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Futures & Derivatives April 2015 n Volume 35 n Issue 3 REPORT The CFTC’s Manipulative and Disruptive Trading Authority in an Algorithmic World BY KENNETH W. MCCRACKEN AND CHRISTINE SCHLEPPEGRELL Kenneth W. McCracken is a partner at Schiff Hardin LLP in its Washington D.C. offices in the firm’s Fi- nancial Markets & Products Group. Prior to joining private practice, Mr. McCracken was a Chief Trial At- torney at the Commodity Futures Trading Commission, where he was a member of the Manipulation and Disruptive Trading Squad and supervised investigations into, and litigation charging manipulation, disrup- tive trading and fraud. Christine Schleppegrell is an associate in the firm’s Washington D.C. office and a member of the Financial Markets & Products Group. The authors wish to acknowledge the generous assistance of Jacob Kahn, an associate in the firm’s Chicago office and a member of the Financial Markets & Products Group. The case summaries, analysis and discussions of the cases contained herein are based solely on the facts made publicly available. The views expressed in this article are those of the authors and do not necessarily reflect the views of other attorneys at Schiff Hardin LLP or of any clients of the firm. As a result of the Dodd-Frank Act,1 the Pursuant to amended Section 6(c)(1) of Commodity Futures Trading Commission the Commodity Exchange Act (CEA) and (“CFTC” or the “Commission”) has new Regulation 180.1, the CFTC’s Division of broader authority to prosecute manipula- Enforcement can now bring a civil action tion and disruptive trading in the derivative against any person who directly or indirectly and swaps markets. However, the commod- uses or employs (or attempts to use or em- ploy) intentionally or recklessly any manipu- The Journal on the Law of Investment & Risk Management Products The Journal ity and derivative industry’s increasing reli- ance on algorithmic trading systems makes lative or deceptive device or contrivance in the breadth of this authority challenging to connection with a swap, contract of sale of apply in a practical sense. This new author- any commodity in interstate commerce or 3 ity will be shaped as the courts continue to for future delivery. The CFTC maintains rule on actions brought by the Commission its traditional manipulation authority under in the future.2 During this period, it will be Section 6(c)(3) and Regulation 180.2, which challenging to operate a legally compliant require specific intent scienter, and asserts it trading company when the unpredictable CONTINUED ON PAGE 3 regulatory environment means waiting for lawsuits and investigations to learn if one’s REPRINT daily business and trading might be seen by Article its regulator as illegal. This article aims to Reprinted from the Futures & Derivatives Law guide practitioners and derivative trading Report. Copyright © 2015 Thomson Reuters. companies on how the Commission may For more information about this publication please visit legalsolutions.thomsonreuters.com wield its expanded authority. Futures & Derivatives Law Futures ARTICLE REPRINT April 2015 n Volume 35 n Issue 3 Futures & Derivatives Law Report © 2015 Thomson Reuters. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered, however it may not necessarily have been prepared by persons licensed to practice law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) 750-8400; fax (978) 646-8600 or West’s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651)687-7551. Please outline the specific material involved, the number of copies you wish to distribute and the purpose or format of the use. For subscription information, please contact the publisher at: [email protected] Editorial Board STEVEN W. SEEMER W. IAIN CULLEN DENNIS KLEJNA KENNETH M. RAISLER Publisher, West Legal Ed Center Simmons & Simmons New York, NY Sullivan & Cromwell London, England New York, NY RICHARD A. MILLER PETER Y. MALYSHEV Editor-in-Chief, Prudential Financial IAN CUILLERIER Latham & Watkins KENNETH M. ROSENZWEIG Two Gateway Center, 5th Floor, Newark, NJ White & Case LLP Washington, D.C., and New York, NY Katten Muchin Rosenman 07102 New York Chicago, IL Phone: 973-802-5901 Fax: 973-367-5135 ROBERT M. MCLAUGHLIN E-mail: [email protected] WARREN N. DAVIS Fried, Frank, Harris, Shriver & Jacobson LLP THOMAS A. RUSSO Sutherland Asbill & Brennan New York, NY American International Group, Inc. MICHAEL S. SACKHEIM Washington, D.C. New York, NY Managing Editor, Sidley Austin LLP CHARLES R. MILLS 787 Seventh Ave., New York, NY 10019 SUSAN C. ERVIN K&L Gates, LLP HOWARD SCHNEIDER Phone: (212) 839-5503 Davis Polk & Wardwell LLC Washington, D.C. Charles River Associates Washington, D.C. New York, NY Fax: (212) 839-5599 DAVID S. MITCHELL E-mail: [email protected] RONALD H. FILLER Fried, Frank, Harris, Shriver & Jacobson LLP LAUREN TEIGLAND-HUNT PAUL ARCHITZEL New York Law School New York, NY Teigland-Hunt LLP New York, NY Wilmer Cutler Pickering Hale and Dorr DENIS M. FORSTER RITA MOLESWORTH Washington, D.C. New York, NY Willkie Farr & Gallagher PAUL UHLENHOP CONRAD G. BAHLKE New York, NY Lawrence, Kamin, Saunders & Uhlenhop THOMAS LEE HAZEN Chicago, IL Strook & Strook & Lavan LLP University of North Carolina at Chapel Hill PAUL J. PANTANO New York, NY Cadwalader, Wickersham & Taft LLP SHERRI VENOKUR DONALD L. HORWITZ ANDREA M. CORCORAN Washington, D.C. Venokur LLC North American Derivatives Exchange New York, NY Align International, LLC Chicago, IL GLEN A. RAE Washington, D.C. Banc of America Merrill Lynch PHILIP MCBRIDE JOHNSON New York, NY Washington, D.C. Futures & Derivatives Law Report For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) 750-8400; fax (978) 646-8600 or West’s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) 687-7551. Please outline the specific material involved, the number of copies you West LegalEdcenter wish to distribute and the purpose or format of the use. 610 Opperman Drive This publication was created to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily Eagan, MN55123 prepared by persons licensed to practice law in a particular jurisdication. The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. © 2015 Thomson Reuters Copyright is not claimed as to any part of the original work prepared by a United States Government officer or employee as part of the person’s official duties. One Year Subscription n 11 Issues n $820.00 (ISSN#: 1083-8562) 2 © 2015 THOMSON REUTERS Futures & Derivatives Law Report April 2015 n Volume 35 n Issue 3 CONTINUED FROM PAGE 1 will be guided by the traditional four-part test for became effective on August 15, 2011 and, in rele- manipulation that was developed in case law aris- vant part, makes it unlawful for any person: ing under Section 6(c) and 9(a)(2).4 In actions that occurred post-Dodd-Frank, the CFTC has exercised in connection with any swap, or contract both its new manipulation authority (e.g. in the re- for sale of any commodity in interstate cent JPMorgan “London Whale” order), and its tra- commerce, or exchange-traded futures ditional manipulation authority (e.g. in the FX fix contract to intentionally or recklessly: (1) cases), as discussed further herein. Use or employ, or attempt to use or em- Further, the CFTC can now bring disruptive trad- ploy, any manipulative device, scheme, or ing actions pursuant to amended Section 4c(a)(5) of artifice to defraud; (2) Make, or attempt to the Commodity Exchange Act, making it unlawful make, any untrue or misleading statement for any person to engage in a trading practice that of a material fact or to omit to state a ma- (1) violates bids or offers, (2) intentionally or reck- terial fact necessary in order to make the lessly disregards the orderly execution of transac- tions during the closing period, or (3) is, or is of the statements made not untrue or misleading; character of, spoofing.5 (3) Engage, or attempt to engage, in any In an effort to guide practitioners and derivative act, practice, or course of business, which trading companies on the CFTC’s expanded author- operates or would operate as a fraud or ity, we first describe the Commission’s new author- deceit upon any person ....8 ity regarding a “manipulative or deceptive device or contrivance” and contrast it with the CFTC’s tra- Together, Section 6(c)(1) and Regulation 180.1 ditional authority to police market manipulation. “augment the Commission’s existing authority 9 Second, we discuss the CFTC’s new authority as it to prohibit fraud and manipulation.” The CFTC relates to disruptive trading. Third, we summarize has taken the position that this expanded author- the Commission’s recent enforcement actions under ity prohibits “manipulative and deceptive devices, Section 6(c)(1), Regulation 180, and Section 4c(a) i.e., fraud and fraud-based manipulative devices and (5), as well as recent matters brought by the CFTC contrivances employed intentionally or recklessly, under its traditional manipulation authority just pri- regardless of whether the conduct in question was 10 or to Dodd-Frank, including matters that appear to intended to create or did create an artificial price.” Additionally, practitioners and derivative trading have encompassed the trading actions now prohib- firms should be aware that the CFTC also takes a ited by Section 4c(a)(5).
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