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CFTC Proposes Anti-Manipulation Rules to Implement Dodd-Frank
November 8, 2010
On October 26, the Commodity Futures Trading Commission (CFTC) proposed rules on market manipulation and false reporting implementing new statutory authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The proposed rules significantly expand the scope of the CFTC's authority to punish actual and attempted fraudulent and manipulative conduct and the making of false statements in the futures, derivatives and over-the-counter swaps markets. The new rules on market-manipulation are in some respects similar to and modeled upon the SEC's main anti-manipulation rule, Rule 10b-5, as well as the existing Federal Energy Regulatory Commission and Federal Trade Commission anti-manipulation rules based on Rule 10b-5.
The new rules will implement the revised Section 6(c) of the Commodity Exchange Act, as set forth in Dodd-Frank. One of the proposed rules will implement new Section 6(c)(1) of the Commodity Exchange Act, which will make it unlawful for any person in connection with any swap, sale contract of any commodity in interstate commerce or contact for future delivery to intentionally or recklessly use or employ (or attempt to use or employ) any manipulative device, scheme or artifice to defraud, or to make any untrue statement of material fact (or omission of material fact), or to engage in any act operating as a fraud; make or attempt to make any untrue or misleading statement of a material fact or omit to state a material fact necessary to make the statement not untrue or misleading; or to knowingly deliver false information concerning market conditions tending to affect the price of any commodity in interstate commerce. This new rule will overlap significantly with existing CFTC authority over manipulation and false reporting. For example, Commodity Exchange Act Section 9(a)(2) currently makes it unlawful to deliver false information tending to affect the price of interstate commodities. The CFTC also has pre-existing authority over manipulation of commodities markets.1 CFTC staff have characterized "fraud" as meaning conduct that impairs, obstructs or defeats a well-functioning market. Both staff and the Commissioners have emphasized that the new regulations and new sections of Dodd-Frank under which the regulations are promulgated are additive, and are not intended to alter existing CFTC regulations and authority.
One important aspect of the proposed rules is that the threshold intent standard used in the proposed rule is "intentionally or recklessly." At the meeting adopting the rules proposal, the commissioners and CFTC staff pointed out that this is not "recklessness" in the negligence context, but rather in the securities context, which staff described as a standard of "lesser intent" rather than "heightened negligence." Thus, intent can be inferred from "recklessness" for a violation of the new regulations, such that the requisite scienter can be based upon facts and circumstances rather than a showing of affirmative intent.
The proposed regulations are written broadly, and the various subsections of the rule on prohibition of manipulation could be read as being redundant. For example, the rule makes acts that "defraud" unlawful in one section, and makes acts that "operate as a fraud or deceit" unlawful in another. Further, the rules make the intentional or reckless making of false statements in connection with swaps or other jurisdictional transactions unlawful while a separate subsection would punish the knowing (or in disregard of falsity) making of a false report concerning market information tending to affect prices. Finally, in recognition of the caveat emptor nature of commodity markets, the rule makes clear that there is no obligation to provide any material non-public information.
The proposed rules leave the potential for the CFTC and courts to interpret these proscriptions very broadly, as the rules of construction call for regulatory language to be interpreted in a manner that removes any redundancy and invests separate meaning in separate sections. As such, if enacted as proposed these regulations are likely to have far-reaching consequences for market participants. In introducing these regulations, the Commission and its staff characterized the new rules are filling in existing gaps in jurisdiction, and suggested that many more successful enforcement actions will result from the enactment of these new regulations.
In addition to the regulation discussed above , the CFTC proposed a further explicit anti-manipulation rule which would make it unlawful to directly or indirectly manipulate (or attempt to manipulate) the price of any swap, or of any commodity in interstate commerce or for future delivery. Again, this anti-manipulation rule is noteworthy in that it expressly mentions "swaps" as transactions within the purview of the rule and appears to overlap with FERC and FTC authority over physical commodity transactions. Violations of the anti-manipulation rules, once final rules are promulgated and effective, would carry up to $1 million/day penalties, similar to FERC's anti-manipulation rules.
Less than a week after rolling out the anti-manipulation rules for comment, the CFTC announced the appointment of David Meister, a former federal prosecutor, as the agency's new Director of Enforcement. Mr. Meister has been characterized by reputation as an active and aggressive prosecutor, and Chairman Gensler announced his appointment with explicit reference to the new anti-manipulation provisions under Dodd-Frank. This appointment signals the CFTC's intention to move aggressively to implement and utilize its new anti-manipulation tools, along with the other enforcement powers granted to the agency under Dodd-Frank.
The public comment period on the new rules runs through January 3, 2011.