Wednesday, June 8, 2011

Dodd-Frank Lowers Market Manipulation Standard, Easier for CFTC to Prove

The U.S. Commodity Futures Trading Commission is on the hunt. The target: market manipulators.

On May 24, 2011 the CFTC filed its biggest market manipulation case ever in CFTC v. Parnon Energy, Inc., et al. On May 25, 2011, CFTC Commissioner, Bart Chilton, confirmed in a press conference the agency’s vow to hunt down market manipulators by stating, “We’re watching and we’ll come and get you.” As if that’s not chilling enough, Dodd-Frank provisions could make it easier for the CFTC and other regulators to bring market manipulation cases by lowering the standard of intent.

Market manipulation is a deliberate attempt to create artificial market prices or market for a particular security, commodity, or currency. In the past, in order to prove a market manipulation claim, the CFTC had to prove (1) an individual actually intended to manipulate prices; (2) that individual had the market power to move the price of a commodity; and (3) that individual actually caused an artificial price in the market. This was a difficult standard to meet--evidenced by the fact that the CFTC only has successfully prosecuted and won one market manipulation case in the futures markets over the agency’s 36-year history.

However, Dodd-Frank sets forth a new standard under which the CFTC will now have to show that a market participant acted in a manner with the potential to disrupt the market. The effect of a lower standard will be two-fold: first, it should make it easier for the CFTC to prove its case, and second, it expands the CFTC’s enforcement jurisdiction by now allowing the agency to prosecute market participants who may have merely acted in a reckless manner to cause a price in the market that otherwise would not have occurred. This standard is analogous to the current SEC standard for market manipulation in securities markets.

Additionally, Dodd-Frank leaves much discretion to the CFTC to determine its own specific enforcement rules. Although final rules have not been approved, the CFTC has stated that it will “crack-down” on three areas under the market manipulator theory: “spoofing”, “banging the close”, and high-frequency trading/algorithmic strategies. “Spoofing” occurs where a trader makes a bid or offer and cancels it before it is carried out. “Banging the close” takes place when a trader acquires a substantial position leading up to the closing period, and then offsets the position before the end of the trading day in an attempt to manipulate closing prices. Finally, the CFTC plans to investigate high-frequency trades and algorithmic strategies to determine whether such techniques have the effect of disrupting markets. If so, then these types of trades will likely face more rules and be subject to the new market manipulation standard.

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