FR Doc 2010-27547[Federal Register: November 2, 2010 (Volume 75, Number 211)]

[Proposed Rules]

[Page 67301-67303]

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

[DOCID:fr02no10-16]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Chapter I

RIN Number 3038-AD26

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.

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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

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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 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, [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.

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.”

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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).

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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,

[[Page 67302]]

“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

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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).

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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

[[Page 67303]]

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.

[FR Doc. 2010-27547 Filed 11-1-10; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: November 2, 2010