CFTC: If Rule 10b-5 Works For the SEC, It Should Work For Us Too (And Maybe We’ll Win More Than One Case Every 35 Years)
The CFTC’s new anti-manipulation and anti-fraud rules are based on the SEC’s Rule 10b-5. One CFTC Commissioner believes the new rule will end the CFTC’s nearly unanimous 35-year losing streak in this area, while another believes the rule’s lack of clarity and vagueness will cause significant confusion in the marketplace. It looks to generate a lot of work for lawyers, since the rule imports the notion of insider trading and the like.
Section 753 of the Dodd-Frank Act amended section 6(c) of the Commodity Exchange Act, or CEA, to prohibit manipulation and fraud 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.
Among other things, Dodd-Frank Act Section 753:
- Expands the reach of the CFTC to prohibit manipulative and fraudulent behavior by eliminating the requirement to show an artificial price and lowering the scienter standard to recklessness for fraud-based manipulations.
- Preserves the CFTC’s existing authority to prohibit the manipulation of prices even in the absence of fraud.
- Adds a special provision for manipulation by false reporting, including an exception for good faith mistakes.
- Makes it unlawful to provide materially false information to the CFTC.
According to the CFTC, its final rules, to be codified in 17 CFR Part 180, function to protect the public from manipulation and fraud in connection with any swap, or contract of sale of a commodity in interstate commerce, or contract for future delivery on or subject to the rules of any registered entity.
Rule 180.1, which is modeled on Securities and Exchange Commission Rule 10b-5, broadly prohibits manipulative and deceptive devices and contrivances, employed intentionally or recklessly, regardless of whether the conduct in question was intended to create or did create an artificial price.
The CFTC believes respective scienter requirements of final Rule 180.1 (intentional or reckless), final Rule 180.2 (specific intent), and CEA section 9(a)(2) (specific intent) function to ensure that good-faith mistakes or negligence will not constitute a violation of the final Rules.
According to the CFTC the final rule:
- Reaches all manner of fraud and manipulation within the scope of the statute it implements, CEA section 6(c)(1).
- Does not impose any new affirmative duties of inquiry, diligence, or disclosure. The failure to disclose information prior to entering into a transaction, either in an anonymous market setting or in bilateral negotiations, will not, by itself, constitute a violation. However, depending on all of the facts and circumstances, trading on the basis of material nonpublic information in breach of a pre-existing duty (established by another law or rule, agreement, understanding, or some other source), or by trading on the basis of material nonpublic information that was obtained through fraud or deception, may violate final Rule 180.1. Similarly, fraud-by-partial-omission or half-truths could violate final Rule 180.1 if the facts and circumstances of a particular case so warrant.
- The “in connection with” requirement is to be read broadly, not technically or restrictively. Section 6(c)(1) and final Rule 180.1 reach all manipulative or deceptive conduct in connection with the purchase, sale, solicitation, execution, pendency, or termination of any swap, or contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity.
CFTC Commissioner Bart Chilton stated “Currently, we have a nearly impossible manipulation standard, winning only one case in 35 years. We have had to prove intent, artificial price, market control and that the manipulators actually caused the artificial price. A very tall order. With the adoption of this new rule, the CFTC will be able to prosecute a broader array of commodity law violations. Here are a few of them:
- First, it will give us the ability to go after fraudulent practices that manipulate prices—like disseminating misinformation about the global availability of crude oil to manipulate the market.
- Pocketing profits from the misuse of privileged information will now be prosecuted. We’ll be able to get at, for example, bad actors akin to insider traders.
- Also, this new regulation moves us toward a reckless standard similar to that under securities laws as defined by the courts, and the law specifically gives us a reckless standard for false reporting.”
CFTC Commission Scott Omalia took a contrary view: “I have concerns that the Anti-Manipulation rule has not provided adequate clarity and that such vagueness as to the course of action that will be taken by the Commission in enforcing this rule will add confusion to the markets. The wholesale incorporation of standards and case law developed under Rule 10b-5 of the Securities Exchange Act of 1934 runs the risk of disregarding the unique qualities of the futures and derivatives markets in its attempts to apply concepts developed in the securities markets such as insider trading based on misappropriation. It is therefore essential for the Commission to be clear as to how judicial precedents under Rule 10b-5 guide our judgment and decision-making as we exercise authority under this rule . . . I believe the Commission could have been more responsive to requests for guidance through the provision of examples of violative conduct. This is especially so with regard to relatively new concepts of liability in our markets such as insider trading and “fraud-on-the-market.””
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