 

 15 been tried in other markets. One is very high 

 16 frequency price limits. Another is randomly 

 17 delaying -- 

 18 MR. SHERROD: Joel, let me slow you 

 19 down. What do you mean by very high frequency 

 20 price limits? 

 21 MR. HASBROUCK: Oh, instead of having 

 22 say daily price limits, very strict variations 
 134 

 1 about the most recent bid offer or transaction 

 2 price. So, you limit the speed with which prices 

 3 can move. 

 4 Other solutions that have been tried in 

 5 other markets are not handling orders in serial 

 6 fashion, but batching them and having high 

 7 frequency call auctions once every 30 seconds, one 

 8 minute, however often enough it seems to be 

 9 consistent with orderly trading. But ultimately 

 10 where we're headed with this race for speed, it is 

 11 going to have to be destabilizing. The analogy 

 12 was drawn, I think Mark drew it between computers 

 13 that can play chess and computers that can react 

 14 quickly. It's not one or the other, there's a 

 15 tradeoff. If you require the chess- playing 

 16 computer to make a move in one millisecond, it 

 17 will not be a very well thought out move. 

 18 MR. PEASE: Okay, professor, I don't 

 19 think you'd let your students get away with that 

 20 answer. You've told us what others have done. 

 21 What we're trying -- we already know -- we should 

 22 know, for the most part, the universe of what some 
 135 

 1 other rules are. What could we or should we 

 2 consider in terms of any restrictions on how 

 3 algorithms would be disrupting our markets? 

 4 MR. HASBROUCK: I think you should 

 5 consider -- if I had to be pinned down to one 

 6 thing -- strict price limits. 

 7 MR. SHERROD: Raj? 

 8 MR. FERNANDO: I have a question -- 

 9 John, do you trade? 

 10 MR. HASBROUCK: I haven't traded since I 

 11 was 23. 

 12 MR. FERNANDO: Okay. The markets have 

 13 changed quite a bit since then and right now these 

 14 markets are as illiquid -- as liquid, excuse me, 

 15 and the bid offer spreads are as narrow as they 

 16 have ever been. If a retail customer wants to go 

 17 to the New York Stock Exchange, it's not an eighth 

 18 wide anymore, there's no specialist getting in the 

 19 middle, it's a penny wide, all they want to do, so 

 20 if someone is trying to hedge their 401(k), it is 

 21 as efficient for this end user as it has ever been 

 22 and we do not want to do anything to disrupt that. 
 136 

 1 And going on speed -- you know, the 

 2 issue of speed, right now in cars you have 

 3 functionality that allows airbags to go off in 

 4 milliseconds and save lives because speed has 

 5 brought this and safety checks are now in place 

 6 that would never have been with not for the advent 

 7 of speed and technology along with this. 

 8 MR. HASBROUCK: In normal market times 

 9 the technology has brought us greater liquidity 

 10 and greater benefits for investors. It has also 

 11 brought us the first May 6th. 

 12 MR. FERNANDO: I will argue that May 6th 

 13 was not any fault of high frequency trading. In 

 14 fact, if anything, there needs to be more 

 15 coordination amongst the ECNs and that one order 

 16 that sold, I think, 75,000 E-Mini and S&P 

 17 contracts, the majority of that order was filled 

 18 on the way up, not on the way down. 

 19 MR. SHERROD: I'm going to turn to Don 

 20 because he's making notes. 

 21 MR. WILSON: Sure, so, this is Don 

 22 Wilson. You know, I think that when we talk about 
 137 

 1 -- when we talk about speed and we talk about, you 

 2 know, the concerns about, you know, the so-called 

 3 arms race, I think that it's important to really 

 4 think about, you know, what risks are we trying to 

 5 prevent, and, you know, certainly the May 6th 

 6 flash crash brought about a number of interesting 

 7 questions and important things that I think that 

 8 we should consider. But, you know, one of the 

 9 things that's generally highlighted as a concern 

 10 about this, you know, ever increasing sensitivity 

 11 to latency is that perhaps somebody who's engaging 

 12 in high-frequency trading will mistakenly unleash 

 13 a barrage of orders that will, you know, disrupt 

 14 the entire marketplace. 

 15 Now, I think we all know that that's not 

 16 what caused the May 6th flash crash, but it's a 

 17 legitimate concern that I think that, you know, 

 18 should be discussed. Now, the way that we at DRW 

 19 go about, you know, minimizing the possibility 

 20 that something like that would happen is we have a 

 21 whole host of pre- and post-trade checks in place. 

 22 Many of those practices that we use are -- and 
 138 

 1 many of the practices that many of our competitors 

 2 used, are actually summarized in a recently 

 3 published paper by the FIA PTG which talks about 

 4 the direct market access, best practices, and 

 5 specifically in the sequel paper, the risk 

 6 controls that trading firms should have in place. 

 7 It's my view that firms which take, you 

 8 know, which take prudent measures to put, you 

 9 know, carefully thought out procedures in place 

 10 can really -- in conjunction with exchanges that 

 11 provide some pre-trade checking functionality, 

 12 it's our belief that these risks can really be 

 13 mitigated and so I think that the right solution, 

 14 rather than trying to slow down the market, is 

 15 actually to think about, you know, ways in which 

 16 we can really encourage people to use these 

 17 procedures. 

 18 Now, I mean, specifically when it comes 

 19 to this rulemaking, one of the things that we 

 20 could talk about -- you know, question 19 asks the 

 21 question, should algorithmic traders be held 

 22 accountable if they disrupt fair and equitable 
 139 

 1 trading? It's a good question. And our view is 

 2 that algorithmic traders that have not put in 

 3 place reasonable procedures to ensure that, you 

 4 know, that something like this doesn't happen 

 5 absolutely should be held accountable because 

 6 these are people who didn't take proper care. I 

 7 think that people who are really diligent about 

 8 this stuff and yet, you know, perhaps something 

 9 winds up happening anyway, should be held to -- 

 10 you know, that's probably a different 

 11 circumstance. 

 12 MR. HIGGINS: Don, this is Mark Higgins, 

 13 section 720 -- 

 14 MR. SHERROD: Mark, before you get 

 15 started, let me just do a timing consideration. 

 16 We have about six minutes or so before we start to 

 17 run over and we probably have five people that 

 18 want to talk. 

 19 MR. HIGGINS: This is just a yes or no 

 20 type answer that I'm hopefully going to solicit, 

 21 and that is, section 720 also -- and it's the 

 22 subject of another panel so I'll be really brief 
 140 

 1 -- creates the opportunity for the Commission to 

 2 promulgate rules that are reasonably necessary to 

 3 prohibit disruptive trading and what you speak 

 4 about triggers my thought on that. Do you think 

 5 that a rule requiring people to pre-test 

 6 algorithms would be a wise thing? And if so, why? 

 7 MR. WILSON: Yeah, I think that's way 

 8 too granular. I don't think that the algorithms 

 9 themselves are what people should be concerned 

 10 about. I think that it's the systems and the 

 11 possibility that systems inadvertently enter a 

 12 bunch of erroneous orders, regardless of what the 

 13 algorithm is supposed to do or the testing of the 

 14 algorithm or any of that kind of stuff. 

 15 MR. SHERROD: Gary, your last thought? 

 16 MR. DEWAAL: Well, I mean, following up 

 17 on what Don said, I mean, I think the world can be 

 18 divided into the purposeful big problems which are 

 19 the things, I think, we were talking about before, 

 20 the trade practice, the intent to cause a non bona 

 21 fide price, and then we've got the accidental big 

 22 problems which is, you know, either stupidity to, 
 141 

 1 maybe it is recklessness. Okay? And it seems to 

 2 me that the way you address them is in fact 

 3 different, the way you approach them. I think 

 4 that, you know, the intent to not cause -- the 

 5 intent to cause a non bona fide price is properly 

 6 done through prescriptions, thou shalt not, okay. 

 7 I think it's wrong to have the accidents, because 

 8 they have big impacts on the market, but I think 

 9 the best way to do it is by holding the industry, 

 10 as Don has suggested, to reasonable practices. If 

 11 the industry itself has come up with 

 12 recommendations and they're followed and they show 

 13 an evidence of if you do these kind of things 

 14 then, you know, you're working reasonably to 

 15 prevent the bad kind of things accidentally, I 

 16 think then that's almost like a safe harbor. You 

 17 know, if something should go wrong but you've 

 18 still done all these good things, to me that's a 

 19 reasonable type of event. 

 20 And again, the threshold is the intent. 

 21 If the intent is to do something bad, then there's 

 22 no safe harbor. Okay? If it's an accident, okay, 
 142 

 1 or even maybe to the point of reckless but, you 

 2 know, where do you go on accepting the 

 3 recommendations of best practices or whatever we 

 4 call them? To me, those are defensible up to a 

 5 certain level. 

 6 MR. CUSIMANO: Steve, this is Jeremy 

 7 Cusimano. Something I'd like to, based on Don's 

 8 point and Gary as well, if people could roll into 

 9 their final comments their thoughts on whether 

 10 they be best practices or safety measures or 

 11 reasonable measures, however you define them, 

 12 should those be, however they're determined, 

 13 requirements at some level, be that at the 

 14 exchange or of the CFTC or of the FCM, should 

 15 those be requirements for those who are operating 

 16 automated trading systems? 

 17 MR. SHERROD: And for the record, Gary 

 18 shook his head no. But I'm going to turn to 

 19 Cameron. 

 20 MR. SMITH: Actually, it turns out my 

 21 comment's on point to what you were just asking 

 22 and that is, I think again looking at the equity 
 143 

 1 market might be useful. They have -- FINRA has 

 2 rules about supervisory procedures that are 

 3 reasonably designed to achieve a specific purpose. 

 4 So, I think it would be a mistake to get very 

 5 granular and proscribe which kinds of procedures 

 6 you have because every trading system is 

 7 different, every firm operates differently, but to 

 8 the extent that you have rules in place -- 

 9 procedures in place, you go, you do an exam -- 

 10 this is how it worked on the ground, the examiner 

 11 comes in, let me see your procedures that prevent 

 12 fat fingers and runaway algorithms, whatever, 

 13 looks pretty reasonable, check. Okay? Then I 

 14 think every firm, it's incumbent on them to have 

 15 those, and you could either have that supervisory 

 16 procedure rule in the CFTC rules or you could 

 17 require exchanges to have such a rule, you could 

 18 do it either way, but I think that's generally the 

 19 approach and again I think there's some model out 

 20 there we should be looking carefully at, and 

 21 creating that. 

 22 Another quick point I want to make just 
 144 

 1 on this whole speed thing that keeps coming up is 

 2 that there seems to be some false notion that 

 3 speed, the faster the orders come, the less well 

 4 considered they are, and I just think that'd be 

 5 news to all my PhDs back in Houston who are 

 6 working hard to make predictive algorithms. I 

 7 mean, I wish trading was so easy that all you had 

 8 to do was be fast, and actually to the extent that 

 9 speed was everything, that just means your tick 

 10 size is terrible and the tick size is too wide, 

 11 and therefore no one can compete on price and 

 12 trading does become a race and I can explain that. 

 13 But to the extent you have an appropriate tick 

 14 size, you have to have predictive abilities and so 

 15 the speed thing, this notion that somehow speed 

 16 means that the trades are less well considered and 

 17 there's more likely to be problems, I just don't 

 18 think is true at all, that we all have some 

 19 element of predictive modeling in these models or 

 20 else you're not going to be profitable. 

 21 MR. NUNES: Just one thing to add to 

 22 that. I think that when you look into the 
 145 

 1 supervisory and control systems, that should not 

 2 be something that's specific to automated firms. 

 3 You know, there's no reason that within a manual 

 4 firm somebody can't fat finger an order and they 

 5 should have those same types of controls in place 

 6 to catch that before it gets to the exchange. 

 7 MR. SHERROD: Thirty seconds, guys. 

 8 Mark? 

 9 MR. FISHER: My concern with speed is 

 10 just during terms of market duress and although 

 11 Chopper Trading may feel that the professor -- my 

 12 professor, actually -- is off base, okay, you 

 13 could talk to people who have traded a hell of a 

 14 lot more than you and I have, like a (inaudible) 

 15 investment, will go ahead and back up what the 

 16 professor just said 1000 percent. Again, speed is 

 17 fine except that value players are afraid of 

 18 speed, perception or not, so in times of market 

 19 duress to bring value players into any market, the 

 20 perception of speed is really what it is more than 

 21 whether the speed really causes the problem or 

 22 not. People don't want to put orders into a 
 146 

 1 market if they feel that speed's going to out do 

 2 them. 

 3 MR. SHERROD: John Lothian? 

 4 MR. LOTHIAN: John Lothian. I just 

 5 wanted to say I didn't like what I was hearing in 

 6 terms of demonizing algorithms. Algorithms are a 

 7 very important part of our markets towards keeping 

 8 them stable and orderly and efficient. Okay? The 

 9 May 6th event was not the only time that the stock 

 10 market has gone down like that. There have been 

 11 lots of other events throughout history where that 

 12 has occurred that had nothing to do with 

 13 technology or algos or anything of that. 

 14 The very first book that I ever was 

 15 recommended to read in these markets was The 

 16 Extraordinary Popular Delusions and the Madness of 

 17 Crowds, okay, and sometimes stuff happens because 

 18 of that. There's always going to be fear and 

 19 greed present in the markets and people are going 

 20 to do silly things at the wide spectrum of those 

 21 emotions. 

 22 MR. SHERROD: John Hyland? 
 147 

 1 MR. HYLAND: Reminding everybody that, 

 2 you know, we -- my firm doesn't represent really 

 3 the trading side or the algorithmic trading side, 

 4 I'm just going to leave sort of like a 50,000 foot 

 5 high view of this. If I was the Commission, if I 

 6 was Commissioner O'Malia and I was sitting here 

 7 listening all this time, I think the things that I 

 8 would most take away in terms of implementing, 

 9 admittedly, an incredibly flawed passage, is what 

 10 Gary and Adam say. This cannot be implemented per 

 11 se. Whatever you do it's got to be patterns and 

 12 practices, facts and circumstances, otherwise 

 13 you're going to screw everything up. 

 14 There has to be intent, otherwise you're 

 15 just going to get stomped by a federal judge who's 

 16 going to toss you out anyway. 

 17 I think those are the important things 

 18 that you're not going to be able to come up with a 

 19 firm framework, and I say this as somebody -- you 

 20 know, whatever you do is going to hurt them 

 21 probably more than it's going to hurt me, but 

 22 that's just my observation from being here for a 
 148 

 1 few hours. 

 2 MR. SHERROD: Cameron, do you want to 

 3 have the last word on this one? 

 4 MR. SMITH: Oh, no thanks. 

 5 MR. SHERROD: Okay, Raj, you'll get the 

 6 last word. 

 7 MR. FERNANDO: Price breakers are an 

 8 important part in the market and if there was good 

 9 coordination between the CFTC and the exchanges in 

 10 setting up proper price limits and price breakers, 

 11 a lot of these catastrophes can be avoided. 

 12 MR. PEASE: Thank you all very much for 

 13 your time. This has been a very interesting, 

 14 informative panel. Thank you for coming here 

 15 today and thank our moderators, Steve and Andrei, 

 16 for your time as well. 

 17 MR. HIGGINS: And for the folks on the 

 18 phone, we will be breaking for lunch between 12:30 

 19 and 1:30, rejoining at 1:30. Thank you. 

 20 (Whereupon, at 12:33 p.m., a 

 21 luncheon recess was taken.) 

 22 
 149 

 1 A F T E R N O O N S E S S I O N 

 2 (1:31 p.m.) 

 3 MR. PEASE: Well, welcome back, folks. 

 4 We'll start Panel 2. 

 5 Let me start -- before I introduce our 

 6 panelists, let me begin again with a few 

 7 housekeeping items. The event is being 

 8 transcribed by a court reporter, who will be 

 9 taking a verbatim transcript. 

 10 The event is being listened to by 

 11 members of the public via listen-only telephone. 

 12 Because we are not webcasting this, we ask each 

 13 speaker to identify themselves each time that they 

 14 are speaking so that those on the telephone will 

 15 know who is talking. 

 16 For the panelists, turn your name 

 17 sideways if you want to speak so we can recognize 

 18 you. 

 19 We're not going to have opening 

 20 presentations, so we'll go right to the questions 

 21 posted by the ANOPR. For this panel, we'll be 

 22 dealing with questions primarily 1, 7, and 14. 
 150 

 1 Push the microphone -- push the button 

 2 to talk on the microphone, and please make sure 

 3 that you don't put your BlackBerry or cell phone 

 4 near the microphones or it will cause potentially 

 5 some interruptions. 

 6 And now I'd like to introduce our 

 7 panelists. Again, my name is Robert Pease. Mark 

 8 Higgins is here. Steve Seitz and Jeremy Cusimano 

 9 will be moderating this session. And we have 

 10 another distinguished group of panelists: Tom 

 11 Gira from FINRA; Chris Heymeyer from NFA; Ike 

 12 Gibbs from ConocoPhillips; Dean Payton from CME; 

 13 Mark Fabian from ICE; Joe Mecane from New York 

 14 Stock Exchange; Greg Mocek from McDermott Will & 

 15 Emery and also representing the Commodity Markets 

 16 Council; Ken Raisler from Sullivan & Cromwell, 

 17 also here on behalf of FIA; Micah Green from 

 18 Patton Boggs; Tyson Slocum from Public Citizen; 

 19 and finally Andrew Lo from MIT. 

 20 Thank you all for volunteering to come 

 21 here today at your own cost, volunteering not only 

 22 your time but your expense in getting here. We 
 151 

 1 very much appreciate it. You have a challenge 

 2 ahead of you. The panel this morning was quite 

 3 forthright in their opinions and not hesitant at 

 4 all to express them, and we expect nothing less of 

 5 this panel. 

 6 So, the questions we're going to be 

 7 dealing with are questions from the ANOPR -- are 

 8 questions 1, 7, and 14, and we'd like to focus the 

 9 discussion as much as we can on those. The first 

 10 one is, Should the commission provide additional 

 11 guidance as to the nature of the conduct as 

 12 prohibited by the specifically enumerated 

 13 statutory provisions? We can start with that, and 

 14 we'd like to go around the table, and we have one 

 15 hour with this panel, and, Tom, we'll start with 

 16 you. 

 17 MR. GIRA: Okay. Hi. My name is Tom 

 18 Gira. I'm from FINRA. You know, I think -- this 

 19 is a very good question, and I think there's 

 20 always been kind of a tension between giving very 

 21 specific -- kind of very specific rules that will 

 22 address a particular conduct versus more general 
 152 

 1 rules that might be more flexible and capable of 

 2 addressing market activity and trading activity as 

 3 it evolves. So, I think it's important to try to 

 4 be as explicit as possible, but I think it's 

 5 important to kind of understand that -- I think 

 6 you want to have rules that can be accommodating 

 7 of future changes. 

 8 MR. HEYMEYER: Well, thank you very 

 9 much. On this particular piece, this particular 

 10 question, I've got a couple of thoughts, and I 

 11 guess I should start real quickly by saying that 

 12 I'm very grateful to the Commission and to all of 

 13 you for having all of us here today and this 

 14 morning. You really brought together a lot of 

 15 talent from the industry. 

 16 And on this particular issue I agree 

 17 with Gary DeWaal that unfortunately it is bad law. 

 18 I guess I should start by saying I've 

 19 been in the futures industry now for over 30 

 20 years. I started as a runner on the floor of the 

 21 Board of Trade. I was a clerk. I was a broker. 

 22 I was a trader in the pit. I started in SCM with 
 153 

 1 my partner in 1985, and we had a big local 

 2 business and a very good grain hedging business, 

 3 which we sold to Penson in 2007, and we kept the 

 4 proprietary trading SAT, and I have recently been 

 5 running the proprietary trading company, and 

 6 that's really what I spend most of my time doing. 

 7 Although my thing says the National 

 8 Futures Association, I am still affiliated with 

 9 Penson -- the FCM -- and I serve as the vice 

 10 chairman of the board of the National Futures 

 11 Association, the vice chairman of the board of the 

 12 Futures Industry Association; and I say all of 

 13 that because I've spent a fair amount of time 

 14 through the years -- I think I was on -- I've 

 15 chaired or vice chaired or served on 40-something 

 16 committees at the Board of Trade back when it was 

 17 a mutually owned organization, and I've spent a 

 18 lot of time in trying to come up with ways that 

 19 stop disruptive practices in the trading pits and 

 20 on the closes and big arguments about how to 

 21 settle prices and trying to weigh and balance the 

 22 interest of the public, the commercial users, the 
 154 

 1 market makers, the liquidity providers; and I 

 2 think all of the people that were here today that 

 3 you've gathered -- as I say, you've brought a very 

 4 diverse and talented group here, and they all have 

 5 come because these markets -- to many of us, this 

 6 is -- these are -- this is our -- these are our 

 7 lives, and the markets are -- the integrity of the 

 8 marketplaces are very important to all of us, and 

 9 it's very difficult to -- and I appreciate your 

 10 challenge of trying to come up with language that 

 11 can legislate -- that carries out the legislation 

 12 as it's directed for you all to consider trying to 

 13 make sure that there aren't disruptive practices. 

 14 And then specific of course, your 

 15 question was, Should the Commission provide 

 16 additional guidance as to the nature of the 

 17 conduct that's prohibited by the specifically 

 18 enumerated practices in A through C? And the 

 19 problem, as Gary DeWaal pointed out this morning 

 20 is unfortunately it's bad law. It wasn't done 

 21 with forethought as to an abusive practice that 

 22 everybody had admitted was a problem in the 
 155 

 1 marketplace. And abusive -- there wasn't evidence 

 2 of that. CFTC -- I don't think it lost cases 

 3 where they felt like they needed "spoofing" 

 4 authority, as we called it earlier, and so it 

 5 leaves the CFTC with considering what's been 

 6 directed by the law of the land. 

 7 And, again, I compliment you all on 

 8 bringing a lot of people who are talented, 

 9 experienced, and concerned. And they know -- they 

 10 need to be brought back to consider problems where 

 11 there are issues, where there are really problems. 

 12 And so I guess I would call on the Commission, 

 13 which a lot of people said this morning, where 

 14 there is the discretion of making rules or not. 

 15 For the most part, we'd probably end up with -- I 

 16 would recommend that the Commission not make rules 

 17 and not try to come up with language for many of 

 18 these practices that aren't, particularly that 

 19 I've noticed, a problem. 

 20 The exchanges have a lot of power and 

 21 authority to regulate these markets, disruptive 

 22 practices, and what's come to be known as 
 156 

 1 "spoofing," and so I agree with a lot of what was 

 2 said this morning. We have to be very careful 

 3 about trying to write language that could create 

 4 more problems than what we've had. 

 5 So, that's my piece from -- and I'll be 

 6 happy to comment some more later. But I again 

 7 thank the Commission for bringing all these people 

 8 here today. 

 9 MR. GIBBS: This is Ike Gibbs, 

 10 ConocoPhillips. I'll echo Chris' thank you, so I 

 11 really appreciate the opportunity to join this 

 12 group. 

 13 We heard a lot earlier today about the 

 14 potential impacts of, you know, more specific 

 15 rules on the market. I'll offer the perspective 

 16 of a compliance officer who's tasked with putting 

 17 in controls to ensure that the business that we 

 18 operate is conducted in an appropriate manner. 

 19 You know, when I think about my role and 

 20 my responsibility and how we would be impacted by, 

 21 you know, more granular rules versus what I'll 

 22 call more principle- based rules, it ultimately 
 157 

 1 comes down to an issue of resources. You know, 

 2 the more specific the rules are, if you apply 

 3 something that carries some type of a strict 

 4 liability measure, in many cases that's easier for 

 5 us. It's easier from both a human resource 

 6 perspective and sometimes from a systems resource 

 7 perspective. One that is less prescriptive, that 

 8 has perhaps an intent element, usually is more 

 9 resource intensive. But at the end of the day, 

 10 those resources are resources and we are good at 

 11 figuring out how we will manage our resources. 

 12 But when I think about my job as a 

 13 compliance officer, I usually try to describe it 

 14 to people with a picture, and I use a bell curve 

 15 as an example. On the tails you have probably -- 

 16 on each tail you have -- probably 10 percent of 

 17 the issues that we deal with are either black and 

 18 white, and the remainder of the issues that we 

 19 deal with in the middle are gray. At the end of 

 20 the day, it's our ability as risk managers, 

 21 because that's really what compliance officers are 

 22 -- we are a type of risk manager -- it's our 
 158 

 1 ability to operate within that gray zone that 

 2 helps our companies navigate those issues, and we 

 3 either make money, we either lose money. And 

 4 sometimes we make good decisions and sometimes we 

 5 make bad decisions. But at the end of the day we 

 6 are comfortable and we're tasked with dealing in 

 7 that gray zone. And so what I would suggest to 

 8 the Commission is it's good for us to have 

 9 specificity; it's good for us to have an 

 10 understanding of what is considered to be 

 11 appropriate and not appropriate. But we would 

 12 really prefer to see a scenario where the 

 13 Commission is not overly prescriptive. We're 

 14 given guidance as to what's appropriate and what's 

 15 not appropriate, but we would like to retain some 

 16 flexibility to use our judgment, our ability to 

 17 assess what's happening in the marketplace, why we 

 18 are doing certain things to judge whether there is 

 19 appropriate conduct or inappropriate conduct. 

 20 Thanks. 

 21 MR. PAYTON: All right, thank you. This 

 22 is Dean Payton from CME Group, and I think a lot 
 159 

 1 of what was talked about this morning was pretty 

 2 well on target. I mean, I think that as people 

 3 look at this new section of the Act, they are very 

 4 much concerned about the lack of clarity in terms 

 5 of what these disruptive practices mean. And, you 

 6 know, there's certainly going to be concern about 

 7 if people do not have the clarity that they need 

 8 in order to determine whether or not to 

 9 participate in these markets, if you chill that 

 10 participation it's going to impact liquidity in a 

 11 way that actually has a perverse effect relative 

 12 to what Dodd-Frank was trying to do. 

 13 You know, that being said, I think 

 14 everybody at the table this morning and everybody 

 15 here today, you know, from the standpoint of 

 16 whether they're a market participant, a market 

 17 operator, or a regulator, I think we all have the 

 18 same objectives in mind -- right? -- which is to 

 19 have a market that is, you know, free from 

 20 manipulation, free from fraud, free from abuse of 

 21 customer orders; and I think that, you know, 

 22 overall market disruption is a certain part of 
 160 

 1 that. But we need to be very, very careful -- 

 2 right? -- that we're not conflating volatility 

 3 with being a disruptive practice, and I think that 

 4 sometimes these issues get politicized in terms of 

 5 how these markets are operating, and I think that, 

 6 you know, we can distinguish certain types of 

 7 activities being problematic, but I think it's 

 8 very, very critical, as many people said this 

 9 morning, that we talk about there being an element 

 10 of intent -- right? -- to disrupt the market and, 

 11 you know, if we want to include as part of intent 

 12 an extreme recklessness standard, which is very 

 13 close to an intent standard, I think that people 

 14 can likely get comfortable around that. But 

 15 anything short of that really creates a situation 

 16 for market participants where they are concerned 

 17 about whether or not they should participate in 

 18 this market, because is there going to be some 

 19 kind of post-hoc analysis that's done based on 

 20 something that they entered in good faith in the 

 21 marketplace. 

 22 MR. FABIAN: Hi. Good afternoon. It's 
 161 

 1 Mark Fabian from ICE. 

 2 I'd just like to again thank the 

 3 Commission for giving us all the opportunity to 

 4 weigh in on the new regulations and some of the 

 5 topics that you're discussing today. And I 

 6 apologize if I'm being redundant from things that 

 7 were said this morning or things that were just 

 8 said just now today at the table, but I think ICE 

 9 would agree that, you know, we definitely want to 

 10 continue to have orderly markets that promote 

 11 efficiency and price discovery without disruption 

 12 or any improper attempts to manipulate price or 

 13 set prices that are not reflective of market 

 14 value. 

 15 But having said that, as a number of 

 16 people said, I think that a lot of these items 

 17 that are listed in A, B, and C -- specifically, as 

 18 they are listed -- require a lot more thought in 

 19 terms of what would be considered volatile or not. 

 20 And, as Gary pointed out this morning -- I thought 

 21 was a very good point -- the discrepancies between 

 22 some of the terminology used in A, B, and C -- for 
 162 

 1 instance, in B there are the terms "reckless" and 

 2 "intentional"; "intentional" appears in C; and 

 3 neither "reckless" nor "intentional" appears in A. 

 4 So, it is somewhat misleading and confusing to 

 5 those who are trying to understand it. 

 6 And as many have also said, you know, 

 7 the last thing we want to do is promote some type 

 8 of regulation or strict rules that will discourage 

 9 participants from entering these markets, 

 10 providing liquidity. If we do that, you know, 

 11 we're going to reduce the amount of liquidity in 

 12 market, which will thereby reduce the efficiency. 

 13 And then in cases where -- you know, we talked 

 14 about this morning large orders impacting the 

 15 market -- when you reduce the liquidity, smaller 

 16 orders could provide the same type of impact on a 

 17 less liquid market the large order may provide on 

 18 a liquid market. 

 19 So, in general I think, like everyone 

 20 has said, there needs to be caution taken in how 

 21 tightly prescribed any rules or guidelines are, 

 22 and I think, as Dean pointed out, we need to -- 
 163 

 1 you know, if there's -- well, I think everybody 

 2 has agreed intent is something that is required to 

 3 -- when you look at a disruptive market or 

 4 potentially disruptive trading practice, and I 

 5 think a pattern is also required. That was 

 6 mentioned several times this morning as well. 

 7 In that instance, when you talk about 

 8 recklessness, I think we also need to make sure 

 9 that we or the Commission gives us real guidance 

 10 on what the difference between intent, 

 11 recklessness, and then just negligence is and make 

 12 sure that there is a clear distinction between 

 13 those three terms and what is meant by each of 

 14 those terms and that just plain activity that was 

 15 not done with intent or with a reckless nature 

 16 would not rise to the level necessarily of 

 17 violations of these suggested regulations. 

 18 MR. LO: My name is Andrew Lo, and I 

 19 want to thank the CFTC for inviting me to 

 20 participate in this panel. 

 21 At the start, I want to just, in the 

 22 matter of full disclosure, mention that in 
 164 

 1 addition to my affiliation at MIT, I'm also 

 2 affiliated with an asset management company, 

 3 AlphaSimplex Group. 

 4 With regard to question 1, I suppose 

 5 that my own perspective is somewhat different from 

 6 some of the other members of the panel. I realize 

 7 that the CFTC is charged with responsibility of 

 8 responding to Dodd-Frank, but frankly I feel that 

 9 the Dodd-Frank bill may be premature in many of 

 10 its mandates. In fact, I find it interesting that 

 11 the bill was passed in July, a full six months 

 12 before the Financial Crisis Inquiry Commission has 

 13 reported its findings. And there's a lot that we 

 14 don't yet know about some of the issues that 

 15 Dodd-Frank is trying to address. So, the first 

 16 point I would make is that it's critical to 

 17 develop a much deeper understanding of the kinds 

 18 of practices that we want to call disruptive 

 19 before we start passing rules as to how to address 

 20 those issues. 

 21 The second point I want to make is that 

 22 I suspect that there are two separate issues going 
 165 

 1 on with regard to paragraphs A through C and with 

 2 the discussions that we're having about disruptive 

 3 trading practices. 

 4 The first issue has to do with 

 5 relatively narrow kinds of behavior that the CFTC 

 6 has already been very much aware of and engaged in 

 7 dealing with, including manipulation and fraud. 

 8 But there's a second and larger issue 

 9 that motivates the Dodd-Frank part of the bill 

 10 that we're talking about today, which is a 

 11 relatively new phenomenon in the financial 

 12 landscape that we're living in, and that's 

 13 systemic risks of financial markets, risks that 

 14 really don't affect any one or two parts but the 

 15 system as a whole. And if we think about 

 16 disruptive trading practices from this broader 

 17 perspective, first of all we see that it's a much 

 18 different animal than any of the other issues that 

 19 the CFTC or the SEC has had to deal with over the 

 20 last several years. And it really is an outcome 

 21 of changes in technology and the fact that 

 22 technological innovations have outstripped our 
 166 

 1 ability to manage them effectively with the rules 

 2 that we've developed. 

 3 So, I would encourage the CFTC and all 

 4 of us to think a little bit more broadly not so 

 5 much about proposing one or two rules that may 

 6 deal with the narrow issues -- because I believe 

 7 the narrow issues, while they're important we 

 8 already have many rules that deal with them -- 

 9 but, rather, to think more expansively about how 

 10 to deal with the larger issues, including a 

 11 definition of disruptive trading practices. 

 12 You know, unlike pornography, I'm not 

 13 even sure I know disruptive trading when I see it, 

 14 and so there's a great deal more effort that's 

 15 required for us to be able to get to the point 

 16 where we can start thinking about what it really 

 17 means. And the CFTC and the SEC have led the 

 18 charge with a number of recent studies that I 

 19 think are great examples of the kinds of forensic 

 20 analysis that need to be conducted before we get 

 21 to the point where we're able to pass the 

 22 appropriate rules to deal with this larger issue. 
 167 

 1 Thank you. 

 2 MR. MECANE: Joe Mecane from NYSE 

 3 Eronext. At the risk of reiterating some of the 

 4 points that were already made, I think a lot of 

 5 what we're talking about is finding a balance. I 

 6 don't think there's a right or wrong answer on one 

 7 side or the other of this particular debate. But 

 8 I think what's changed in the context behind a lot 

 9 of the issues that we're talking about is the huge 

 10 rate of automation and technology that's been 

 11 brought into the trading space -- you know, 

 12 different levels and different products but 

 13 clearly moving in a consistent direction. And the 

 14 balance that I think we're trying to find is 

 15 between certainty for market participants, which 

 16 obviously leads to people's propensity to offer 

 17 liquidity into the market. The more certainty 

 18 people have about what algorithms and what 

 19 practices are permitted versus not permitted, the 

 20 more likely they'll be to commit capital to the 

 21 market to maintain robust bids and offers. 

 22 And the counter side to that is that 
 168 

 1 it's probably unrealistic to expect that we can 

 2 descriptively carve out exactly what type of 

 3 behaviors are not permissible and at the same 

 4 time, to the extent that we do find very 

 5 prescriptive rules for what types of behaviors 

 6 aren't permitted, people will find ways around 

 7 them, and then you end up in the situation where 

 8 you've so narrowly defined or too narrowly defined 

 9 what practices are permitted that people end up 

 10 working around them. 

 11 So, the right balance needs to be struck 

 12 between giving enough credible guidance to 

 13 participants about what practices are okay and, 

 14 you know, not being so prescriptive to the point 

 15 where people find loopholes or can operate in a 

 16 way that circumvents the original intent of the 

 17 rule. 

 18 MR. MOCEK: I echo the comments thanking 

 19 you for the invitation to speak today. 

 20 Am I on? Gregory Mocek on behalf of 

 21 Commodity Markets Council. Before we get into the 

 22 question in particular that's on the table, 
 169 

 1 question 1, from 10,000 feet I think -- and 

 2 although clarity is very important, and that was 

 3 clearly evident this morning from the three-hour 

 4 discussion amongst the panel participants -- what 

 5 we're facing is that the Commission is in a 

 6 situation where it's rushing to complete multiple 

 7 rules, more rules than they've ever attempted to 

 8 digest in the history of the Commission in 12 

 9 months, and the rules that have finite time tables 

 10 where they have to be completed by next summer 

 11 generally. 

 12 I can tell you after now sitting on this 

 13 side of the fence, after 10 years in government, 

 14 the perspective from the commercial end users from 

 15 the financial institutions, from the trading 

 16 community, is that the rules are coming with such 

 17 velocity it's akin to drinking out of a fire hose 

 18 in the middle of winter on the sidewalk. And 

 19 given that these are very important rules that are 

 20 going to change the whole industry, the thought 

 21 may be -- and just to try to put it the mind of 

 22 the Commission, maybe the prudent thing to do is 
 170 

 1 go back to Congress and say we need much more time 

 2 to complete these rules rather than finishing at 

 3 the end of 12 months. Just something to think 

 4 about, because I know, just trying to interpret 

 5 them for clients, and what could come down the 

 6 pike is unbelievably hard, and in many ways it's 

 7 like looking into a crystal ball. 

 8 But with regard to question 1 and the 

 9 additional guidance on the nature of the conduct 

 10 that we're talking about here, whether it's A, B, 

 11 or C, the Commodity Markets Council clearly thinks 

 12 there needs to be guidance. I mean, not to 

 13 reiterate what was said this morning on vagueness, 

 14 but there are a lot of issues on vagueness and 

 15 these concepts that we don't need to rehash here 

 16 today. And the vagueness is going to chill 

 17 legitimate trading. There's no doubt about it. 

 18 But the vagueness is also going to 

 19 impede the ability of the Enforcement Division to 

 20 bring cases. I've dealt with that before with you 

 21 guys, and it was tough having a vague statute. We 

 22 constantly had to think about how we were going to 
 171 

 1 be creative in dealing with vagueness in certain 

 2 situations, and it was tough, and it made our jobs 

 3 really hard. And I have to tell you, this section 

 4 of the statute 4(c) has been challenged for 

 5 vagueness in the '70s with regard to fictitious 

 6 sales and the government lost, because the statute 

 7 was too vague in the context of a criminal 

 8 proceeding. 

 9 So, as the court will review the terms, 

 10 whether it be "spoofing" -- and I'm not quite sure 

 11 I know what spoofing is, and I'm not quite sure I 

 12 know what the Enron loophole is either, even 

 13 though Ken supposedly wrote it -- you know, 

 14 there's a lot of issues that have been around that 

 15 have multiple meanings. 

 16 But the court isn't going to go through 

 17 the process and say okay, wait a second here, is 

 18 there a common understanding or meaning to the 

 19 terms that -- or in the statute, and the answer 

 20 is, after this morning's conversation -- this 

 21 conversation -- is no. The court's going to go 

 22 through an analysis as is there a prior judicial 
 172 

 1 construction, and the answer is no. The court's 

 2 going to go through an analysis and say, Is there 

 3 a treatise out there? Are there terms commonly 

 4 used in the industry to define these terms that 

 5 are in the statute? And the answer is no. And 

 6 then the final answer is a ruling that says that 

 7 the statute is unconstitutionally vague. 

 8 So, you know, given that analysis, I 

 9 think it is evident that we need to clearly think 

 10 how these things can be defined and you -- it's 

 11 undoubtable that you've got to clarify these vague 

 12 issues, because from your perspective as well as 

 13 the industry's perspective, you can't have them 

 14 laying out there, because you'll never be able to 

 15 use them. If you do use them, it's going to be 

 16 problematic. There's more practical issues -- and 

 17 this is going to go too long, so I'll wrap up -- 

 18 there's more practical issues to think about in 

 19 the context of the concepts themselves and how the 

 20 industry is structured, things like violating a 

 21 bid and an offer. 

 22 How do you get in a situation where you 
 173 

 1 violate a bid and an offer in an over-the-counter 

 2 market where it's a thinly traded market and you 

 3 don't really know what the bid or the offer really 

 4 is in the market or in a phone broker market, 

 5 which are legitimate. They're going to be around 

 6 for a long time, even though people think that 

 7 they're not. 

 8 You know, those markets -- you've got 

 9 prices in those markets and how are you going to 

 10 make sure that, you know, you can deal with those 

 11 issues? It's a practical implication that you've 

 12 got to think about. How do you define the term 

 13 "closing period"? It's easy to define the term 

 14 "closing period" presumably in a designated 

 15 contract market. Are you planning on defining 

 16 that period in a SEF? Because it's an issue 

 17 that's going to be applicable the way the statute 

 18 is written, presumably. Maybe it won't. But it's 

 19 going to be an issue. And in the area of 

 20 spoofing, how do you spoof when it's not 

 21 electronic? Can you spoof when it's not 

 22 electronic? Maybe. But it's something to think 
 174 

 1 about. 

 2 I yield the rest of my time to Dr. 

 3 Raisler. 

 4 MR. RAISLER: Thank you. Ken Raisler 

 5 with Sullivan & Cromwell on behalf of the FIA, and 

 6 again thank you for inviting us and for putting 

 7 this program together. 

 8 I would like to rephrase the question 

 9 one slightly. Do we need additional guidance? 

 10 The answer is absolutely yes, but on the issue not 

 11 of conduct that is prohibited but actually conduct 

 12 that is not prohibited. 

 13 Those of us who followed -- and Greg 

 14 being one of course -- this industry for a while, 

 15 I've always felt that we have on the one hand the 

 16 CFTC's authority in the areas of manipulation, 

 17 attempted manipulation, and bona fide trading. 

 18 And on the other hand, we had the exchange's 

 19 ability to provide discipline and monitor the 

 20 market and ultimately, because of the membership 

 21 market, declare conduct detrimental to the 

 22 interest of the exchange if they were uncertain as 
 175 

 1 to what the violation was but were still unhappy 

 2 with it. 

 3 I'm not aware that there was a gap in 

 4 that world, and this statutory provision seems to 

 5 imply a gap. I think it's incumbent on the 

 6 Commission in the first instance if they wanted to 

 7 pursue rules, and it would be my suggestion not to 

 8 do so but to explain what that problem is that's 

 9 trying to be solved here -- I think that's really 

 10 a missing element. And the problem of course is 

 11 acute, because it's not just a vagueness issue, 

 12 but the threat of an enforcement action applying 

 13 these vague standards is chilling to the 

 14 marketplace and could obviously discourage 

 15 activity in the market. 

 16 What's happened here is the language -- 

 17 I think Gary DeWaal did make the point -- and I'm 

 18 sitting in his chair, so I'll echo it -- is that 

 19 the terms here are not easy to follow. They're 

 20 (sic) seemingly adoption to some extent of some 

 21 securities law concepts -- they don't really have 

 22 a very clear application. 
 176 

 1 Violating bids and offers, as Greg 

 2 mentioned -- how does that work in the OTC market? 

 3 There are a number of people advocating with 

 4 respect to the SEF market. There'll be RFQ-type 

 5 markets. Those -- you may not select the best bid 

 6 or best offer. Block trades fundamentally violate 

 7 a bid offer -- a best bid -- best offer 

 8 environment. So, clarity is absolutely essential 

 9 there. 

 10 Orderly execution of transactions during 

 11 the closing period -- John Hyland talked about 

 12 size of trade. It shouldn't be a criteria. 

 13 There's a whole variety of things that should not 

 14 be prohibited. This one I think is extremely 

 15 vague and scary because of the recklessness 

 16 standard that's associated with it. 

 17 Spoofing -- you know, our research 

 18 indicates that there are two administrative cases 

 19 at the FCC in 2004 and 2006 that describe spoofing 

 20 I think, as the professor from NYU illustrated, 

 21 associated with the NBBO environment. Hard to 

 22 imagine how that even applies to the futures world 
 177 

 1 or how it should be applied. So, I guess my 

 2 recommendation here would be not to be adopting 

 3 rules but to adopt clarification. 

 4 To the extent that there needs to be 

 5 more done to deal with disruption, the first 

 6 course of action should be to work with the 

 7 exchanges -- I guess that's sort of what the next 

 8 panel is about -- but to get them to address the 

 9 issues that you think are necessary. I mean, 

 10 Dodd-Frank did amend the core principle No. 4, 

 11 which is the core principle that has enhanced 

 12 language about not just the exchanges have the 

 13 responsibility to monitor, but now they have the 

 14 obligation to have the capacity and responsibility 

 15 to prevent manipulation and distortions and 

 16 disruptions in the market. And they talk about do 

 17 market surveillance compliance and enforcement 

 18 practices. So, I think that's really where the 

 19 attention should be directed, and if the exchanges 

 20 are not doing their job, then the CFTC has 

 21 recourse there. I don't see the idea of using the 

 22 threat of enforcement to be a helpful one for the 
 178 

 1 industry or for the CFTC or from the standpoint of 

 2 what Congress was trying to accomplish. 

 3 MR. GREEN: Micah Green with Patton 

 4 Boggs, and I've been in this building long enough 

 5 to know that the best way to establish a bona 

 6 fides at any meeting like this is to say I agree 

 7 with what Ken said. (Laughter) 

 8 But, seriously, I represent several 

 9 companies that are in the automated trading 

 10 business, as well as companies that are in the 

 11 brokering business and particularly consider 

 12 themselves potentially part of the swap execution 

 13 facility world. So, while I associate myself with 

 14 the remarks that have been talked about as it 

 15 relates to prescriptive versus principle based, 

 16 there needs to be enough clarity to have an 

 17 ability to comply with the rules. But if clarity 

 18 is so precise, you'll probably get it precisely 

 19 wrong, so there needs to be flexibility. You also 

 20 don't want to stifle innovation and the use of 

 21 technology to make markets more efficient and more 

 22 liquid and more transparent. Yet, at the same 
 179 

 1 time, you don't want such vagueness that it makes 

 2 it impossible to not only comply with but to 

 3 enforce. So, where that balance is -- I'm sure 

 4 all of us will be happy to comment on where you 

 5 come up with the balance. It's very difficult for 

 6 us to tell you exactly where that balance is. 

 7 But I do want to also reiterate 

 8 something that Ken touched on. You can't look at 

 9 each section of the statute in a silo, because 

 10 there's an interrelated nature to it. This is in 

 11 Title 7, the title dealing with derivatives. The 

 12 derivatives market is not the equity market; it's 

 13 not the futures market. It is a new marketplace 

 14 that's been designed by the statute, the 

 15 derivatives market, and that market is either 

 16 going to be cleared or uncleared. And uncleared 

 17 transactions can be executed one way, and cleared 

 18 transactions have to be executed in a precise way 

 19 as described by the statute. And that precise way 

 20 is a competitive environment but through 

 21 intermediaries -- but not a single intermediary -- 

 22 through exchanges or swap execution facilities. 
 180 

 1 It does not define a marketplace that is a 

 2 monopolistic, solid marketplace where execution 

 3 clearing and everything is wrapped up into one 

 4 place. It is a competitive environment, and the 

 5 rules, whatever they are, have to be consistent 

 6 with that competitive environment. 

 7 I know we're going to talk later about 

 8 putting responsibilities on execution facilities, 

 9 but I just think it's very important that as you 

 10 look at -- from a compliance standpoint, when you 

 11 look at the desired -- have flexibility enough to 

 12 encourage innovation and growth of the markets, 

 13 you also have to recognize that it is a different 

 14 marketplace than the traditional futures and the 

 15 traditional equity marketplace. 

 16 MR. SLOCUM: Hi, I'm Tyson Slocum. I 

 17 direct the Energy and Climate Program at Public 

 18 Citizen. For those unfamiliar with my 

 19 organization, we're a national, nonprofit group. 

 20 My salary and the operations of our organization 

 21 are funded by the generous contributions of over 

 22 120,000 families across the United States. These 
 181 

 1 members are typically not the Warren Buffetts of 

 2 the world but hardworking families who, from my 

 3 perspective, want access to energy prices that are 

 4 set in transparent functional ways. And I think 

 5 that advances in technology, not to sound like an 

 6 anti-technology lyddite here, but I think that 

 7 there can be no question that there have been 

 8 trading practices built upon very complex 

 9 algorithms and high-frequency trading practices 

 10 that exceed the ability of regulators to ensure 

 11 that my constituents have access to a transparent 

 12 marketplace. 

 13 And I think that we need to, rather than 

 14 get down in the weeds of trying to determine which 

 15 technologies are legitimate, which ones are 

 16 disruptive, and which ones are creating 

 17 competitive advantages for different firms, I 

 18 think we need to question whether or not these 

 19 advances in technologies employed with 

 20 high-frequency trading and these complex 

 21 algorithms are far beyond the ability of our 

 22 hardworking public servants at regulatory agencies 
 182 

 1 to be able to protect consumers from abusive 

 2 practices. 

 3 So, when I read about banks designing 

 4 algorithms mainly to attack their competitors' 

 5 algorithms, or where billions of dollars or 

 6 hundreds of billions of equities or commodities 

 7 are traded on autopilot at best, or at worst in 

 8 specific ways to create harm against their 

 9 competitors, I think we need to figure out where 

 10 this conflicts with the public interest. And 

 11 until we have regulators that are on equal footing 

 12 in terms of funding capabilities, in terms of 

 13 their access to technology, I don't think that we 

 14 should continue to allow these across-the-board, 

 15 high-frequency trading programs to continue. 

 16 Thank you. 

 17 MR. PEASE: Let's move to question No. 

 18 7, and we'll switch the order for question No. 7, 

 19 Should executing brokers have an obligation to 

 20 ensure the customer trades are not disruptive 

 21 trade practices in the similar circumstances of 

 22 the subparts of that question? And what -- let's 
 183 

 1 see -- 

 2 MR. HIGGINS: And in so doing, Micah -- 

 3 this is Mark Higgins for the people on the phone 

 4 -- one thing that you sparked in my head is that I 

 5 seem to interpret from your comments that there 

 6 may not be a one-size-fits-all disruptive practice 

 7 and instead there are nuances, if you will, 

 8 between marketplaces and the manner in which 

 9 trades are executed and are cleared. And so in 

 10 your comments to question 7 -- if you could try to 

 11 highlight some of the distinctions between them, 

 12 that would be helpful, but let's start with Tyson 

 13 if you have a response to question 7. 

 14 MR. SLOCUM: Yeah, well, I think that it 

 15 needs to be incumbent upon brokers and banks to 

 16 justify how their trading algorithm programs, how 

 17 their employment of high-frequency trading is 

 18 consistent with maintaining a transparent and 

 19 orderly market; and I think at this point, again, 

 20 the capabilities of the very competent enforcement 

 21 staff are being absolutely overwhelmed. And every 

 22 time that we think that we might have gotten a 
 184 

 1 handle on some of these very complex trading 

 2 schemes, the traders are always going to be 

 3 hundreds of steps ahead of regulators simply 

 4 because of the assets dedicated by banks and 

 5 brokers to ever increasingly complex trading 

 6 algorithms. And the question is, is it consistent 

 7 to allow these trading practices to flourish? Is 

 8 it consistent with the Commodity Exchange Act's 

 9 emphasis on ensuring transparent and orderly 

 10 markets? And I think that we've gotten smart -- 

 11 we've gotten too smart in terms of getting ahead 

 12 of ourselves in allowing the technologies to 

 13 dictate the pace of the markets rather than the 

 14 other way around. 

 15 MR. CUSIMANO: Sorry, excuse me, Micah? 

 16 MR. GREEN: Yeah. 

 17 MR. CUSIMANO: Just -- Jeremy Cusimano. 

 18 I would like to, if I could, add to this question 

 19 and for purposes of this discussion, if -- we're 

 20 referring to algorithmic traders or high-frequency 

 21 traders that may not necessarily deal with 

 22 executing brokers as an intermediary and where if 
 185 

 1 they have direct access, could you also include in 

 2 your discussion perhaps the role of the clearing 

 3 firms in this process in their pre-trade checks or 

 4 controls? 

 5 MR. GREEN: Yeah. Let me first just 

 6 respond a little bit to what Tyson said. I think 

 7 the goal of this statute and the goal of the CFTC 

 8 and the SEC and the goal of this roundtable and 

 9 the panel earlier today is to try to figure out 

 10 ways that you can route out disruptive trading 

 11 practices while not destroying a market structure 

 12 that actually has created a very low-cost, 

 13 efficient means of transacting, which ultimately, 

 14 if done properly and cleanly, benefits not only 

 15 the market participants involved in the 

 16 transaction but the consumers who openly consume 

 17 that product or commodity. So, I think everyone 

 18 agrees with that goal. If there's, God forbid, a 

 19 plane crash because of poor maintenance, you don't 

 20 shut down the air traffic control system and stop 

 21 flying; you figure out what the problem is, fix 

 22 the problem, and recognize that air travel is a 
 186 

 1 good thing for the economy overall. So, I think 

 2 it's a similar sort of thing. So, I think we all 

 3 share the same goal. The question is: How do you 

 4 do it and do it as precisely as possible so you 

 5 don't overshoot and have unintended consequences 

 6 that ultimately will cost everybody in the 

 7 marketplace whether you're a consumer or a trader 

 8 all the way across the line. 

 9 But, to get to the point I think, yes, 

 10 there is a slightly different dichotomy if you 

 11 have direct access. If you obviously go through 

 12 an intermediary and that intermediary is the only 

 13 place where you can transact that business, that 

 14 intermediary can see everything and to be able to 

 15 judge whether or not a practice is disruptive or 

 16 fraudulent because they see the breadth of the 

 17 marketplace. If it's a competitive environment, 

 18 in fact they can only see the marketplace that's 

 19 kind of within their school box. They can see 

 20 what's going in their schoolyard, but they can't 

 21 necessarily see what's going in the schoolyard of 

 22 a competitive execution platform or facility. 
 187 

 1 Only a regulator or a self-regulator can really do 

 2 that with the protection of antitrust and 

 3 whatever. 

 4 So, really, I think, you know, it really 

 5 becomes then a partnership between the customer 

 6 and the execution facility to the extent that the 

 7 execution facility has a series of rules that are 

 8 consistent with whatever the regs that come out of 

 9 this building are going to be. But that doesn't 

 10 mean that they can probe into what every client is 

 11 doing, because that client may be transacting 

 12 somewhere else as well. In fact, they may 

 13 actually be transacting somewhere else outside the 

 14 U.S., too. So, global coordination on this is 

 15 probably also an important thing. 

 16 So, I do think it becomes more 

 17 complicated because the marketplace that's been -- 

 18 this -- you know, that's been designed in 

 19 Dodd-Frank for the derivatives marketplace is a 

 20 competitive one, not a monopolistic-styled one. 

 21 MR. RAISLER: Ken Raisler. I think we 

 22 need to be extremely careful here. I think for 
 188 

 1 the same reasons we just finished discussing on 

 2 the last go-around about the vagueness of these 

 3 provisions and Professor's Lo's comment about not 

 4 even knowing when you look -- not -- you know, 

 5 unlike pornography, you don't even know disruptive 

 6 practice when you see it. Imposing these kinds of 

 7 obligations on an executing broker, particularly 

 8 after the fact when you decide that this was 

 9 disruptive under whatever that standard is and say 

 10 you should have known it before the trade was 

 11 executed is, I think, an extremely dangerous 

 12 development. 

 13 I think the same concern motivates me to 

 14 advocate a principle-based approach to this kind 

 15 of oversight rather than a rules-based specific 

 16 requirement to take into account that there are 

 17 different trading environments, that the customers 

 18 are different one from the other, that the 

 19 technology is continuing to evolve, and so 

 20 therefore trying to put a rigid structure around 

 21 it in a point in time is, in my view, constitutes 

 22 a mistake. 
 189 

 1 On the principle-based approach there 

 2 has been a lot of work done in this area both in 

 3 the context of direct market access and through 

 4 executing broker environments, and certainly there 

 5 is an understanding that the executing brokers 

 6 along with the exchanges and along with the algo 

 7 and high-frequency trader all have 

 8 responsibilities, and nobody should shirk from 

 9 those responsibilities to establish an 

 10 appropriately defined control environment. 

 11 The NFA has been working on that; the 

 12 exchanges have been working on that; and just to 

 13 promote the client here a little bit, the FIA has 

 14 been working on that. And the FIA has two 

 15 reports, both in 2010, one actually before the 

 16 flash crash, one more detailed after, market 

 17 access risk management recommendations, including 

 18 recommendations in the area of direct market 

 19 access. 

 20 To have as a responsibility, the 

 21 executing brokers deal with things like having a 

 22 kill button to stop trading; having pre-trade and 
 190 

 1 post-trade risk and position limits and controls; 

 2 having fat-finger quantity limits, repeated 

 3 automated execution throttles, and the like, all 

 4 set forth in the report. And then more recently, 

 5 along with their principle trader group members, 

 6 they've come up with recommendation for risk 

 7 controls for trading firms. And that process of 

 8 best practices continues to evolve in the 

 9 industry. 

 10 Certainly with the Commission's help, 

 11 the exchange's help, and the community's help I 

 12 think we can get to the right place. But 

 13 prescriptive rules is not the way to go. 

 14 MR. HIGGINS: Ken, just before we leave 

 15 you, because it relates to the FIA materials that 

 16 you talk about, part of Dodd-Frank section 747 

 17 also talks about the Commission's ability to 

 18 promulgate rules that are reasonably necessary to 

 19 prohibit disruptive trading practices, and so is 

 20 what you're talking about that latter category of 

 21 747? And if so, would you, the FIA -- or if 

 22 anybody has a thought on this -- support and be 
 191 

 1 proponents of a requirement that market 

 2 participants, whoever they may be, institute 

 3 programs to ensure that their trading is not 

 4 disruptive, not necessarily getting to that level 

 5 of granularity that folks seem to want to avoid to 

 6 give flexibility for their various systems but 

 7 something more general but have it be a 

 8 requirement such that if you don't have that, 

 9 you're in violation? 

 10 MR. RAISLER: Certainly, our -- on 

 11 behalf of the FIA, I mean, our bias would be 

 12 toward looking at working with the exchanges as 

 13 members of those environments. We have 

 14 obligations that they impose and that that again 

 15 is the concept of having a reasonable control 

 16 environment pursuant to whatever the evolving 

 17 technologies are make sense, but it's much more 

 18 effective I think on a principle basis to do that 

 19 through an exchange interface or a SEF interface 

 20 or whatever the marketplace interface is rather 

 21 than having a rule coming out of the Commission. 

 22 I think the language on reasonable necessary also 
 192 

 1 has the word "may" before it, and so, you know, 

 2 I'm saying that if -- the Commission should step 

 3 in if it's convinced that the environment, the 

 4 community, the players, the traders, the brokers, 

 5 and the exchanges are not doing their job. In my 

 6 opinion, all of them have a very strong incentive 

 7 to do their job so I wouldn't think that would be 

 8 a necessary step for the CFTC to take. 

 9 MR. MOCEK: With regard to -- Greg 

 10 Mocek, with regard to imposing an obligation on 

 11 the broker to ensure the trades are not 

 12 disruptive, I don't think you need to impose that 

 13 obligation on the brokerage firm given the tools 

 14 that you already have. For example, you've got 

 15 aiding and abetting under section 13 that you 

 16 could use to go after a broker who actually is 

 17 participating in a scheme or as it was in the 

 18 past, willful now. With swaps it's reckless. 

 19 Under the new Dodd-Frank law, you can use that 

 20 tool in your toolbox to pursue misconduct, and if 

 21 it's their own employees, beyond the customer, you 

 22 can obviously use 166.3 as a (inaudible) supervise 
 193 

 1 employees or any other sections of the statute. 

 2 But I think what we're talking about 

 3 here is really not so much imposing an obligation 

 4 as they've been traditionally imposed on the 

 5 statute, but the discussion is imposing an 

 6 obligation of prevention. And that's a much 

 7 higher standard to be imposed upon the industry 

 8 where you actually have to prevent the disruptive 

 9 behavior however "disruptive" is defined. And I 

 10 don't think -- you know, to a large degree, that's 

 11 never been mandated under the statute, and it 

 12 creates practical implications because to say that 

 13 a FCM, for example, has an obligation to somehow 

 14 prevent disruptive trading practices in an algo, 

 15 if I'm running an FCM, I probably want to take a 

 16 good, hard look under the engine -- under the hood 

 17 and look at the engine to determine what that 

 18 algo's all about and maybe even have my PhDs look 

 19 at it. Well, that's not practical, because no one 

 20 wants to reveal, you know, the secret sauce. 

 21 So, I think in many ways it would be 

 22 really hard to mandate, and you already have 
 194 

 1 certain tools in your toolbox to use to go after 

 2 the activity. 

 3 MR. MECANE: This is Joe Mecane. I 

 4 think there's -- or I think about the question at 

 5 multiple levels. I think the first level is 

 6 around allowing customers direct access into 

 7 markets where they might not be a member, and what 

 8 seems prudent in that case is ensuring that there 

 9 isn't the ability for someone to circumvent, 

 10 exchange marketplace-type rules as a result of the 

 11 fact that they are not a direct member and they're 

 12 utilizing the membership of an executing broker. 

 13 And so ensuring that there's a standard in place 

 14 that encompasses rule adherence in that type of 

 15 executing broker-customer relationship is I think 

 16 one level. 

 17 The other level and where it obviously 

 18 gets more complicated is around customer 

 19 utilization of executing broker-supplied 

 20 algorithms and where the division falls in terms 

 21 of whether those algorithms could be disruptive to 

 22 the market or utilized in a way that is in fact 
 195 

 1 disruptive. 

 2 And I think there's a few levels to that 

 3 question also, and I would lump them into two 

 4 broad headings, one being algo development and the 

 5 other being algo utilization. And each of those 

 6 probably requires their own set of requirements 

 7 and their own set of principles that have to be 

 8 adhered to. 

 9 On the algo development side, clearly 

 10 the executing broker in that case should have some 

 11 standards applied to them in terms of -- and a lot 

 12 of those requirements already apply through 

 13 supervisory-type requirements, but at the same 

 14 time there is probably an opportunity to give more 

 15 clarity and to develop best practices and more 

 16 principle-based approaches that the executing 

 17 brokers could adopt in order to have certain 

 18 standards that as algorithms are developed they do 

 19 adhere to. 

 20 The utilization question is harder, 

 21 because that gets into training issues; it gets 

 22 into, you know, how do you ensure that once you 
 196 

 1 give the gun to someone they don't use it 

 2 inappropriately. 

 3 And those are the harder questions, and 

 4 I think in a way there's a feedback loop back to 

 5 the first point, because you could have standards 

 6 around ensuring that the customer using those 

 7 algorithms has some preventative measures or some 

 8 protections, pop-up windows, things along those 

 9 lines to let them know when they might have an 

 10 order that shouldn't pass some risk check or could 

 11 have a disruptive effect on the market. You know, 

 12 there could be standards imposed in terms of 

 13 training and utilization of algorithms, but 

 14 clearly, you know, going to the other extreme of, 

 15 you know, having a full-proof rule that 

 16 encompasses all different types of prohibited-type 

 17 utilization of algorithms that applies through to 

 18 the customer isn't a practical solution. 

 19 MR. LO: This is Andrew Lo. So, from my 

 20 perspective as a portfolio manager, I was always 

 21 taught that the reason they called them brokers is 

 22 all they do is they make you broker and broker. 
 197 

 1 (Laughter) So, it's not clear to me that imposing 

 2 the affirmative obligation for brokers to 

 3 determine whether or not a client is engaged in 

 4 disruptive behavior is even feasible, because it's 

 5 not clear that their expertise or their economic 

 6 interests are going to be focused in a direction 

 7 that will allow them to make that determination. 

 8 But I think the larger issue is one that 

 9 has been repeated on a number of occasions by 

 10 others on the panel, which is it's very difficult 

 11 to require that brokers have this obligation if we 

 12 don't define very clearly what disruptive trading 

 13 practices are. In particular, it seems to me that 

 14 there are two aspects of disruptive trading 

 15 practices that really need to be specified. One 

 16 is intent, and the second is a continuing pattern 

 17 of behavior. And I realize that these two 

 18 criteria raise the bar for any enforcement action, 

 19 but it seems to me that to get to the heart of 

 20 this issue of disruptive trading practices, you 

 21 have to have both, and it's not clear to me that 

 22 brokers are in a position to be able to make that 
 198 

 1 determination for all the reasons that were 

 2 described. 

 3 Let me just conclude with two very 

 4 concrete examples, because I think that it's very 

 5 difficult -- at least for me -- to talk about 

 6 disruptive trading practices without coming up 

 7 with some hypotheticals so that we can understand 

 8 what the motivation for this potential set of 

 9 rules might be. 

 10 One example is something that was 

 11 highlighted by the excellent report that was put 

 12 together by the joint CFTC-SEC project on the 

 13 Flash Crash of May 6, 2010. That report 

 14 highlights the fact that this so-called Flash 

 15 Crash had many different causes, and while the 

 16 media has focused on this single entity that 

 17 submitted a 75,000-contract sale order for SMP 

 18 E-minis the afternoon of May 6, the question is, 

 19 Was that considered disruptive? It certainly was 

 20 a disruptive market, and one could argue that if 

 21 the single entity did this recklessly and 

 22 intentionally that that was a disruptive trade. 
 199 

 1 But according to the joint CFTC-SEC report, that 

 2 entity had submitted the order in order to hedge a 

 3 large equity exposure. And we generally think of 

 4 hedging as a good thing for the clients. 

 5 So, it's not clear, even in that case of 

 6 the Flash Crash, and we know a great deal about 

 7 that day thanks to this joint report, whether or 

 8 not that would be considered a disruptive trade. 

 9 Second example is something that was 

 10 reported today in the Wall Street Journal. The 

 11 Wall Street Journal had an article that reported 

 12 that a single trader apparently controls between 

 13 50 to 80 percent of the London Metal Exchange's 

 14 copper stores among its warehouses. One trader 

 15 controls over half the inventory of copper today. 

 16 Now, is that considered a disruptive 

 17 trade? Certainly. If that trader has some 

 18 problem financing that position and has to unload 

 19 it, there's going to be serious repercussions for 

 20 that unwind. 

 21 But, on the other hand, we don't know 

 22 who the trader is; we don't know what the 
 200 

 1 intention of the trader is; we don't know what the 

 2 objective is. So, in both of these cases, I'm 

 3 arguing that there's enough vagueness and 

 4 ambiguity that it would it be virtually impossible 

 5 to require their brokers to make any kind of 

 6 affirmative determination of whether or not their 

 7 practices are disruptive. 

 8 Thank you. 

 9 MR. FABIAN: Mark Fabian. In response 

 10 to this question, I don't know that there's a need 

 11 for additional obligations from beyond what 

 12 currently exists for executing brokers with 

 13 respect to their customers. I mean, when you look 

 14 at the pre-trade controls or risk controls that 

 15 are out there, they stem from exchanges having 

 16 order size, position size, credit controls. If 

 17 the exchange level on accounts, then you go to the 

 18 clearing firms that have similar controls 

 19 implemented and even third-party front ends offer 

 20 different types of risk control. 

 21 So, from that perspective, there's a lot 

 22 of pre- trade controls that are out there at many 
 201 

 1 different levels, and I would say that in respect 

 2 to our ability to take action or regulate those 

 3 activities, we have -- as mentioned, exchanges 

 4 have supervisory rules that require that firms, 

 5 members, supervisor, employees -- very similar to 

 6 166.3 -- and we also have -- and also that it 

 7 applies not only to exchange members but anybody 

 8 that comes to an exchange with direct access signs 

 9 an agreement with an exchange that makes them 

 10 subject to the exchange rules as well. 

 11 And we also have rules that require that 

 12 if any of our clearing firms become aware of 

 13 actual or constructive knowledge that potential 

 14 trading practices -- illegal or improper trader 

 15 practice exists or may exist, they're also 

 16 required to notify the exchange. 

 17 So, I think there's a number of things 

 18 out there, from an exchange perspective, as well 

 19 as controls at the firm levels that -- you know, 

 20 as well as supervisory regulations -- that I think 

 21 at this point I don't know that there's any 

 22 additional obligation that's necessary on an 
 202 

 1 executing broker. 

 2 MR. PEASE: Dean, could I skip you since 

 3 you're since you're going to be on the next panel 

 4 and we're almost out of time and I wanted to let 

 5 Ike, who will not be on the next panel, speak? 

 6 MR. PAYTON: Sure. 

 7 MR. GIBBS: Sure, and I'll be brief on 

 8 this, because I think it's been pretty well 

 9 covered. But our position is, you know, the short 

 10 answer is no, we don't think that the executing 

 11 brokers should be in a position of having to be 

 12 the arbiter of whether a trade is disruptive or 

 13 not. 

 14 And I think Micah and Andrew have really 

 15 covered what I think are the two most important 

 16 points. First, in a competitive market it's 

 17 unlikely -- or it's highly likely that an 

 18 executing broker probably will not be able to see 

 19 the whole scope of information that could even 

 20 lead to that type of conclusion. And then I 

 21 think, even more importantly, if you read in an 

 22 element of intent, even if the broker saw the full 
 203 

 1 book of business, there will always be underlying 

 2 facts and circumstances that a broker, based on 

 3 just simple knowledge of what's in the book, would 

 4 not be able to come to a conclusion as to whether 

 5 something was disruptive or not. So, we really 

 6 think that, you know, at the end of the day, you 

 7 know, this is more of a fact- finding scenario 

 8 that has to do much deeper than just looking at 

 9 the executing broker as being kind of the 

 10 gatekeeper for whether something is disruptive or 

 11 not. 

 12 Thanks. 

 13 MR. PEASE: I think we're about out of 

 14 time on this panel, and the other panel will -- 

 15 some of you will be back on the next panel. I 

 16 want to thank you all very much for helping us to 

 17 address at least two of these questions here 

 18 today. Thank you again for your time, and we'll 

 19 take about a 15-minute break and then begin with 

 20 our last panel. 

 21 (Recess) 

 22 MR. HIGGINS: Okay, we'll get started in 
 204 

 1 a minute, so if folks want to grab their seats 

 2 that'd be great. 

 3 Okay, we're going to get started again. 

 4 This is our third and final panel. It's entitled 

 5 Exchange Perspective on Disruptive Trading, and 

 6 then also Potential New Disruptive Trading 

 7 Practices. For the folks on the phone, there's no 

 8 corresponding questions to this panel. Instead, 

 9 what we're going to try to do is generate a 

 10 dialogue, and we're going to start by asking a 

 11 somewhat provocative question, and that is, you 

 12 know, What are you observing on your markets that 

 13 is disruptive? And just sort of maybe start with 

 14 a non-exchange person. 

 15 Professor Lo, if you want to kick that 

 16 off. 

 17 MR. LO: Sure. Andrew Lo. So, from the 

 18 perspective of the academic research that's been 

 19 done, over the last 10 years there's been a 

 20 significant change in financial market dynamics 

 21 without a doubt. Part of that has to do with 

 22 advances in technology so that trading now happens 
 205 

 1 at the speed of light, and the combination of 

 2 algorithms, as well as the demand for the use of 

 3 those algorithms by institutions and individuals, 

 4 has really made markets far faster than we've ever 

 5 contemplated. At the same time, the growth of the 

 6 hedge fund industry has really changed the 

 7 dynamics of market prices in very different ways. 

 8 It used to be the case, say in 1998, 

 9 that the hedge fund industry was considered a bit 

 10 of a cottage industry, but over the last decade 

 11 we've seen enormous growth in assets as well as in 

 12 sophistication of hedge funds in deploying a 

 13 variety of different strategies. 

 14 One case in point is the comparison 

 15 between what happened during August of 1998 in the 

 16 wake of the LTCM debacle versus what happened in 

 17 August 2007, the so-called quant meltdown that 

 18 afflicted equity market neutral managers and 

 19 spread far beyond those markets shortly 

 20 thereafter. 

 21 In the first instance, August of 1998, 

 22 we had a liquidity crisis that really focused on 
 206 

 1 fixed income arbitrage trading. There was 

 2 virtually no spillover effect equity markets. 

 3 In 2007, we had a liquidity crisis due 

 4 to sub- prime mortgage problems, and the spillover 

 5 effects occurred in every corner of the financial 

 6 market. 

 7 In August of 2007, we had an equity 

 8 market unwind that created repercussions in a 

 9 variety of markets. But for many of us that were 

 10 trading in currency markets, our August 2007 

 11 occurred in July with the unwind of the carry 

 12 trade. 

 13 So, over the course of the last 10 

 14 years, the financial marketplace has gotten 

 15 extraordinarily crowded. That's a good thing in 

 16 one respect, because liquidity has been very high. 

 17 There's been a lot of market participation. But 

 18 at the same time, liquidity can be withdrawn at a 

 19 moment's notice. So, in that respect, the kind of 

 20 market dynamics that we see -- the May 6, 2010, 

 21 the so-called Flash Crash -- the consensus among 

 22 academics is that these kinds of events are not 
 207 

 1 anomalies, but they are becoming more and more 

 2 prevalent and they're likely to occur. And it's 

 3 really the confluence of a variety of forces that 

 4 have made the financial system much more 

 5 precarious than ever before, which is why in the 

 6 previous panel I argued that we focus not so much 

 7 on individual rulemaking activities among 

 8 regulatory agencies but, rather, focusing on the 

 9 systemic approach to try to understand how the 

 10 system has changed and what kinds of regulations 

 11 need to be put into place that deal with those 

 12 kinds of systemic exposures. 

 13 Thank you. 

 14 MR. HIGGINS: And, Joe, do you have any 

 15 thoughts on this issue? 

 16 MR. MECANE: Sure. I don't know that 

 17 I'd necessarily classify it as an issue yet, but 

 18 I'll highlight I guess one developmental aspect 

 19 that at least is a topical theme that we're 

 20 dealing with -- and, you know, stepping back, what 

 21 we've really seen evolve, especially on the equity 

 22 side, just given a lot of the developments that 
 208 

 1 Andrew referenced and some other items that we're 

 2 familiar with. But as technology has gotten more 

 3 and more prevalent in the space, as the cost of 

 4 technology has continued to increase, the speed at 

 5 which transactions happen just continues to reach 

 6 new levels. We've quickly gone from measuring 

 7 things in seconds to milliseconds to now 

 8 microseconds. Millionths of a second is the 

 9 amount of time duration that we're using to 

 10 measure quotes and transaction speeds. 

 11 At the same time, two parallel 

 12 developments have really been around quote 

 13 competition, meaning in the new world what 

 14 generally determines success especially among the 

 15 algorithms and the high-frequency trading 

 16 strategies has been getting to the inside first 

 17 and fastest. And compounding that, we've also 

 18 seen an explosion on the equity side and 

 19 increasingly on the option side, and just the 

 20 fragmentation across all the different venues. 

 21 And so what that all leads to when you put it all 

 22 together is just an explosion in message traffic, 
 209 

 1 which has truly been exponential over the last few 

 2 years. And I think there's been a lot of dialog, 

 3 a lot of public speculation about, you know, 

 4 quoting and do we need to slow down the markets, 

 5 et cetera, and I don't think that's really the 

 6 right issue that needs to be addressed. But I do 

 7 think there's two things that it raises. One is 

 8 just around capacity utilization in the industry 

 9 and some of the free-rider concerns that come 

 10 along with, you know, the fact that there isn't a 

 11 lot of cost, though. There isn't a lot of tax on 

 12 utilizing quotes and bandwidth and quoting very 

 13 frequently. 

 14 And then the second issue, which I think 

 15 is more of an issue for Tom Gira but is one that 

 16 we struggle with also, is surveilling the activity 

 17 in the markets and understanding -- you know, a 

 18 lot of the things that we were talking about on 

 19 the last panel in terms of putting standards in 

 20 place and having principles out there in terms of 

 21 what types of behaviors are permissible and non- 

 22 permissible is one aspect. 
 210 

 1 The second aspect from a regulatory 

 2 standpoint is once you have those principles in 

 3 place, how do you surveil for it? And with the 

 4 amount of traffic that exists, I don't think the 

 5 answer is to necessarily impact that amount of 

 6 traffic but just making sure that we have adequate 

 7 resources and capabilities to surveil for patterns 

 8 and practices. 

 9 MR. HIGGINS: And before we go to you, 

 10 Tom, I just want to ask you, Joe, do you think you 

 11 have the systems in place to drink from the fire 

 12 hydrants, so to speak? 

 13 MR. MECANE: I mean, I'll answer half 

 14 the question, and then Tom's organization does a 

 15 lot of the market surveillance work for us, so 

 16 I'll defer to him. But what I would say is on the 

 17 exchange side we've done, I'd say, two primary 

 18 things. One is we've put -- we have a lot of 

 19 procedures, requirements, rules in place that are 

 20 meant to minimize the amount of disruptive 

 21 behavior that can occur. So, we have a lot of 

 22 rules around the open, the close in terms of the 
 211 

 1 types of orders and the timing of orders, things 

 2 along those lines. We have LRPs or pauses when 

 3 something comes in that's disruptive. So, we have 

 4 things designed to catch items that might be 

 5 disruptive. 

 6 We also have a number of internal 

 7 monitoring tools where we look for normal 

 8 activity, things that might warrant referral to a 

 9 regulator or more investigation, but, you know, 

 10 not to put Tom on the spot but a lot of the day- 

 11 to-day market surveillance is done on our behalf 

 12 by FINRA. 

 13 MR. PEASE: Tom and when the other -- 

 14 Dean and Mark, when you also go -- we've heard a 

 15 lot today about how very few understand what the 

 16 disruptive trading practices are that are 

 17 specified in Dodd-Frank, but do you survey for 

 18 these regardless of whether you understand them or 

 19 not? And are there other areas that you do 

 20 surveillance on or other areas, as Mark has 

 21 indicated, where you want to -- where do you see 

 22 it going next in terms of potentially disruptive 
 212 

 1 practices that we should be on the lookout for? 

 2 MR. GIRA: This is Tom Gira speaking, 

 3 and again maybe this is a little bit of background 

 4 about FINRA, and admittedly this is going to have 

 5 kind of a securities bent to it. So, it may not 

 6 be, you know, completely applicable on a futures 

 7 site. But, what we've seen is the real 

 8 fragmentation of the market on the equity side, 

 9 and along with that, though, over the last couple 

 10 of years at least, we started to see some 

 11 consolidation on the regulatory side. So, for a 

 12 variety of reasons, both the NASDAQ stock market 

 13 and recently the New York Stock Exchange have made 

 14 decisions to outsource their surveillance 

 15 obligations to FINRA. And so by doing that, we 

 16 now have a window into 80 percent of the equity 

 17 market. And so what that allows us to do is to 

 18 frankly see a larger part of the elephant. I 

 19 think in the past, every exchange was kind of 

 20 looking at it independently, and I think you do 

 21 see, unlike on the futures side, there's a lot 

 22 more multiple trading, there's a lot more 
 213 

 1 cross-market trading by participants. And because 

 2 of that, you know, in the first panel there was 

 3 some -- you know, I think it is a lot different 

 4 when you're talking about a market where you have 

 5 one order book and then just kind of one market 

 6 based (inaudible). It's substantially different I 

 7 think when you've got the ability for market 

 8 participants to, for example, try to impact a 

 9 closing spin on one market by putting orders in on 

 10 another market knowing that those orders will be 

 11 reacted to, and then you get a (inaudible) 

 12 execution on the market that you were -- that you 

 13 have your closing order in. 

 14 And so what we find is that firms are, 

 15 in some cases -- and it's a spectrum. I think 

 16 most firms, you know, have adequate procedures in 

 17 place and are trying to do the right thing, but 

 18 there are some firms that are consciously, I 

 19 think, trying to spread their activity across 

 20 multiple marketplaces to be under the radar 

 21 screen. And so we have brought -- and if you want 

 22 to call it spoofing, we did bring a case against 
 214 

 1 Trillium, which was called a layering case where 

 2 you had firms putting in kind of orders on side of 

 3 the market to try to, frankly, bait other algos to 

 4 react and then hit an order that was placed on the 

 5 other side of the market. And we are seeing that 

 6 increasingly. We're seeing variations of that. 

 7 We're seeing scenarios where rather than layering 

 8 with smaller orders, somebody might put it in a 

 9 very large block order that's away from the inside 

 10 so it doesn't have an execution risk, and they 

 11 might do some wash sales to make it look like that 

 12 block is getting executed, again trying to get 

 13 momentum in the marketplace. We've been able to 

 14 prosecute those cases using, you know, traditional 

 15 anti-fraud rules and anti-manipulation rules. 

 16 But one of the troubling things that we 

 17 are seeing in terms of patterns is direct market 

 18 access, and then so increasingly we're seeing some 

 19 firms that are setting up shop outside of the 

 20 U.S., and they have direct market access into the 

 21 U.S. and they're very, very aggressive, and so I 

 22 think the last panel where we were talking about 
 215 

 1 should there be obligations on the executing 

 2 brokers -- I think -- again, with the securities 

 3 experience I think our -- that I would be -- you 

 4 know, sometimes it's almost like executing brokers 

 5 are aiding and abetting and kind of facilitating 

 6 that activity. So we do think it's very important 

 7 that they're kind of -- that gatekeeper there. 

 8 So, I think it's a different set of issues because 

 9 of the fragmented market, but we are seeing a lot 

 10 of activity that's preying on, frankly, the 

 11 disaggregation sometimes of the markets. And one 

 12 of the things that the Commission -- the SEC has 

 13 proposed that FINRA's been very supportive of is 

 14 the (inaudible) the New York Stock Exchange and 

 15 NASDAQ and (inaudible) markets as they have a 

 16 broader consolidated order trail, and so what 

 17 we've got now is pockets of audit trails that 

 18 aren't really linked. And so this consolidated 

 19 audit trail would impose, you know, a common 

 20 standard of capturing orders, trades, and quotes 

 21 across all marketplaces and having the same 

 22 moniker that would attach to a firm -- would 
 216 

 1 attach to that firm where it's trading on any 

 2 market so that you could more readily put together 

 3 the pieces of the puzzle as you're looking at the 

 4 activity of a firm or the activity of a customer. 

 5 MR. HIGGINS: Chris, if we can move to 

 6 you before we get to electric exchanges that are 

 7 here and ask you to respond wearing your NFA hat 

 8 -- if you would. 

 9 MR. HEYMEYER: Well, they -- from NFA's 

 10 perspective, the hard part here is what's 

 11 disruptive, right? And with regard to the members 

 12 of NFA, CTA, CPOs, introducing brokers, and FCMs, 

 13 it's very difficult for those companies to -- in 

 14 all due respect for the brokers to know what the 

 15 customers are doing, because the customers don't 

 16 want the broker to know what they're doing, and it 

 17 could be -- and the hard part is -- I'm not even 

 18 sure if I know it when I see it. If you get a big 

 19 order like the (inaudible) order, for the FCM to 

 20 question that order before it goes in, they could 

 21 be liable for questioning it because it's a hedge 

 22 order, right? So, why are you holding up our 
 217 

 1 order that's hedging for our public customers? 

 2 So, then it's really difficult for those 

 3 registered entities without the power of the data 

 4 that you can see and that the exchange on the 

 5 futures side of the exchanges can see to get -- to 

 6 see and to recognize something that looks either 

 7 abusive or disruptive. 

 8 MR. HIGGINS: But, Chris, let me draw an 

 9 analogy to retail banking, which folks will 

 10 probably be aware. If I try to move more than 

 11 $9,999 between accounts at a bank or try to 

 12 withdraw it, I trigger some sort of reporting 

 13 requirement to the bank and then to the 

 14 government. Should the executing broker not have 

 15 some sort of similar requirement where that, as 

 16 Tom was getting to, somebody with offshore 

 17 direct-market access or not using the executing 

 18 broker have some obligation without having to try 

 19 to necessarily identify what's disruptive? I 

 20 mean, certain things should, on their face, be 

 21 curious given past patterns and practices, and so, 

 22 you know, what liability should, if any, the 
 218 

 1 executing brokers have? 

 2 MR. HEYMEYER: Well, somebody comes in 

 3 with more than $9,000 in cash to a broker, they 

 4 have to report it to. That's one thing. But if 

 5 somebody wires out $3 million, they got the money 

 6 in their account, it's very difficult to 

 7 understand what they're doing. Now, certainly if 

 8 they're wiring money in and out into different 

 9 accounts, there's -- you would raise questions. 

 10 And it gets into practice, and it gets into 

 11 defining what's a disruptive practice. And that 

 12 gets -- there are a lot of laws in place now that 

 13 raise standards for the brokers to be aware of 

 14 certain activities they mentioned. There are 

 15 certain things that the brokers look for that 

 16 don't pass the smell test. If somebody's wiring 

 17 money in and out and it goes to a certain place 

 18 out of the country or something and it's got a 

 19 pattern to it. And they can see certain things 

 20 like that. But that -- the standards today -- it 

 21 would be very difficult to impose on the brokers a 

 22 standard for them to understand an abusive 
 219 

 1 practice without knowing what the whole book looks 

 2 like. It's very difficult to legislate that aside 

 3 from the basic standards that are in place today. 

 4 And it's just difficult to say, and it's easy to 

 5 sit and try and impose that kind of a standard on 

 6 the brokers, but it's -- and I've -- as I say, 

 7 I've cleared lots of people through my 20 years, 

 8 and I've seen a lot of things, and some of them I 

 9 would say have been something I didn't like and 

 10 we've gone after it and either asked them to go 

 11 someplace else or asked them to leave and they'd 

 12 go right down the street. And then I've seen them 

 13 go up and down the street. But that's -- it's a 

 14 difficult standard to try to prescriptively write 

 15 and define. That's all I'm saying, that you've a 

 16 challenge in trying to do it prescriptively. 

 17 MR. HIGGINS: And now let's move to our 

 18 exchanges, Dean and Mark, and when you opine on 

 19 this question, in particular I'd like to have you 

 20 not only talk about what you're seeing in your 

 21 market as disruptive but also how you address an 

 22 issue Tom raised, which is are you talking to each 
 220 

 1 other and if so how and how do you ensure that, 

 2 you know, one person's not doing something on ICE 

 3 to effect CME's position or a position they had on 

 4 CME and vice versa. So, thanks. 

 5 MR. PAYTON: Well, I think there's a 

 6 couple of places -- I'm sorry? Oh, sorry, this is 

 7 Dean Payton from CME Group. So, I think there's a 

 8 couple of issues, right? I think, one, when we 

 9 talk about disruption, I still believe that in 

 10 many people's mind when we talk about disruption 

 11 we're talking about price moves in the 

 12 marketplace, right? There's that type of 

 13 disruption, and there's the manipulative type of 

 14 disruption that we're talking about with some of 

 15 the articulated disruptive practices that are in 

 16 4(c), right? 

 17 On the risk side of the equation -- 

 18 right? -- it goes back to what Professor Lo was 

 19 talking about in terms of systemic risk -- 

 20 right -- to the broader marketplace, and I think 

 21 that, you know, if you look at how speed has 

 22 evolved even over the last five years -- right? -- 
 221 

 1 along with that the risk management capabilities 

 2 of firms and exchanges have evolved as well. 

 3 So, in terms of protecting against, you 

 4 know, those kinds of systemic issues, I mean, at 

 5 CME group today we have fewer error trades than 

 6 we've ever had, right? That's not by accident, 

 7 right? Volume is up. Participation is up, right? 

 8 But the number of error trades is down. And 

 9 that's because, you know, we've worked hard just 

 10 as other exchanges have to really put in place 

 11 technology that avoids the types of conduct that 

 12 could lead to disruption. 

 13 So, now, if you're doing the things on 

 14 an exchange level and the firms are doing what 

 15 they should be doing on a risk management level on 

 16 their side, a lot of the potential for 

 17 systemic-type of disruptive conduct really goes 

 18 away, at least in the context of, you know, the 

 19 idea that you're going to have an algorithm go 

 20 awry that's going to cause some, you know, 

 21 cataclysmic event in the marketplace, right? So, 

 22 if we're putting in place things like price 
 222 

 1 banding and protection points for market orders 

 2 and stop orders, we have maximum order quantities, 

 3 we have messaging throttles, we have stop logic 

 4 that, you know, pauses the market when there's a 

 5 transitory liquidity gap. 

 6 All those things taken together -- 

 7 right? -- impact what is happening in terms of the 

 8 ability for a particular player or a combination 

 9 of players to disrupt the market in that capacity. 

 10 That's not to say -- right -- that there's, you 

 11 know, any perfect way -- right? -- to prevent 

 12 every possible error in the marketplace, but I 

 13 think that if we're doing the things that we need 

 14 to do on the risk management side at every level 

 15 -- right? -- in that chain, then, you know, the 

 16 marketplace is going to be very well protected in 

 17 that regard. 

 18 And exchanges -- right? -- continue to 

 19 evolve. I mean, we just put our Globex credit 

 20 controls in place and made them mandatory in 2010, 

 21 right? There's another element of that going 

 22 into effect in 2011. People are continuing to 
 223 

 1 employ technology to actually monitor the 

 2 technology. So, you have algorithms monitoring 

 3 algorithms -- right? -- to ensure that, you know, 

 4 the inputs that are coming into these algorithmic 

 5 trading models, you know, aren't flawed in a way 

 6 that's going to cause issues there. 

 7 So, the risk side I think is very, very 

 8 critical, so we have technology. We do go in and 

 9 do things like clearinghouse risk management 

 10 reviews where they're going in to each of our 

 11 clearing firms -- right? -- on a regular basis, 

 12 talking to them about their risk management 

 13 practices, particularly in the arena of direct 

 14 access and obviously broader issues around 

 15 operational risk as well and credit risk. 

 16 So, I guess in short, the risk side of 

 17 things needs to be monitored -- right? -- very 

 18 effectively, and everybody has a role in that -- 

 19 right? -- from the customer to the clearing firm 

 20 to the exchange. 

 21 The other side of the equation that I 

 22 think 4(c) gets at, you know, more specifically, 
 224 

 1 are disruptive practices that really I think have 

 2 largely a manipulative bent to them, right? And I 

 3 think that from an exchange perspective, again we 

 4 have worked very hard to build and anticipate the 

 5 types of technology capabilities that we need in 

 6 order to police the markets effectively. 

 7 So, you know, whereas today we're taking 

 8 in 4- to 5 billion, you know, order and market 

 9 data messages a month -- right? -- it's only 

 10 because we built the infrastructure several years 

 11 ago to be able to take in that kind of data and be 

 12 able to work with that data very efficiently, very 

 13 quickly. We can look at that data, every audit 

 14 trail element on a real time basis -- right? -- at 

 15 every investigator in the analyst's desk, and 

 16 that's, you know, hugely powerful. But we're 

 17 always, you know, looking to continue to refine 

 18 those capabilities as well. I mean, we've built, 

 19 you know, new functionality, you know, over the 

 20 course of the last year that, you know, provides 

 21 us with live alerting capabilities. 

 22 So, on a real time basis, if a position 
 225 

 1 exceeds a particular threshold or somebody's 

 2 50-day moving average, we get immediate alerts. 

 3 Same on the volume side. We share that with our 

 4 clearinghouse risk management folks. We've now 

 5 built many capabilities to, you know, identify at 

 6 a very granular level both, you know, at a minute, 

 7 an hour, a day where there are volume and price 

 8 spikes, actually down to a second, where there are 

 9 volume and price spikes during the day. 

 10 And, you know, we have a whole slate of 

 11 additional, you know, programs that we're building 

 12 in 2011, so that's a constant process. I mean, I 

 13 think to -- Tyson had said earlier -- you know, he 

 14 suggested that the regulators are a hundred steps, 

 15 you know, behind where the trading community is. 

 16 But I don't think the fact that we have, you know, 

 17 a great deal of speed and a significant amount of 

 18 messaging if we built the right systems and have 

 19 the right audit trails that we can't reconstruct 

 20 that activity on a very, very granular basis. I 

 21 mean, we know, you know, who the users are in our 

 22 markets, what time they've made every click of the 
 226 

 1 mouse, or everything the black box did down to the 

 2 millisecond, and, you know, that allows you to 

 3 reconstruct what you need to reconstruct in order 

 4 to determine where there are issues. 

 5 Just quickly to the earlier question as 

 6 to kind of what kinds of things that, you know, 

 7 we're looking at in the context of our markets, 

 8 you know, there are things that we identify from 

 9 time to time that look like they're problematic, 

 10 and typically when we see those things we either 

 11 write a rule -- right? -- to address it or we put 

 12 out an advisory that relates to one of our current 

 13 rules. So, you know, for example, in the early 

 14 part of the year we had concerns about what was 

 15 going on during our pre-opening period and what, 

 16 you know, the indicative opening price that -- you 

 17 know, there appeared to be some potential game 

 18 playing during that period. So, we created an 

 19 advisory notice, put the marketplace on notice as 

 20 to what specific type of conduct we had concerns 

 21 with and that that we would prosecute under our 

 22 rules related to conduct inconsistent with just 
 227 

 1 and equitable principles of trade. And we put 

 2 that out to the community so they have clarity. 

 3 They're on notice. They know what the issues are 

 4 that the exchange is concerned about and will 

 5 prosecute. 

 6 Similarly, you know, we had an issue 

 7 with trading at settlement -- all right? -- and 

 8 this was really a structural issue, right? 

 9 Because of the way that the trading at settlement 

 10 worked -- right? -- there was a significant 

 11 advantage to being first in, right? It had a 

 12 FIFA-based algorithm, and so what we would see is 

 13 prior to the market opening, participants would be 

 14 sending in order messages, because as soon as that 

 15 window opened -- right? -- they wanted to be the 

 16 first in. So, what we would see is people sending 

 17 in a ton of messages in order to increase the 

 18 probability that they would be first in, and so as 

 19 soon as that window opened you'd have a ton of 

 20 messaging going in and you'd have, you know, 

 21 potential latency concerns during that period 

 22 where we saw the excessive messaging. So, we 
 228 

 1 looked at that, but again we addressed it through 

 2 rulemaking and advisory. We basically changed the 

 3 structure so that it's no longer permitted to 

 4 enter an order to the system -- right? -- until 

 5 after that state change message has been put out 

 6 by Globex. So, if you actually put an order in 

 7 before the state change goes to pre-open, that's a 

 8 violation of our rules. We'll see that, because 

 9 we see every rejected order -- right? -- that 

 10 comes to the exchange, and so the problem is 

 11 essentially solved, right? We no longer see the, 

 12 you know significant increase in messaging prior 

 13 to the pre-open. It doesn't have an effect on the 

 14 efficiency of, you know, of our data. 

 15 So, you know, there are other issues 

 16 like that. We've put out a new money pass rule -- 

 17 right? -- where we saw some issues related to 

 18 people passing money. We added clarity by putting 

 19 that rule out and making clear that that's not an 

 20 appropriate use of the marketplace. You know, we 

 21 certainly have things that we're continuing to 

 22 look at. I think that broadly would fall into 
 229 

 1 what might be considered spoofing -- right? -- and 

 2 I think that, you know, from our perspective it's 

 3 certainly much different in context than what's 

 4 played out, you know, in, you know, the revised 

 5 4(c) provisions. 

 6 MR. HIGGINS: And just on that point, 

 7 although spoofing was addressed earlier, you might 

 8 want to avail yourself of the opportunity to just 

 9 identify the differences, in your view, of 

 10 spoofing. 

 11 MR. PAYTON: Well, you know, I think 

 12 that the big thing is that again there needs to be 

 13 clarity that the idea that at the time you enter 

 14 an order if you don't have the intent to trade 

 15 that that's necessarily a violation. If you don't 

 16 clarify that, there's a host of, you know, orders 

 17 that would potentially go in that aren't going to 

 18 be executed -- right? -- that there's a 

 19 probability that they may not be executed. 

 20 You know, Gary was given an example 

 21 earlier about stop orders, but, you know, I may 

 22 have an order that I put in that is only going to 
 230 

 1 be executed under very specific circumstances and 

 2 very specific market conditions. If those change 

 3 -- right? -- and they could change in a 

 4 millisecond, five milliseconds, or five minutes -- 

 5 that order is going to be cancelled. There's 

 6 nothing inherently problematic about that. 

 7 But where you have situations that 

 8 somebody is entering an order that they don't 

 9 intend to execute with the specific intent to 

 10 mislead other market participants and then exploit 

 11 that deception for their own benefit -- right? -- 

 12 that's a situation where, again, we would look at 

 13 that and say, you know, this is conduct that is, 

 14 you know, potentially inconsistent with just and 

 15 equitable principles of trade or is uncommercial 

 16 and address that conduct accordingly. But, you 

 17 know, the difference there -- right? -- I think 

 18 is clearly the intent to deceive and to exploit 

 19 that deception. 

 20 MR. PEASE: So, you catch that on your 

 21 -- you would prosecute this on your catch-all 

 22 provisions. 
 231 

 1 MR. PAYTON: Correct. 

 2 MR. PEASE: Equivalent of manipulation 

 3 without needing -- you don't feel a need -- I 

 4 mean, your role is to identify the specific one, 

 5 for example, that are listed at 747. 

 6 MR. PAYTON: Now, that -- I think that's 

 7 correct, Bob. The only caveat I would say is 

 8 that, you know, there may be circumstances again, 

 9 as we've done in other cases, where if we identify 

 10 very specific conduct that we want to give clarity 

 11 to the marketplace about, then we would typically 

 12 do that through an advisory or a rulemaking. 

 13 MR. HIGGINS: And then just before we 

 14 move to Mark, if you could, Dean, talk a little 

 15 bit about how CME interfaces with other platforms 

 16 where people can execute trades. 

 17 MR. PAYTON: Yeah, I think that this is 

 18 certainly one of the challenges -- right? -- for 

 19 an SRO and is certainly something that we've 

 20 talked about with the Commission in the past that 

 21 we do think that where we're talking about 

 22 cross-market and cross-asset class issues that 
 232 

 1 that is an area that I think is important for the 

 2 federal agencies who have visibility into all of 

 3 that to look at. 

 4 That being said, we don't ignore that by 

 5 any stretch. I mean, we're obviously members of 

 6 the Intermarket Surveillance Group, which includes 

 7 all of the domestic and international securities 

 8 exchanges, as well as many of the futures 

 9 exchanges. We are able to -- in any matter that 

 10 we have, you know, particular concerns about, 

 11 we're able to share information with one another 

 12 and basically conduct the types of investigations 

 13 that we need to conduct. 

 14 I mean, the same is true, you know, and 

 15 we've dealt with this for obviously decades with 

 16 respect to cash market activity, right? If we see 

 17 something in our futures market -- right? -- that 

 18 is problematic and we think it's related or 

 19 potentially related to cash market activity, we 

 20 have the ability to go in from those participants 

 21 and get that related activity. 

 22 So, I think from an SRO perspective, 
 233 

 1 it's certainly not a perfect model. I mean, we 

 2 have great, great visibility into what's going on, 

 3 on our markets. We certainly have cooperation 

 4 from, you know, other markets that, you know, may 

 5 be impacted or related to the markets that we 

 6 trade, but there's a different level of visibility 

 7 than you have as a direct SRO. 

 8 MR. HIGGINS: Thank you. And now, Mark, 

 9 you're going to do cleanup for us here. 

 10 MR. FABIAN: Cleanup committee. I guess 

 11 I would start off by saying, you know, part of the 

 12 purpose that we're here today is there's an 

 13 ever-changing environment out there obviously, and 

 14 it seems to be accelerating from where it was 20 

 15 years ago. But in a regulatory world, and I know 

 16 Dean would probably agree with this, you know, 

 17 once you've identified an activity on an exchange 

 18 that seems to be problematic or is in violation of 

 19 the rules and you prosecute a few cases and you're 

 20 successful in that, then somebody comes up with a 

 21 new method or a new practice that becomes 

 22 problematic. And once you've identified that 
 234 

 1 practice and taken some actions on it, then the 

 2 focus may change. So, it's an ever- revolving 

 3 process and, you know -- 

 4 MR. HIGGINS: Let me just interrupt you, 

 5 because that sounds like so long as you're first 

 6 you get a free bite of the apple, and how do you 

 7 mitigate against that? 

 8 MR. FABIAN: No, I'm not saying that. 

 9 MR. HIGGINS: Okay. 

 10 MR. FABIAN: I mean, you know, you 

 11 identify the activity, and once, you know, these 

 12 cases have actions taken against them, it stops 

 13 with -- it's -- what I'm trying to get at is it's 

 14 a constantly changing environment. People are 

 15 constantly looking for new ways, you know, to come 

 16 up with different types of practices, and, you 

 17 know, until it becomes evident that it's a 

 18 problematic practice, you know, it will continue 

 19 to evolve like that I think, and that's not 

 20 necessarily true for the trading population as a 

 21 whole, but, you know, there's the one office out 

 22 there that, you know, engages in those types of 
 235 

 1 practices. So, what I'm trying to get at is the 

 2 exchange has to be constantly flexible. You have 

 3 to have rules that you can adapt in various 

 4 circumstances. Your systems have to be flexible. 

 5 You have to constantly review your systems to make 

 6 sure that you have the capacity to look for 

 7 different types of new trading that may surface or 

 8 you may hear about or learn about. 

 9 In terms of trying to mitigate effects 

 10 on markets from trading in those markets -- you 

 11 know, we've talked about price banding. Well, the 

 12 exchanges -- electronic exchanges have price 

 13 banding. We have certain types of orders, stops 

 14 with protections, stops with limits, market orders 

 15 that are limited by, you know, reasonability or 

 16 some other degree of price banding that helps to 

 17 mitigate the impact of orders on a market, buy-in 

 18 ratio policy. 

 19 We've talked about measuring the number 

 20 of messages that come in for a trade -- things of 

 21 that nature being spoke about their systems. We 

 22 have a number of systems -- T+1 systems -- that we 
 236 

 1 have developed over the past couple of years. 

 2 Obviously, you know, we've only been trading -- at 

 3 least speaking on behalf of ICE Futures U.S., 

 4 which was a completely open outcry system prior to 

 5 2007, we've developed systems over the past couple 

 6 of years that have improved our capacities 

 7 tremendously. 

 8 We recently implemented a tool that 

 9 allows us to look at the markets real time, replay 

 10 the markets real time, see the order book, and, 

 11 you know, get down to a very granular level of 

 12 detail in terms of the timing and even graphing of 

 13 the markets real time. 

 14 So, you know, like I said, it's 

 15 constantly changing. You're constantly trying to 

 16 adapt, and as Dean mentioned, you know, we have 

 17 many rules out there that already exist that we 

 18 use. We have a misconduct rule that's like a 

 19 catch-all. We have rules that prohibit 

 20 manipulation or attempted manipulation. We have 

 21 rules that prohibit fictitious bids and offers 

 22 both on the floor and electronically. So, you 
 237 

 1 know, there's a lot of tools at our disposal that 

 2 we can use to identify or at least prosecute 

 3 trading patterns that may come up from time to 

 4 time. 

 5 You mentioned certain new practices. 

 6 TAS is -- Trading at Settlement is a tool that we 

 7 began using -- and NYMEX I think had it prior to 

 8 us. Interestingly enough through communication 

 9 with NYMEX, when they learned that we were going 

 10 to start TAS trading, colleagues at NYMEX said, 

 11 you know, be careful, we've seen this in our 

 12 markets, you might want to preempt it by putting 

 13 out a notice. They gave us some, you know, advice 

 14 heads up on it. We put out a notice specific to 

 15 TAS, what we believed would constitute improper 

 16 trading with respect to trading at settlement. 

 17 So, similar to the CME when we identify 

 18 a trading pattern or activity that we think is 

 19 problematic, we put out advisories notifying 

 20 people what we think is wrong with it and the 

 21 potential for action and what types of rules we 

 22 would take action under or if we think there's a 
 238 

 1 new rule that needs to be put in place, we will do 

 2 so. 

 3 You know, one thing I would like to 

 4 point out. There's been some discussion 

 5 throughout the day about high-frequency algo 

 6 trading, and from our perspective we don't treat a 

 7 high-frequency algo trader any different than the 

 8 individual independent trader that's on our 

 9 platform using it. We view them all the same way. 

 10 One engages in an improper activity we're going to 

 11 go after them just as much as any other either 

 12 automated system or individual. 

 13 We also don't particularly put a lot of 

 14 focus on the closes. You know, when it comes to 

 15 disruptive trading practices, you want to look at 

 16 the whole bag. They could happen any time during 

 17 the day, and as I think was mentioned this 

 18 morning, you know, sometimes particularly during 

 19 the overnight periods when it's less liquid, you 

 20 know, there could be issues there. But that's not 

 21 to say that we don't look at the close; we 

 22 obviously do look at the close or the settlement 
 239 

 1 period for specific types of activity and we have. 

 2 And we have pursued cases there as well. 

 3 So, if I can answer any questions, I'd 

 4 be glad to. 

 5 MR. PEASE: Thank you. Professor, Lo, 

 6 I'd like to ask you a question. 

 7 You've cautioned us to go slowly in 

 8 identifying a procedure with any further 

 9 rulemakings on disruptive trading practices, and 

 10 that's good advice. But we have -- the Commission 

 11 has a number of options obviously that it can go 

 12 and a number of directions it can go in. Three 

 13 statutory provisions that we've talked about off 

 14 and on today will become effective whether the 

 15 Commission engages in the rulemaking or not one 

 16 year after the date of Dodd-Frank. Do you think 

 17 we should provide clarity to those three 

 18 provisions or leave them as the statute has them? 

 19 And if so, would you suggest any specific areas 

 20 that we should focus on? 

 21 MR. LO: This is Andrew Lo. Obviously 

 22 the Commission has a responsibility to respond to 
 240 

 1 the charges that it's been given, and so providing 

 2 clarity even to the extent of what may not be 

 3 covered would be just as useful as being able to 

 4 provide explicit guidelines as to what is covered. 

 5 So, certainly clarity I think is key in the proper 

 6 functioning of any kind of market environment. 

 7 But I hope that it doesn't stop there, 

 8 because I believe that this is an opportunity for 

 9 the Commission to go far beyond the simple 

 10 rulemaking activities that most regulatory bodies 

 11 engage in. And, in particular, it seems that 

 12 there's one innovation that could be 

 13 extraordinarily beneficial not only for this 

 14 particular instance but for many future instances, 

 15 and that is the ability to conduct forensic 

 16 investigations of issues that are going to be 

 17 emerging from time to time, because while 

 18 disruptive trading practices are difficult to 

 19 define, I think we all agree that having a 

 20 disruptive market is not in anybody's interest. 

 21 So there is an issue here, but the issue may not 

 22 be easily addressed by one or two rules, and so it 
 241 

 1 seems like the Commission has an opportunity to 

 2 address this on an ongoing basis. 

 3 In fact, in one sense, the Commission's 

 4 very mandate of maintaining open, competitive, and 

 5 financially sound markets is really the exact 

 6 opposite of disruptive markets, so in that sense 

 7 monitoring and addressing issues about disruptive 

 8 trading practices is something the CFTC's always 

 9 been charged to do. 

 10 But one way to respond explicitly to 

 11 Dodd-Frank, in addition to providing clarity on 

 12 the points that were raised, is to create a 

 13 permanent investigatory body much like the 

 14 National Transportation Safety Board that the CFTC 

 15 engages in forensic analysis, emerging issues that 

 16 could become disruptive trading practices and then 

 17 develops proposals of perhaps new rules or new 

 18 practices that addresses them. 

 19 For example, one of the issues that was 

 20 raised earlier was the fact that the single entity 

 21 on May 6 submitted an extraordinarily large sell 

 22 order of 75,000 contracts. Well, that's not 
 242 

 1 necessarily a disruptive trading practice from the 

 2 perspective of that individual, but it certainly 

 3 can disrupt the market. So, effectively what 

 4 we're saying is that markets have capacity limits. 

 5 Well, why is that such a surprise? If 

 6 we think about this room that we're in today, this 

 7 room has an occupancy limit and you're not allowed 

 8 to go over that; otherwise you violate the fire 

 9 code. The reason is that if there's a fire, it's 

 10 going to be awfully hard to get 500 people out of 

 11 this tiny room. Well, if there are capacity 

 12 limits for physical spaces, shouldn't there be 

 13 capacity limits for markets as well? And wouldn't 

 14 a simple solution be to post occupancy limits or 

 15 volume limits such that if you exceed them, 

 16 certain activities are prohibited or ultimately 

 17 curtailed to limit that kind of danger? 

 18 That's an example of a one-off decision 

 19 of a particular kind of disruptive trading 

 20 practice that can only come about from an analysis 

 21 of the data and a more logical deliberation as to 

 22 what particular kinds of practices you want to 
 243 

 1 limit. 

 2 The point is that these kind of 

 3 practices will change over time, and whether it's 

 4 spoofing or pinging or any number of practices 

 5 that could evolve over time, it's important to 

 6 have some kind of analysis on an ongoing basis. 

 7 So, one way to respond to this Dodd-Frank 

 8 initiative is to create that investigatory body so 

 9 that on an ongoing basis the CFTC can continue to 

 10 monitor these issues as they emerge. 

 11 MR. HIGGINS: Thank you. Any last 

 12 thoughts before we wrap up the final panel? Okay, 

 13 seeing no hands shoot into the air, we'll adjourn. 

 14 Thank you all for your time, and thanks to the 

 15 audience and the people who are on the telephone 

 16 as well. Thank you. 

 17 (Whereupon, at 3:31 p.m., the 

 18 PROCEEDINGS were adjourned.) 

 19 * * * * * 

 20 

 21 

 22 
 244 

 1 CERTIFICATE OF NOTARY PUBLIC 

 2 DISTRICT OF COLUMBIA 

 3 I, Irene Gray, notary public in and for 

 4 the District of Columbia, do hereby certify that 

 5 the forgoing PROCEEDING was duly recorded and 

 6 thereafter reduced to print under my direction; 

 7 that the witnesses were sworn to tell the truth 

 8 under penalty of perjury; that said transcript is a 

 9 true record of the testimony given by witnesses; 

 10 that I am neither counsel for, related to, nor 

 11 employed by any of the parties to the action in 

 12 which this proceeding was called; and, furthermore, 

 13 that I am not a relative or employee of any 

 14 attorney or counsel employed by the parties hereto, 

 15 nor financially or otherwise interested in the 

 16 outcome of this action. 

 17 

 18 

 19 ----------------------------------- 

 20 Notary Public, in and for the District of Columbia 

 21 My Commission Expires: April 14, 2011 

 22