2010-27547. Antidisruptive Practices Authority Contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Advance notice of proposed rulemaking; request for comments.

SUMMARY:

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amends section 4c(a) of the Commodity Exchange Act (“CEA”) in section 747 to expressly prohibit certain trading practices deemed disruptive of fair and equitable trading. The Commodity Futures Trading Commission (“Commission”) is issuing this advance notice of proposed rulemaking and request for public comment to assist the Commission in promulgating such rules and regulations to meet the requirements of section 747.

DATES:

Comments must be in writing and received by January 3, 2011.

ADDRESSES:

You may submit comments, identified by RIN number AD26, by any of the following methods:

• Agency Web site, via its Comments Online process: Comments may be submitted to: http://comments.cftc.gov. Follow the instructions for submitting comments on the Web site.
• Mail: David A. Stawick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
• Hand Delivery/Courier: Same as mail above.
• Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that is exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the established procedures in CFTC Regulation 145.9.^[1]

The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse or remove any or all of your submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT:

Robert Pease, Counsel to the Director of Enforcement, 202-418-5863, [e-mail], or Mark D. Higgins, Counsel to the Director of Enforcement, 202-418-5864, [e-mail], Division of Enforcement, Commodity Futures Trading Commission, Three Lafayette Centre, 1151 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).^[2] Title VII of the Dodd-Frank Act ^[3] amended the Commodity Exchange Act (“CEA”) ^[4] to establish a comprehensive new regulatory framework for swaps and security-based swaps. The legislation was enacted to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things: (1) Providing for the registration and comprehensive regulation of swap dealers and major swap participants; (2) imposing clearing and trade execution requirements on standardized derivative products; (3) creating robust recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight. Section 747 of the Dodd-Frank Act amends section 4c(a) of the CEA to add a new section entitled “Disruptive Practices.”

II. Solicitation for Comments About Disruptive Practices Pursuant to Dodd-Frank Act Section 747

In section 747 of the Dodd-Frank Act, Congress amended the CEA to expressly prohibit certain trading practices that it determined were disruptive of fair and equitable trading. Dodd-Frank section 747 amends section 4c(a) of the CEA to make it unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—

(A) violates bids or offers;

(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or

(C) is, is of the character of, or is commonly known to the trade as, “spoofing” (bidding or offering with the intent to cancel the bid or offer before execution).

Dodd-Frank section 747 also amends section 4c(a) by granting the Commission authority to promulgate such “rules and regulations as, in the judgment of the Commission, are reasonably necessary to prohibit the trading practices” enumerated in section 747 “and any other trading practice that is disruptive of fair and equitable trading.” The prohibition on the disruptive practices specified in new section 4c(a) will become effective 360 days after the enactment of the Dodd-Frank Act.

The Commission invites comment on all aspects of Dodd-Frank Act section 747. In particular, commenters are encouraged to address the following questions:

1. Should the Commission provide additional guidance as to the nature of the conduct that is prohibited by the specifically enumerated practices in paragraphs (A-C)?

2. With respect to the practice enumerated in paragraph (A)—violating bids and offers—how should the provision be applied in the context of electronic trading platforms with pre-determined order-matching algorithms that preclude a trader from executing an order against a quote other than the best one available? In particular, should the provision apply to “buying the board” in an illiquid market? ^[5]

3. How should the Commission distinguish between orderly and disorderly trading during the closing period as articulated in paragraph (B)? What factors should a factfinder consider in this inquiry?

4. How should “orderly execution” be defined? How should the closing period be defined? Should the definition of closing period include:

a. Daily settlement periods?

b. Some period prior to contract expiration?

c. Trading periods used to establish indices or pricing references?

5. Should the Commission recognize that a trading practice or conduct outside of the closing period is actionable so long as it “demonstrates intentional or reckless disregard for the execution of transactions during the closing period?”

6. Should (B) extend to order activity as well as consummated transactions?

7. Should executing brokers have an obligation to ensure that customer trades are not disruptive trade practices? If so, in what circumstances? What pre-trade risk checks should executing brokers have in place to ensure customers using their automated trading systems, execution systems or access to their trading platforms do not engage in disruptive trade practices?

8. How should the Commission distinguish “spoofing,” as articulated in paragraph (C), from legitimate trading activity where an individual enters an order larger than necessary with the intention to cancel part of the order to ensure that his or her order is filled?

9. Should the Commission separately specify and prohibit the following practices as distinct from “spoofing” as articulated in paragraph (C)? Or should these practices be considered a form of “spoofing” that is prohibited by paragraph (C)?

a. Submitting or cancelling bids or offers to overload the quotation system of a registered entity, or delay another person's execution of trades;

b. Submitting or cancelling multiple bids or offers to cause a material price movement;

c. Submitting or cancelling multiple bids or offers to create an appearance of market depth that is false.

10. Does partial fill of an order or series of orders necessarily exempt that activity from being defined as “spoofing”?

11. Are there ways to more clearly distinguish the practice of spoofing from the submission, modification, and cancelation of orders that may occur in the normal course of business?

12. Should the Commission specify an additional disruptive trading practice concerning the disorderly execution of particularly large orders during periods other than the closing period? If so, at what size should this provision become effective and how should the Commission distinguish between orderly and disorderly trading?

13. Should the Commission specify and prohibit other additional practices as disruptive of fair and equitable trading?

14. Should the Commission articulate specific duties of supervision relating to the prohibited trading practices articulated in paragraphs (A-C) (as well as any other trading practice that the Commission determines to be disruptive of fair and equitable trading) to supplement the general duty to supervise contained in Commission Regulation 166.3? To which entities should these duties of supervision apply?

15. Should the Commission consider promulgating rules to regulate the use of algorithmic or automated trading systems to prevent disruptive trading practices? If so, what kinds of rules should the Commission consider?

16. Should the Commission consider promulgating rules to regulate the design of algorithmic or automated trading systems to prevent disruptive trading practices? If so, what kinds of rules should the Commission consider?

17. Should the Commission consider promulgating rules to regulate the supervision and monitoring of algorithmic or automated trading systems to prevent disruptive trading practices? If so, what kinds of rules should the Commission consider?

18. Should the Commission promulgate additional rules specifically applicable to the use of algorithmic trading methodologies and programs that are reasonably necessary to prevent algorithmic trading systems from disrupting fair and equitable markets? If so, what kinds of rules should the Commission consider?

19. Should algorithmic traders be held accountable if they disrupt fair and equitable trading? If so, how?

When commenting on the above questions, please comment generally and specifically, and please include empirical data and other information in support of such comments, where appropriate and available, regarding any of the comments provided and please also take into account the statutory text of Dodd-Frank Act section 747, reprinted herein as follows:

Sec. 747. ANTIDISRUPTIVE PRACTICES AUTHORITY

Section 4c(a) of the Commodity Exchange Act (7 U.S.C. 6c(a)) (as amended by section 746) is amended by adding at the end the following:

“(5) Disruptive practices.—It shall be unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—

“(A) violates bids or offers;

“(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or

“(C) is, is of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).

“(6) Rulemaking authority.—The Commission may make and promulgate such rules and regulations as, in the judgment of the Commission, are reasonably necessary to prohibit the trading practices described in paragraph (5) and any other trading practice that is disruptive of fair and equitable trading.

“(7) Use of swaps to defraud.—It shall be unlawful for any person to enter into a swap knowing, or acting in reckless disregard of the fact, that its counterparty will use the swap as part of a device, scheme, or artifice to defraud any third party.”

Dated: October 26, 2010.

By the Commodity Futures Trading Commission.

David A. Stawick,

Secretary of the Commission.

Statement of Chairman Gary Gensler Anti-Disruptive Practices Authority Contained in Title VII of Dodd-Frank Wall Street Reform and Consumer Protection Act, October 26, 2010

I support the proposed Advanced Notice of Proposed Rulemaking concerning disruptive trading practices. Congress expressly prohibited three trading practices that it deemed were disruptive of fair and equitable trading. In addition, Congress granted the Commission authority to prohibit other trading practices that are disruptive of fair and equitable trading. Today's advanced notice of proposed rulemaking asks 18 questions, the answers to which will inform moving forward with a proposed rule on this issue. Commission staff also will lead a roundtable on December 2 on disruptive trading practices. I am particularly interested in hearing from the public on algorithmic trading. In addition to the public comments and the December 2 roundtable, we will benefit from the input of the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues.

Footnotes

1.  17 CFR 145.9.

2.  See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law No. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov./​LawRegulation/​OTCDERIVATIVES/​index.htm.

3.  Pursuant to Section 701 of the Dodd-Frank Act, Title VII may be cited as the “Wall Street Transparency and Accountability Act of 2010.”

4.  7 U.S.C. 1 et seq. (2006).

5.  Specifically, in a sufficiently illiquid market, a trader might enter an order for a large quantity at a price that is so far beyond the best available resting quote that the order executes against all resting quotes. In doing so, the trader would establish a new artificial best bid or offer that does not reflect market forces. See In re Henner, 30 Agric. Dec. 1151, 1155 (1971) (Defendant “bought the board”—accepted all outstanding offers—and then bid for a single contract well in excess of the previously prevailing price. He was sanctioned for manipulating the price of egg futures; the fact that he paid more than necessary for shell egg futures was the basis for finding an artificial price).