FR Doc 2010-27541[Federal Register: November 3, 2010 (Volume 75, Number 212)]

[Proposed Rules]

[Page 67657-67662]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr03no10-22]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 180

RIN Number 3038-AD27

Prohibition of Market Manipulation

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission is proposing rules to

implement new anti-manipulation authority in section 753 of the Dodd-

Frank Wall Street Reform and Consumer Protection Act. The proposed

rules expand and codify the Commission’s authority to prohibit

manipulation.

DATES: Comments must be received on or before January 3, 2011.

ADDRESSES: You may submit comments, identified by RIN number AD27, 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

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1 17 CFR 145.9.

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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 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, [email protected] or Mark D. Higgins,

Counsel to the Director of Enforcement, 202-418-5864,

[email protected], Division of Enforcement, Commodity Futures Trading

Commission, Three Lafayette Centre, 1151 21st Street, NW., Washington,

DC 20581.

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.

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2 See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

Dodd-Frank Act may be accessed at http://www.cftc.gov./

LawRegulation/OTCDERIVATIVES/index.htm.

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).

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In addition, Title VII of the Dodd-Frank Act contains expanded and

clarified authority to prohibit manipulative behavior.

Section 753 of the Dodd-Frank Act amends section 6(c) of the CEA to

expand the authority of the Commission to prohibit fraudulent and

manipulative behavior. New CEA section 6(c)(1), which prohibits the use

or employment of any manipulative or deceptive device or contrivance,

requires the Commission to promulgate implementing rules within one

year of enactment of the Dodd-Frank Act. The Commission also proposes

to implement regulations pursuant to section 6(c)(3) of the CEA under

its general rulemaking authority in section 8(a)(5) of the CEA.5

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5 7 U.S.C. 12a(5).

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Accordingly, the Commission is proposing rules to address

manipulative behavior. The Commission requests comment on all aspects

of the proposed rules, as well as comment on the specific provisions

and issues highlighted in the discussion below.

II. Manipulation Under Section 753

A. Section 753’s Amendments to the CEA

Section 753 of the Dodd-Frank Act gives the Commission enhanced

“anti-manipulation authority” as part of its expanded enforcement

powers. It does so by amending section 6(c) of the CEA in a number of

respects.

First, section 753 adds a new subsection (c)(1). Subsection (c)(1)

broadly prohibits fraud-based manipulative schemes as follows:

It shall be unlawful for any person, directly or indirectly, to

use or employ, or attempt to use or employ, in connection with any

swap, or a contract of sale of any commodity in interstate commerce,

or for future delivery on or subject to the rules of any registered

entity, any manipulative or deceptive device or contrivance, in

contravention of such rules and regulations as the Commission shall

promulgate by not later than 1 year after the date of enactment of

the Dodd-Frank Act, provided no rule or regulation promulgated by

the Commission shall require any person to disclose to another

person nonpublic information that may be material to the market

price, rate, or level of the commodity transaction, except as

necessary to make any statement made to the other person in or in

connection with the transaction not misleading in any material

respect.

[[Page 67658]]

In addition, section 753 adds subsections (c)(1)(A), (B), and (C).

Subsection (c)(1)(A) is a “Special Provision for Manipulation by False

Reporting.” This subsection provides that:

Unlawful manipulation for purposes of this paragraph shall

include, but not be limited to, delivering, or causing to be

delivered for transmission through the mails or interstate commerce,

by any means of communication whatsoever, a false or misleading or

inaccurate report concerning crop or market information or

conditions that affect or tend to affect the price of any commodity

in interstate commerce, knowing, or acting in reckless disregard of

the fact that such report is false, misleading or inaccurate.

Section 6(c)(1)(C) provides that “Good Faith Mistakes” in the

transmission of “false or misleading or inaccurate information to a

price reporting service would not be sufficient to violate subsection

(c)(1)(A).”

Subsection (c)(1)(B), captioned: “Effect on Other Law,” provides

that nothing in Dodd-Frank shall affect, or be construed to affect, the

applicability of CEA section 9(a)(2). Section 9(a)(2) is a provision in

the CEA prohibiting, among other things, market manipulation and false

reporting.6

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6 7 U.S.C. 13(a)(2) states that it shall be a felony

punishable by a fine of not more than $1,000,000 or imprisonment for

not more than 10 years, or both, together with the costs of

prosecution, for [a]ny person to manipulate or attempt to manipulate

the price of any commodity in interstate commerce, or for future

delivery on or subject to the rules of any registered entity, or to

corner or attempt to corner any such commodity or knowingly to

deliver or cause to be delivered for transmission through the mails

or interstate commerce by telegraph, telephone, wireless, or other

means of communication false or misleading or knowingly inaccurate

reports concerning crop or market information or conditions that

affect or tend to affect the price of any commodity in interstate

commerce, or knowingly to violate the provisions of section 4,

section 4b, subsections (a) through (e) of subsection 4c, section

4h, section 4o(1) or section 19.

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Dodd-Frank Act section 753 also adds a new CEA section 6(c)(2),

which is a “Prohibition Regarding False Information.” A prohibition

regarding false information was previously in section 6(c) of the

CEA,7 but Dodd-Frank Act section 753 revises it to include not only

false statements made in registration applications or reports filed

with the Commission but now also any statement of material fact made to

the Commission in any context. New section 6(c)(2) reads as follows:

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7 7 U.S.C. 9, 15; see also Section 9(a) of the CEA, 7 U.S.C.

13(a)(2).

It shall be unlawful for any person to make any false or

misleading statement of a material fact to the Commission, including

in any registration application or any report filed with the

Commission under this Act, or any other information relating to a

swap, or a contract of sale of a commodity, in interstate commerce,

or for future delivery on or subject to the rules of any registered

entity, or to omit to state in any such statement any material fact

that is necessary to make any statement of a material fact made not

misleading in any material respect, if the person knew, or

reasonably should have known, the statement to be false or

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misleading.

Finally, section 753 creates a new CEA section 6(c)(3), entitled

“other manipulation.” 8 This provision provides that “[i]n

addition to” the prohibition in section 6(c)(1):

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8 While this is a new statutory provision, the conduct

prohibited is generally prohibited by CEA section 9(a)(2).

it shall be unlawful for any person, directly or indirectly, to

manipulate or attempt to manipulate the price of any swap, or of any

commodity in interstate commerce, or for future delivery on or

subject to the rules of any registered entity.

B. Overview of the Commission’s Proposed Rules Under Section 753

The Commission proposes two rules under section 753. The first rule

would be promulgated pursuant to new CEA section 6(c)(1), under which

rulemaking is mandatory and must be completed within one year after the

date of enactment of the Dodd-Frank Act (July 21, 2010). The second

rule would be promulgated pursuant to new section 6(c)(3), and is

proposed pursuant to the Commission’s general rulemaking authority

under section 8(a)(5) of the CEA.

The remaining provisions of section 753, including provisions

prohibiting false reporting and information, are self-actuating; no

rulemakings are needed to implement them. These new provisions will be

automatically effective one year from the date of enactment of the

Dodd-Frank Act. The Commission’s authority under CEA section 9(a)(2) is

not affected by new sections 6(c)(1) or (3).

1. Section 6(c)(1)

The text of CEA section (c)(1) is patterned after section 10(b) of

the Securities Exchange Act of 1934 (“Exchange Act”).9 Exchange Act

section 10(b) has been interpreted as a broad, “catch-all”

prohibition on fraud and manipulation.10 Likewise, the Commission

proposes to interpret CEA section 6(c)(1) as a broad, catch-all

provision reaching fraud in all its forms–that is, intentional or

reckless conduct that deceives or defrauds market participants.

Subsection (c)(1) is also similar to the anti-manipulation authority

granted to the Federal Energy Regulatory Commission (“FERC”) in

sections 315 and 1283 of the Energy Policy Act of 2005, amending the

Natural Gas Act and the Federal Power Act, respectively,11 and the

Federal Trade Commission (“FTC”) in sections 811 and 812 of the

Energy Independence and Security Act of 2007.12

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9 15 U.S.C. 78j(b).

10 Chiarella v. United States, 445 U.S. 222, 226 (1980)

(“Section 10(b) was designed as a catch-all clause to prevent

fraudulent practices”).

11 Energy Policy Act of 2005, Public Law 109-58, Sec. Sec.

315, 1283, 119 Stat. 594 (2005) (amending 15 U.S.C. 717c-1; 16

U.S.C. 824v).

12 Energy Independence and Security Act of 2007, Public Law

110-140, Sec. Sec. 811, 812, 121 Stat. 1492 (2007) (amending 42

U.S.C. 17301, 17302).

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The SEC promulgated Rule 10b-5 to implement section 10(b) of the

Exchange Act.13 The FERC and the FTC have promulgated rules based on

SEC Rule 10b-5 to implement their respective statutory anti-

manipulation authority, but have modified SEC Rule 10b-5 as appropriate

to reflect their distinct regulatory missions and responsibilities.14

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13 17 CFR 240.10b-5.

14 18 CFR Part 1c (FERC Rules prohibiting energy market

manipulation); 16 CFR Part 317 (FTC Rule prohibiting energy market

manipulation).

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Guided by section 6(c)(1)’s similarity to Exchange Act section

10(b), the Commission proposes an implementing rule that is also

modeled on SEC Rule 10b-5, with modification to reflect the CFTC’s

distinct regulatory mission and responsibilities.

2. Section 6(c)(3)

Before enactment of the Dodd-Frank Act, the Commission charged

manipulation and attempted manipulation under CEA sections 6(c), 6(d),

and 9(a)(2).15 In Dodd-Frank, Congress provided a direct statutory

prohibition on manipulation of prices of swaps, futures contracts, and

commodities. The Commission proposes a rule under its general

rulemaking authority, section 8(a)(5) of the CEA that mirrors the text

of new CEA section 6(c)(3). The Commission proposes to continue

interpreting the prohibition on price manipulation and attempted price

manipulation to encompass every effort to improperly influence the

price of a swap, commodity, or commodity futures contract.

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15 As stated above, the amendments to CEA section 6 do not

affect the Commission’s authority under section 9(a)(2).

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C. The Proposed Rule Under CEA Section 6(c)(1)

Pursuant to section 6(c)(1) of the CEA, as added by section 753(a)

of Dodd-Frank, the Commission proposes to add a new Part 180.

[[Page 67659]]

As stated in proposed Sec. 180.1 (as set forth in the regulatory

text of this proposed rule), the proposed rule is modeled, in part, on

SEC Rule 10b-5, with modification to account for the unique regulatory

mission of the CFTC. The discussion below is intended to give notice of

how the Commission intends to interpret the elements of the

Commission’s proposed rule.

1. Manipulative or Deceptive Device or Contrivance

One purpose of the Commodity Exchange Act is to “deter and prevent

price manipulation or any other disruptions to market integrity.” 16

The Commission has historically relied upon multiple provisions of the

CEA, including section 9(a)(2) and old section 6(c), to prevent and

deter price manipulation of commodities in interstate commerce or for

future delivery through administrative and civil enforcement

actions.17 Section 9(a)(2) makes it unlawful for any person “to

manipulate or attempt to manipulate the price of any commodity in

interstate commerce, or for future delivery * * *” 18 The Dodd-Frank

Act preserves this purpose and the Commission’s authority to pursue

instances of price manipulation and attempted price manipulation by

making clear in new section 6(c)(1)(B) that nothing in section 6(c)(1)

affects the applicability of section 9(a)(2), and by adding new section

6(c)(3), both of which are classified as anti-manipulation provisions.

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16 7 U.S.C. 5(b) (2006).

17 In case law, “[t]he Commission has long recognized that

the intent to create an artificial price is the sine qua non of

manipulation.” In re Sumitomo Corporation, [1996-1998 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ] 27,327 at 46,499 (CFTC May 11,

1998), citing In re Indiana Farm Bureau Cooperative Assoc., Inc.,

[1982-1984 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 21,796 at

27,282 (CFTC Dec. 17, 1982).

18 7 U.S.C. 13(a)(2).

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The scope of new section 6(c)(1) differs from that of sections

9(a)(2) and 6(c)(3) in that it prohibits the use or employment of “any

manipulative or deceptive device or contrivance” in connection with

any swap, or a contract of sale of any commodity in interstate

commerce, or for future delivery. For example, this provision has been

interpreted in the SEC Rule 10b-5 context as prohibiting all practices

“that are intended to mislead investors by artificially affecting

market activity.” 19 Consistent with judicial interpretations of the

scope of SEC Rule 10b-5, the Commission proposes that subsection (c)(1)

be given a broad, remedial reading, embracing the use or employment, or

attempted use or employment, of any manipulative or deceptive

contrivance for the purpose of impairing, obstructing, or defeating the

integrity of the markets subject to the jurisdiction of the

Commission.20

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19 Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 494

(1977).

20 See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 202-

03 (1976) (holding section 10(b) of the Securities Exchange Act of

1934 [15 U.S.C. 78j(b)] and SEC Rule 10b-5 thereunder [17 CFR

240.10b-5], on which section 753(c)(1) and the proposed rule are

modeled, contain “catch-all” clauses that prohibit all fraudulent

securities trading schemes, whether typical or novel); SEC v.

Zandford, 535 U.S. 813, 819 (2002) (stating section 10(b) of the

Exchange Act, “should be construed not technically and

restrictively, but flexibly to effectuate its remedial purposes”)

(internal citations and quotations omitted); Superintendent of Ins.

of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6, 12 (1971)

(noting that section 10(b) of the Exchange Act “must be read

flexibly, not technically and restrictively”); Dennis v. United

States, 384 U.S. 855, 861 (1966) (noting that fraud within the

meaning of a statute prohibiting conspiracy to defraud the United

States, 18 U.S.C.A. Sec. 371, need not be confined to the common

law definition of fraud: Any false statement, misrepresentation or

deceit. Instead, fraud “reaches any conspiracy for the purpose of

impairing, obstructing or defeating the lawful function of any

department of Government”) (internal quotations and citations

omitted); United States v. Richter, 610 F.Supp. 480 (N.D. Ill.

1985), affirmed, United States v. Mangovski, 785 F.2d 312 (7th Cir.

1986), affirmed, United States v. Konstantinov, 793 F.2d 1296 (7th

Cir. 1986). See also FERC, Prohibition of Energy Market

Manipulation, 71 FR 4244, 4253 (Jan. 26, 2006) (“[f]inal rule

prohibits the use or employment of any device, scheme, or artifice

to defraud. The Commission defines fraud generally, that is, to

include any action, transaction, or conspiracy for the purpose of

impairing, obstructing or defeating a well-functioning market”)

(citations omitted).

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2. Scienter

The Commission proposes that, consistent with the Supreme Court’s

interpretation of Exchange Act section 10(b) and SEC Rule 10b-5, a

person must act with “scienter” in order to violate subsection

6(c)(1) of the CEA and the Commission’s implementing rule.21

“Scienter” in this context refers to a mental state embracing intent

to deceive, manipulate or defraud, and it includes recklessness.22

Just as negligent conduct, even gross negligence, will not satisfy the

scienter requirement under Exchange Act section 10(b) and SEC Rule 10b-

5 (nor under the anti-fraud provision in CEA section 4b),23 the

Commission similarly proposes that only intentional or reckless conduct

may violate CEA subsection 6(c)(1) and the Commission’s implementing

rule. Moreover, the Commission proposes that judicial precedent

interpreting and applying Exchange Act section 10(b) and SEC Rule 10b-5

in the context of the securities markets should guide, but not control,

application of the scienter standard under subsection 6(c)(1) and the

Commission’s implementing rule. The Commission believes that sufficient

leeway must be given to permit application of the scienter standard

under subsection 6(c)(1) and the Commission’s implementing rule in a

manner that comports with the purposes of the CEA and the functioning

of the markets regulated by the CFTC. Therefore, application of the

proposed scienter standard under subsection 6(c)(1) and the

Commission’s implementing rule will be tailored to the facts and

circumstances of each case.

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21 Ernst, 425 U.S. at 192-93 (holding that scienter is

required for private actions for damages under Section 10(b) and SEC

Rule 10b-5); Aaron v. SEC, 446 U.S. 680, 691 (1980) (applying Ernst

to SEC action for injunctive relief under same provisions, and

holding that its rationale “ineluctably leads to the conclusion

that scienter is an element of a violation of Sec. 10(b) and SEC

Rule 10b-5, regardless of the identity of the plaintiff or the

nature of the relief sought”); See also Drexel Burnham Lambert,

Inc. v. CFTC, 850 F.2d 742, 748 (DC Cir. 1988) (applying same

requirement to the general fraud provision in section 4(b) of the

CEA, 7 U.S.C. 6(b)).

22 See, e.g., Ernst, 425 U.S. at 193; Hoffman v. Estabrook &

Co., 587 F.2d 509, 516-17 (1st Cir. 1978); Grebel v. FTP Software,

Inc., 194 F.3d 185 (1st Cir. 1999); Novak v. Kasaks, 216 F.3d 300,

308 (2d Cir. 2000); In re Advanta, 180 F.3d 525, 535 (3d Cir. 1999);

Ottman v. Hangar, 353 F.3d 338, 343-44 (4th Cir. 2003); Nathenson v.

Zonagen Inc., 267 F.3d 400, 408 (5th Cir. 2001); In re Comshare,

Inc. Securities Litig., 183 F.3d 543, 550 (6th Cir. 1999);

Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th

Cir. 1977); Fla. State Bd. of Admin. v. Green Tree Fin. Corp., 270

F.3d 645, 654 (8th Cir. 2001); In Re Silicon Graphics Sec. Litig.,

183 F.3d 970, 977 (9th Cir. 1999); Howard v. Everex, 228 F.3d 1057,

1064 (9th Cir. 2000); City of Philadelphia v. Fleming Cos., 264 F.3d

1245, 1258, 1260 (10th Cir. 2001); Bryant v. Avardo Brands, Inc.,

187 F.3d 1271, 1282 (11th Cir. 1999); Rockies Fund v. SEC, 428 F.3d

1088, 1093 (DC Cir. 2005).

23 See, e.g., Ernst, 425 U.S. at 214; see also, Drexel Burnham

Lambert, Inc. v. CFTC, 850 F.2d at 742, 748 (DC Cir. 1988) (“mere

negligence, mistake, or inadvertence fails to meet [CEA] section

4b’s scienter requirement * * * a degree of intent beyond

carelessness or negligence” is necessary to violate CEA section

4b.) (citations omitted).

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3. In Connection With

Consistent with Supreme Court precedent interpreting the words “in

connection with” in the context of section 10(b) of the Exchange Act

and SEC Rule 10b-5, the Commission proposes that “in connection with”

under (c)(1) be given the same meaning–that is, where the scheme to

defraud and the transactions subject to the jurisdiction of the

Commission “coincide.” 24 Guided by securities law precedent, the

Commission proposes this requirement would be satisfied whenever

misstatements or other relevant conduct are made in a manner

[[Page 67660]]

reasonably calculated to influence market participants.25

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24 SEC v. Zandford, 535 U.S. at 822 (“It is enough that the

scheme to defraud and the sale of securities coincide.”).

25 See United States SEC v. Pirate Investor LLC, 580 F.3d 233,

249 (4th Cir. 2009) citing SEC v. Rana Research, Inc., 8 F.3d 1358,

1362 (9th Cir. 1993) (affirming the Second Circuit’s holding in SEC

v. Texas Gulf Sulphur Co., 401 F.2d 833, 862 (2d Cir. 1968) that SEC

Rule 10b-5 is violated whenever assertions are made in a manner

reasonably calculated to influence the investing public).

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4. Reliance, Loss Causation and Damages

Like precedent under both SEC Rule 10b-5 and CEA section 4b, the

Commission proposes that the common law elements of fraud, reliance,

loss causation, and damages, are not needed to establish a violation of

subsection 6(c)(1) and the Commission’s implementing rule in the

context of an enforcement action.26

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26 Berko v. SEC, 316 F.2d 137, 143 (2d Cir. 1963) (reliance,

loss causation and damages not relevant because “the Commission’s

duty is to enforce the remedial and preventive terms of the statute

in the public interest, and not merely to police those whose plain

violations have already caused demonstrable loss or injury”);

accord United States v. Davis, 226 F.3d 346, 358 (5th Cir. 2000);

United States v. Haddy, 134 F.3d 542 (3d Cir. 1998); Slusser v.

CFTC, 210 F.3d 783, 785-87 (7th Cir. 2000).

—————————————————————————

Reliance, loss causation and damages are elements of private

claims, but not enforcement actions brought by the CFTC or SEC.27

This is so because the government’s duty is to enforce the remedial and

preventative terms of the statute in the public interest, and not

merely to police those whose plain violations have already caused

demonstrable loss or injury.28 However, reliance, loss causation, and

damages may be relevant in any Commission determination of the

appropriate penalty or remedy for a violation.

—————————————————————————

27 Id.

28 Berko, 316 F.2d at 143.

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5. Attempt

The Commission’s proposed rule under (c)(1) explicitly prohibits

attempted fraud. The Commission proposes that an “attempt” here, as

elsewhere in the CEA, requires: (1) the requisite intent and (2) an

overt act in furtherance of that intent.29

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29 See, e.g., In re Hohenberg Bros. Co., [1975-1977 Transfer

Binder] No. 75-4, Comm. Fut. L. Rep. (CCH) ] 20,271 at 21,477. (CFTC

Feb. 18, 1977).

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6. Materiality

Sections (1)(b) and (2) of the Commission’s proposed rule

incorporate the concept of materiality. In the securities context, the

Supreme Court has rejected the adoption of a bright-line rule to

determine materiality.30 Instead, the Supreme Court directed lower

courts to engage in a “fact-specific inquiry” in assessing

materiality in securities cases.31 The Commission proposes that the

determination of whether a fact is “material” be fact and

circumstance dependent.32 The Commission proposes that the standard

for materiality should be objective rather than subjective.33 That

is, the test is whether a reasonable person would have considered the

fact material. Further, as a general proposition, statements of

optimism alone (i.e., “puffery”) are not material.34 Finally, with

respect to omissions, the Commission proposes that an omission be

considered material if there is a substantial likelihood that the

omitted fact would have been viewed by a reasonable person as having

significantly altered the total mix of information available.35

—————————————————————————

30 Basic Inc. v. Levinson, 485 U.S. 224, 236 & n.14 (1988)

(“A bright-line rule indeed is easier to follow than a standard

that requires the exercise of judgment in the light of all the

circumstances. But ease of application alone is not an excuse for

ignoring the purposes of the Securities Acts and Congress’ policy

decisions. Any approach that designates a single fact or occurrence

as always determinative of an inherently fact-specific finding such

as materiality, must necessarily be overinclusive or

underinclusive”).

31 Id. at 240. See also SEC v. Talbot, 530 F.3d 1085, 1097

(9th Cir. 2008) (quoting Arrington v. Merrill Lynch, Pierce, Fenner

& Smith, Inc., 651 F.2d 615, 619 (9th Cir. 1981) (“Questions of

materiality [under the securities laws] * * * involv[e] assessments

peculiarly within the province of the trier of fact”).

32 Dodd-Frank section 6(c)(1) makes clear that “no rule or

regulation promulgated by the Commission shall require any person to

disclose to another person nonpublic information that may be

material to the market price, rate, or level of the commodity

transaction, except as necessary to make any statement made to the

other person in or in connection with the transaction not misleading

in any material respect.”

33 Cf. TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 445

(1976).

34 Cf. Raab v. General Physics Corp., 4 F.3d 286, 289-90 (4th

Cir. 1993).

35 Cf. TSC Indus., 426 U.S. at 449; Basic, 485 U.S. at 231-32.

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D. The Proposed Rule Under CEA Section 6(c)(3)

The Commission proposes a rule under new CEA section 6(c)(3) that

mirrors the statute, making it:

unlawful for any person, directly or indirectly, to manipulate or

attempt to manipulate the price of any swap, or of any commodity in

interstate commerce, or for future delivery on or subject to the

rules of any registered entity.

The Commission proposes to continue interpreting the prohibition on

price manipulation and attempted price manipulation to encompass every

effort to influence the price of a swap, commodity, or commodity

futures contract that is intended to interfere with the legitimate

forces of supply and demand in the marketplace.36 The Commission

reaffirms this broad reading of the term “manipulation” with respect

to new CEA section 6(c)(3), while also recognizing that manipulation

cases are fact-intensive and that the law in this area will continue to

evolve largely on a case-by-case basis.

—————————————————————————

36 See Cargill, Inc. v. Hardin, Secretary of Agriculture, 452

F.2d 1154, 1163 (8th Cir. 1971) (“The methods and techniques of

manipulation are limited only by the ingenuity of man. The aim must

be therefore to discover whether conduct has been intentionally

engaged in which has resulted in a price that does not reflect basic

forces of supply and demand”).

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Early manipulation cases involving “corners” and “squeezes”

produced an analytical framework that has since been applied in a wide

variety of other factual situations not involving “market power.”

37 That framework requires that the Commission establish: “(1) That

the accused had the ability to influence market prices; (2) that they

specifically intended to do so; (3) that artificial prices existed; and

(4) that the accused caused the artificial prices.” 38 The

Commission reaffirms this four-part test and, in the section to follow,

discusses the element of artificial price.

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37 See, e.g., In re DiPlacido, 2008 WL 4831204 (CFTC 2008),

aff’d in pertinent part, DiPlacido v. Commodity Futures Trading

Comm’n, 364 Fed.Appx. 657, 2009 WL 3326624 (2d Cir. 2009), Comm.

Fut. L. Rep. ] 31,434 (noting evolution of analytical framework and

applying it to scheme affecting settlement price); In re Henner, 30

Agric. Dec. 1151 (1971) (applying traditional framework sub silentio

to scheme involving uneconomic behavior); In re Soybean Futures

Litig., 892 F. Supp. 1025, 1047 (N.D. Ill. 1995) (While the

traditional framework derived from “market power” cases such as

corners and squeezes, market power is not a necessary element of

manipulation cases.).

38 In re Cox, [1986-1987 Transfer Binder] Comm. Fut. L. Rep.

(CCH) ] 23,786 at 34,061 (CFTC July 15, 1987).

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1. Price Affected by Factors Outside of the Forces of Supply and Demand

The traditional framework for price manipulation has required

demonstrating the existence of an “artificial price.” In various

circumstances, extensive economic analysis may not be necessary to

demonstrate that this element has been met. The conclusion that prices

were affected by a factor not consistent with normal forces of supply

and demand will often follow inescapably from proof of the actions of

the alleged manipulator. For example, in one of the landmark

manipulation cases,39 the respondent placed an order well above the

price he needed to pay for egg futures so that the closing price would

influence the market to place a higher than expected value on futures

contracts for November 1968 eggs. The

[[Page 67661]]

Commission’s predecessor agency sustained the finding of the judicial

officer that:

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39 In re Henner, 30 Agric. Dec. 1151.

[t]he inference is inescapable that the respondent paid more than he

had to * * * for the purpose of causing the closing price to be at

that high level. No further proof is needed to show that the

settlement price was artificial.40

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40 30 Agric. Dec. 1151, 1194.

The Commission recently cited this “conclusive presumption” with

approval in In re DiPlacido.41 In that case, DiPlacido placed

proportionately large orders, in an illiquid market, while ignoring

more favorable bids and offers, so that closing prices for electricity

futures would be inflated. These actions convinced the Commission and

the Second Circuit Court of Appeals that the resulting closing prices

were de facto illegitimate.42 Cases of this nature, where distorted

prices foreseeably follow from the device employed by the manipulator,

do not require detailed economic analysis of the effect on prices.43

As the Commission explained in In re Hohenberg Bros: 44

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41 In re DiPlacido, 2008 WL 4831204 (CFTC 2008), aff’d in

pertinent part, DiPlacido v. Commodity Futures Trading Comm’n, 364

Fed.Appx. 657, 2009 WL 3326624 (2d Cir. 2009), Comm. Fut. L. Rep. ]

31,434, cert. denied, 130 S. Ct. 1883 (2010).

42 Id.

43 See, e.g., In re Eisler and First West Trading, Inc.,

[2003-2004 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 29,664 at

55,837, 2004 WL 77924 (CFTC Jan. 20, 2004) (involving direct

falsification of data input to calculation of settlement prices).

44 [1975-1977 Transfer Binder] No. 75-4, Comm. Fut. L. Rep.

(CCH) ] 20,271 at 21,477 (emphasis added); see also, United States

v. Reliant Energy Services, Inc., 420 F. Supp. 2d 1043 (N.D. Cal.

2006).

[T]o determine whether an artificial price has occurred one must

look at the aggregate forces of supply and demand and search for

those factors which are extraneous to the pricing system, are not a

legitimate part of the economic pricing system, are not a legitimate

part of the economic pricing of the commodity, or are extrinsic to

that commodity market. When the aggregate forces of supply and

demand bearing on a particular market are all legitimate, it follows

that the price will not be artificial. On the other hand, when a

price is affected by a factor which is not legitimate, the resulting

price is necessarily artificial. Thus, the focus should not be as

much on the ultimate price, as on the nature of the factors causing

—————————————————————————

it. (emphasis added).

In keeping with the fact-intensive nature of manipulation cases,

the Commission recognizes that economic analysis may in some cases be

appropriate to determine whether the conduct in question actually

caused an artificial price. The Commission stresses, however, that an

illegal effect on price can often be conclusively presumed from the

nature of the conduct in question and other factual circumstances not

requiring expert economic analysis.

The Commission also emphasizes, consistent with the weight of

existing precedent, that the conduct giving rise to a manipulation

charge need not itself be fraudulent or otherwise illegal.45 The

actions of the respondents in Zenith-Godley,46 Henner,47 and

DiPlacido,48 for instance, were not intrinsically fraudulent or

otherwise illegal apart from violating the CEA, and the manipulation

charges were sustained in each of those cases.

2. Attempt

The Commission’s proposed anti-manipulation rule under (c)(3)

explicitly prohibits attempted price manipulation. The Commission

proposes that attempt here, as elsewhere in the CEA, requires: (1) The

requisite intent and (2) an overt act in furtherance of that

intent.49

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45 See, e.g., Cargill, Inc. v. Hardin, 452 F.2d 1154 (8th Cir.

1971); G.H. Miller & Co. v. United States, 260 F.2d 286 (7th Cir.

1958).

46 In re Zenith-Godley Co., Inc. and John McClay, Jr., 6

Agric. Dec. 900 (1947) (extravagant purchases of butter for the

purpose of supporting milk prices).

47 In re Henner, 30 Agric. Dec. 1155.

48 In re DiPlacido, 2008 WL 4831204 (CFTC 2008), aff’d in

pertinent part, DiPlacido v. Commodity Futures Trading Comm’n, 364

Fed.Appx. 657, 2009 WL 3326624 (2d Cir. 2009), Comm. Fut. L. Rep. ]

31,434.

49 See, e.g., In re Hohenberg Bros., [1975-1977 Transfer

Binder] No. 75-4, Comm. Fut. L. Rep. (CCH) ] 20,271 at 21,477.

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III. Request for Comment

The Commission requests comment on all aspects of the proposed

rules.

IV. Administrative Compliance

A. Cost-Benefit Analysis

Section 15(a) of the CEA 50 requires the Commission to consider

the costs and benefits of its actions before promulgating a regulation

under the CEA. By its terms, section 15(a) does not require the

Commission to quantify the costs and benefits of a rule or to determine

whether the benefits of the regulation outweigh its costs; rather, it

requires that the Commission “consider” the costs and benefits of its

actions. Section 15(a) further specifies that the costs and benefits

shall be evaluated in light of five broad areas of market and public

concern: (1) Protection of market participants and the public; (2)

efficiency, competitiveness and financial integrity of futures markets;

(3) price discovery; (4) sound risk management practices; and (5) other

public interest considerations. The Commission may in its discretion

give greater weight to any one of the five enumerated areas and could

in its discretion determine that, notwithstanding its costs, a

particular rule is necessary or appropriate to protect the public

interest or to effectuate any of the provisions or accomplish any of

the purposes of the CEA.

—————————————————————————

50 7 U.S.C. 19(a).

—————————————————————————

With respect to benefits, the proposed rules would enhance the

authority of the Commission to ensure fair and equitable markets. The

Commission has determined that market participants and the public will

benefit substantially from prevention and deterrence of manipulation.

Markets that are free of market manipulation will function better as

venues for price discovery and hedging.

With respect to costs, the Commission has determined that

participants in the markets should already have mechanisms in place to

ensure that their employees and agents will refrain from attempting to

manipulate the markets.

The Commission invites public comment on its cost-benefit

considerations. Commenters are also invited to submit any data or other

information that they may have quantifying or qualifying the costs and

benefits of the proposed rules with their comment letters.

B. Anti-Trust Considerations

Section 15(b) of the CEA, 7 U.S.C. 19(b), requires the Commission

to consider the public interests protected by the antitrust laws and to

take actions involving the least anti-competitive means of achieving

the objectives of the CEA. The Commission believes that the proposed

rules will have a positive effect on competition by improving the

fairness and efficiency of the markets through reducing the adverse

effects of manipulation and disruptive practices.

C. Paperwork Reduction Act

The provisions of the proposed Commission Regulation [17 CFR Part

180] would not result in new recordkeeping requirements within the

meaning of the Paperwork Reduction Act of 1995 (“PRA”).

D. Regulatory Flexibility Act

The Regulatory Flexibility Act (“RFA”) 51 requires that

agencies consider whether the rules they propose will have a

significant economic impact on a substantial number of small entities

and, if so, provide a regulatory flexibility analysis respecting the

impact.52 The rules proposed by the

[[Page 67662]]

Commission will not have a significant economic impact on a substantial

number of small entities. As explained above, legitimate market

participants should already have procedures in place to prevent their

employees and agents from manipulating the markets. Accordingly, the

Chairman, on behalf of the Commission, hereby certifies, pursuant to 5

U.S.C. 605(b), that the proposed rules will not have a significant

impact on a substantial number of small entities.

—————————————————————————

51 5 U.S.C. 601.

52 Id.

—————————————————————————

E. Congressional Review Act

The Congressional Review Act establishes certain procedures for

major rules, defined as those rules that would result in an annual

effect on the economy of $100 million or more, or have other

substantial impacts. These proposed rules are not subject to any of

those requirements because they would not have any of these substantial

impacts; rather, they should result in significant economic benefits.

List of Subjects in 17 CFR Part 180

Commodity futures.

For the reasons stated in the preamble, the Commodity Futures

Trading Commission proposes to add a new 17 CFR Part 180 as set forth

below:

PART 180–PROHIBITIONS AGAINST MANIPULATION

Sec.

180.1 Prohibition against manipulation.

180.2 Other manipulation.

Authority: 7 U.S.C. 6c(a), 9, 12(a)(5) and 15, as amended by

Title VII of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, Pub. L. 111-203, 124 Stat. 1376 (June 16, 2010); 5

U.S.C. 552 and 552(b), unless otherwise noted.

Sec. 180.1 Prohibition against manipulation.

(a) It shall be unlawful for any person, directly or indirectly, in

connection with any swap, or contract of sale of any commodity in

interstate commerce, or contract for future delivery on or subject to

the rules of any registered entity, to intentionally or recklessly:

(1) Use or employ, or attempt to use or employ, any manipulative

device, scheme, or artifice to defraud;

(2) Make, or attempt to make, any untrue or misleading statement of

a material fact or to omit to state a material fact necessary in order

to make the statements made not untrue or misleading;

(3) Engage, or attempt to engage, in any act, practice, or course

of business, which operates or would operate as a fraud or deceit upon

any person; or,

(4) Deliver or cause to be delivered, or attempt to deliver or

cause to be delivered, for transmission through the mails or interstate

commerce, by any means of communication whatsoever, a false or

misleading or inaccurate report concerning crop or market information

or conditions that affect or tend to affect the price of any commodity

in interstate commerce, knowing, or acting in reckless disregard of the

fact that such report is false, misleading or inaccurate.

Notwithstanding the foregoing, no violation of this section shall exist

where the person mistakenly transmits, in good faith, false or

misleading information to a price reporting service.

(b) Nothing in this section shall be construed to require any

person to disclose to another person nonpublic information that may be

material to the market price, rate, or level of the commodity

transaction, except as necessary to make any statement made to the

other person in or in connection with the transaction not misleading in

any material respect.

(c) Nothing in this section shall affect, or be construed to

affect, the applicability of Commodity Exchange Act section 9(a)(2).

Sec. 180.2 Other manipulation.

It shall be unlawful for any person, directly or indirectly, to

manipulate or attempt to manipulate the price of any swap, or of any

commodity in interstate commerce, or for future delivery on or subject

to the rules of any registered entity.

Issued in Washington, DC, on October 26, 2010 by the Commission.

David A. Stawick,

Secretary of the Commission.

Statement of Chairman Gary Gensler

Prohibition of Market Manipulation

October 26, 2010

I support the proposed rulemaking to enhance the Commission’s

ability to protect against manipulation. Today’s rule builds upon

important new authorities that Congress granted the Commission to

protect market participants in the commodities, futures and swaps

markets. Together with the authority granted by Congress to prohibit

disruptive trading, this proposed rule gives the Commission the broad

new ability to effectively combat fraud and manipulation. The proposed

rulemaking promotes fair and efficient markets, for the first time

allowing the Commission to protect against fraud-based manipulation. I

thank Senator Cantwell for her leadership in bringing this important

new authority to the Commission.

[FR Doc. 2010-27541 Filed 11-2-10; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: November 3, 2010