December 28, 2010

Via Electronic Submission: http://comments.cftc.gov

Commodity Futures Trading Commission

c/o David A. Stawick, Secretary
Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581

Re: Antidisruptive Practices Authority Contained in the Dodd-

Frank Wall Street Reform and Consumer Protection Act.
RIN No. 3038-AD26.

Dear Mr. Stawick:

Managed Funds Association (“MFA”)1 submits the following comments in

response to the Commodity Futures Trading Commission‟s (the “Commission”) request for
comment in its Advance Notice of Proposed Rulemaking and Request for Comments (“ANPR”)
on Antidisruptive Practices Authority contained in the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the “Dodd-Frank Act”) Section 747.

We appreciate the opportunity to provide comments to the Commission at an

early stage of the rulemaking process. MFA and its members unequivocally support the
Commission‟s mission of deterring and preventing price manipulation and other disruptions to
market integrity. We look forward to working closely with the Commission to promulgate rules
that serve the public interest by preserving the liquidity of the futures and derivatives markets; so
that these markets can continue to provide a means of managing price risks, discovering prices
and disseminating price information through liquid, fair and financially secure trading practices. 2

I. Summary

The Commission has asked in its ANPR, among other things, how various
statutory terms should be defined. Many of the terms referenced in the ANPR are based on
1
MFA is the voice of the global alternative investment industry. Its members are professionals in hedge
funds, funds of funds and managed futures funds, as well as industry service providers. Established in 1991, MFA is
the primary source of information for policy makers and the media and the leading advocate for sound business
practices and industry growth. MFA members include the vast majority of the largest hedge fund groups in the
world who manage a substantial portion of the approximately $1.5 trillion invested in absolute return strategies.
MFA is headquartered in Washington, DC, with an office in New York.
2
See 7 U.S.C. § 5(a)

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
Page 2 of 10

securities law precedent that has limited, if any, relevance to trading activities in the futures or
derivatives markets. MFA believes that definitions such as “orderly execution,” “violates bids
and offers” and “spoofing” require refinement so that their meanings relate to specific and
measurable characteristics that can guide market participants in their conduct and in a manner
that takes into account futures and derivatives market structures, practices and customs. Since
the Commission requested and Congress agreed to provide the enforcement authority in Section
747, we think it is incumbent on the Commission to establish clearly what conduct it was
concerned about when it asked for this authority and how it plans to apply the authority.

In summary, MFA submits the following recommendations:

 The Commission should continue its policy of delegating supervisory and

disciplinary authority in the area of market disruptions to the exchanges;

 However, if the Commissions promulgates rules, it should adopt rules that define
specifically and narrowly the prohibited disruptive trading practices;

 The Commission should interpret and confine Section 747 to well-established

legal standards and principles set forth in the DiPlacido3 precedent and in a
manner that remains faithful to the plain language of Section 747;

 Violating bids or offers is impermissibly vague and any potential rule should not
be actionable in the absence of manipulative intent to influence price;

 Demonstrating an “intentional or reckless disregard for the orderly execution of

transactions during the closing period” should be understood to refer to trading
activities similar to marking the close and should not be actionable in the absence
of manipulative intent or, at the minimum, extreme recklessness;

 “Spoofing” should be narrowly defined and should take into account the distinct
market structure, practices and customs of the futures and derivatives markets;
and

 The Commission should provide clarity as to the type of conduct that constitutes
anti-disruptive practices in the context of algorithmic and high-frequency trading,
and any potential rulemaking should be principles-based and not hinder the ability
of these traders to continue to add value to the markets.

II. The Commission Should Reinforce the Expanded Responsibilities of the Exchanges
to Oversee the Markets to Prevent Disruptive Trading Practices

3
DiPlacido v. CFTC, 2009 WL 3326624 (2d Cir. Oct. 16, 2009)

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Mr. Stawick
December 28, 2010
Page 3 of 10

In our opinion, both the traditional supervisory structure in the futures and
derivatives markets and the Dodd-Frank Act support delegating to the exchanges responsibility
of regulating market disruptions. The Commodity Exchange Act (“CEA”) has long recognized
the role of the exchanges as the first line of defense in preventing market disruptions. Reflecting
a principles-based regulatory approach, the CEA required the exchanges to comply with certain
core principles and allowed the exchanges “reasonable discretion in establishing the manner in
which [the board of trade] complie[d] with the core principles.”4 Given the constantly evolving
nature of the markets and the increased role and importance of technology, MFA believes
exchanges are in the best position to monitor and control the risk of market disruptions; and the
adoption of prescriptive rules are inherently at odds with effective enforcement in this area.
Prior to its amendment by the Dodd-Frank Act, core principle number four required that boards
of trade “monitor trading to prevent manipulation, price distortion, and disruptions of the
delivery or cash-settlement process.”5 Additionally, to aid in enforcement, the CEA required
boards of trade to maintain rules and procedures to provide for the recordkeeping of all
identifying trade information “for purposes of assisting in the prevention of customer and market
abuses and providing evidence of any violations of the rules. . . .”6

Rather than reducing the regulatory and supervisory significance of the boards of
trade, the Dodd-Frank Act enhanced the role of the boards of trade. Once required merely to
monitor trading, boards of trade now must have:

the capacity and responsibility to prevent manipulation, price

distortion, and disruptions of the delivery or cash-settlement
process through market surveillance, compliance, and enforcement
practices and procedures, including—

(A) methods for conducting real-time monitoring of trading; and

(B) comprehensive and accurate trade reconstructions.7

Additionally, under the Dodd-Frank Act, Swap Execution Facilities (“SEFs”) have monitoring
obligations similar to the boards of trades‟ enhanced provisions.8

The decision to increase the role of the boards of trade in preventing market
disruptions is a recognition by Congress that the boards of trade have the right experience,
capabilities and track records to monitor and discipline markets. The Commission‟s principles-
based guidance should likewise acknowledge and reinforce the exchanges‟ extensive capabilities
and past regulatory experience.

4
7 U.S.C. § 7(d)(1).
5
7 U.S.C. § 7(d)(4).
6
7 U.S.C. § 7(d)(10).
7
Dodd-Frank Act § 735(b) (emphasis added).
8
Dodd-Frank Act § 733.

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Mr. Stawick
December 28, 2010
Page 4 of 10

We also believe that this approach is appropriate because it will preserve the long-
standing distinction between the Commission and the exchanges with respect to disciplinary
authority and, in doing so, will reinforce the market regulatory and monitoring roles of each.
Market manipulation, in which market participants intentionally interfere in market performance
to create personal gains, traditionally has merited federal sanctions. Unlike market
manipulations, market disruptions are not used to generate profit illegally at the expense of the
market or another individual market participant. Market disruptions, traditionally in the purview
of the exchanges, are not events engineered by market participants to earn illegal or unfair
profits. We recommend that the Commission focus its enforcement actions to punish and
prevent market manipulators and leave to the exchanges primary authority to monitor market
disruptions and discipline parties responsible for market disruptions. We are concerned that
imposing federal enforcement authority in areas of vague definition and unclear standards of
intent will chill legitimate market activity. Boards of trade already have the appropriate tools to
monitor, prevent and curb the recurrence of market disruptions and have greater experience and
flexibility than federal regulators to adopt and revise standards. We urge that the Commission‟s
regulations preserve the CEA‟s delegation of disciplinary responsibility in this area.

III. If the Commission Decides to Promulgate Rules, It Should Define Specifically and
Narrowly the Prohibited Disruptive Trading Practices.

MFA is concerned that Dodd-Frank Act Section 747 as written is vague and
particularly vulnerable to constitutional challenge by market participants. We are concerned that
without greater clarity from exchanges, or the Commission, this provision may serve to
undermine the Commission‟s enforcement efforts to deter and prevent price manipulation and
will have a chilling effect on legitimate trading practices. Market participants that exercise
legitimate trading strategies should not have to operate in an industry where there are potentially
onerous regulatory and reputational risks for conduct where no specific or clear guidance is
issued as to what is prohibited. “[A] regulation carrying penal sanctions [must] give fair warning
of the conduct it prohibits or requires.”9 Traditional concepts of due process preclude an agency
from penalizing a private party for violating a rule without first providing adequate notice of the
substance of the rule.10 We believe regulators should provide clear guidance under Section 747
before bringing enforcement actions to provide market participants with notice as to what
constitutes violative trading activity.

To provide market participants with guidance under Section 747, we believe the
Commission should reinforce its delegation of authority to the exchanges in the areas as
explained above. Alternatively, if the Commission proceeds towards rulemaking, we believe it
should define specifically and narrowly the type of trading activities that are prohibited to
provide clear guidance to market participants. We are concerned that if the Commission were to
use its authority under Section 747 to charge market participants engaged in routine trading
activities after the fact as disruptive, when there is no manipulative intent or effect, it would

9
DiPlacido v. CFTC, 2009 WL 3326624, at *1 (2d Cir. Oct. 16, 2009) (citing Rollins Envtl. Servs. (NJ) Inc.
v. U.S. EPA, 937 F.2d 649, 653 n.2 (D.C. Cir. 1991).
10
Satellite Broad. Co. v. FCC, 824 F.2d 1, 3 (D.C. Cir. 1987).

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
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severely limit the efficient functioning of the markets and cause more instability to the markets.
Without greater guidance under Section 747, enforcement actions could undermine, rather than
enhance, the functioning of the markets. Market participants may choose not to enter the market
because of the increased and uncertain enforcement risk, thereby harming the liquidity and depth
of the markets.

A. If It Promulgates Rules, the Commission Should Clearly Define What

Constitutes “Violat[ing] Bids or Offers” and Any Definition Must Require
Manipulative Intent.

What constitutes a violation of bids or offers is not at all clear in the context of the
futures and derivatives markets. The term “violate bids or offers” has been used in the
Commission‟s enforcement actions involving floor traders, but it has virtually no application to
electronic trading where systems buy or sell at the best available quote. Similarly, violations of
bids or offers should not apply in the over-the-counter markets or in the execution of block
trades. Over-the-counter and block trades often occur at prices inconsistent with contemporary
bids and offers, because privately negotiated purchases and sales reflect the positions and unique
characteristics of the parties, including the size of their holdings relative to the market and the
liquidity of the instruments being traded, among other factors. Moreover, in some thinly traded
markets, there are no clear parameters as to what the bid or offer price is at any given time.

If it proceeds to rulemaking, we believe the Commission should look to judicial

precedent in order to craft a rule that is specific, narrow and clear enough not only to give market
participants notice of what is prohibited, but also clear enough to withstand judicial scrutiny.
The Commission should also follow its own past enforcement practices and require that a
violation of bids or offers be actionable only if undertaken with manipulative intent to influence
prices. Under an arbitrary and capricious standard of review, the Second Circuit upheld the
Commission‟s definition of manipulation, a four-part test which was established in the absence
of a statutory definition of “manipulation.”11 The Second Circuit placed emphasis on the fact
that the Commission had fulfilled its burden of proof to demonstrate manipulative intent. The
Court explained:

DiPlacido further challenges the Commission‟s standard on the

ground that the elements of the four-part test „collapse[]‟ into one-
uneconomic trading so that a violation exists wherever bids and
offers are violated, and even lawful hedging may constitute
manipulation. We are not persuaded. The Commission stated that
„violating bids and offers—in order to influence prices‟ was
„sufficient to show manipulative intent.‟ Its findings of intent thus

11
DiPlacido, 2009 WL 3326624, at *2 (2d Cir. Oct. 16, 2009). Manipulation cases involving “corners” and
“squeezes” produced a framework requiring 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.” The Commission has also reaffirmed this four-part test in its Notice of
Proposed Rulemaking on the Prohibition of Market Manipulation. See Prohibition of Market Manipulation, 75 Fed.
Reg. 67657, 67660 (Nov. 3, 2010).

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
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depended not merely on DiPlacido‟s [violations of] bids and offers,

but also on taped conversations signaling manipulative intent …12

Thus, the Commission should reaffirm in any potential rulemaking that it intends to interpret
Section 747 as a codification of DiPlacido‟s principles requiring manipulative intent. Without
incorporating this manipulative intent, the “violates bids or offers” clause lacks any language of
scienter and is therefore unconstitutionally vague. The Supreme Court has long recognized
that—

[T]he constitutionality of a vague statutory standard is closely

related to whether that standard incorporates a requirement of mens
rea. Because the absence of a scienter requirement in the
provision [in question], the statute is little more than „a trap for
those who act in good faith.‟13

Without including specific intent in the rule, market participants that do not intend to move the
market and are acting in good faith may face substantial enforcement risk given the ambiguity of
the provision. This risk may prove too great for market participants seeking to enter the futures
and derivatives market and their decision to not enter the markets may ultimately result in
decreased liquidity and depth. The Commission will help add clarity to the proposed rule‟s
prohibitions by closely following this firmly established judicial precedent. Market participants
are now familiar with the contours of the DiPlacido case and DiPlacido‟s concrete facts will
help show how the rule‟s prohibitions will be applied in practice.

B. The “Intentional or Reckless Disregard for the Orderly Execution of

Transactions During the Closing Period” Should Be Clearly Defined and
Require Manipulative Intent.

Dodd-Frank Act Section 747 prohibits an “antidisruptive” trade practice, defined

as “demonstrating an intentional or reckless disregard for the orderly execution of transactions
during the closing period.” We are concerned that this clause is impermissibly vague. We
believe that any proposed rulemaking should provide guidance on violative conduct and the
meaning of “orderly execution”.

We believe any proposed rule under this clause should also require manipulative
intent, or at the very least an “extreme departure from the standards of ordinary care, and which
presents a danger of misleading buyers or sellers that is either known to the defendant or so
obvious that the actor must have been aware of it.”14 The “extreme recklessness” standard
carries with it the notion that a person is acting willfully to carry out his or her ultimate
objective. Even in connection with transactions under the securities laws involving retail

12
DiPlacido, 2009 WL 3326624, at *3 (2d Cir. Oct. 16, 2009) (citations omitted; emphasis original).
13
Colautti v. Franklin, 439 U.S. 379, 395 (1979) (collecting cases that recognize the proposition; citations
omitted). See also DiPlacido, 2009 WL 3326624, at *2 (citing Colautti).
14
Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044 (7th Cir.), cert. denied, 434 U.S. 875 (1977)
(emphasis added).

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
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unsophisticated investors, courts have imposed a high standard.15 The same standard should
apply here. This is especially crucial because of the unpredictability of the futures markets‟
ability to absorb any given trade at any given time. Market participants may have executed the
same exact trade the day before without any disruptive effect, but given the unpredictable
volatility and liquidity profile of the market on another day, the exact same trade may cause a
disruption. Market participants simply cannot predict prospectively with certainty that their
trades will not be disruptive. Thus, the Commission should only focus on those disruptions that
were caused while employing manipulative intent, and leave to the exchanges the responsibility
to discipline market participants where there is disruption without manipulative intent.

Finally, MFA stresses that there are many routine and legitimate trading activities
that are required to be conducted during the closing period and as such, market participants
require more clarity and guidance on the definition of “orderly execution” during the closing
period to prevent running afoul of Section 747.

C. “Spoofing” Should Be Narrowly Defined and Should Take Into Account

Distinct Market Structures, Practices and Customs of the Futures and
Derivatives Markets.

We respectfully request that the Commission give additional guidance as to what

the prohibition on “spoofing” entails in the context of the futures and derivatives markets.
Section 747 defines spoofing as “bidding or offering with the intent to cancel the bid or offer
before execution.”16 The statutory definition is vague and does not offer market participants
guidance about what behavior and activities are prohibited. More generally, “spoofing” is not a
term that has ever been commonly used in the futures and derivatives markets. Securities
markets have their own concept of “spoofing,” but its application in the futures and derivatives
markets is not at all clear.17 MFA is of the view that there is simply no commonly understood or
accepted meaning among market participants of what the term prohibits.

MFA is concerned that the statutory definition is sufficiently broad to capture

many legitimate trading practices in the futures and derivatives markets. The Commission itself
recognizes in question eight of the ANPR one of the practices captured by the statutory
definition. In futures trading, it is a legitimate practice for an individual to “enter[] an order
larger than necessary with the intention to cancel part of the order to ensure that his or her order

15
See Phillips v. LCI Int’l, Inc., 190 F.3d 609, 621 (4th Cir. 1999); SEC v. Steadman, 967 F.2d 636, 641
(D.C. Cir. 1992); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en banc); Ross v. Bank
South, N.A., 885 F.2d 723, 730 n.10 (11th Cir. 1989); Hackbert v. Holmes, 675 F.2d 1114, 1118 (10th Cir. 1982);
Broad v. Rockwell, 642 F.2d 929, 961 (5th Cir. 1981) (en banc); McLean v. Alexander, 599 F.2d 1190, 1197 (3d.
Cir. 1979); Mansbach v. Prescott, Ball, & Turben, 598 F.2d 1017, 1025 (6th Cir. 1979); see also Greebel v. FTP
Software, 194 F.3d 185, 198 (1st Cir. 1999); Camp v. Dema, 948 F.2d 455, 461 (8th Cir. 1991).
16
CEA § 4c(a)(5)(C).
17
See, e.g., In re Fishman, Exchange Act Release No. 40115 (June 24, 1998) (violating Section 10(b) by
submitting limit orders to move the public bid or offer quote and then cancelling the orders).

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
Page 8 of 10

is filled.”18 Similarly, “spoofing” is arguably indistinguishable from the legitimate strategies

employed by high-frequency traders that enter and cancel orders at high volumes, but in doing so
serve to add liquidity to the markets. The increase in the volume of placed and cancelled orders,
made possible by high-frequency trading strategies and technology is a sign of a competitive
market that contributes to the price discovery function of markets. Distinguishing this objective
behavior from prohibited conduct is not at all easy.

As noted above, the execution of trade practices captured by the term “spoofing”
in the futures or derivatives markets do not automatically imply clear manipulative intent.
Because order execution is not guaranteed, market participants legitimately compensate against
this by entering larger orders than are necessary in order to meet their trading needs.
Cancellations of orders also serve other legitimate purposes and do not imply manipulative
intent. This, in turn, leads to many practices being labeled as “disruptive” by the plain terms of
Section 747. Given this probabilistic component in the futures and derivatives markets, MFA
believes that anything short of a requirement of manipulative intent will not properly distinguish
legitimate from illegitimate trading practices.

IV. Antidisruptive Practices Authority Is Unclear in the Context of Algorithmic and

High-Frequency Trading Entities.

In questions 15-19 of the ANPR, the Commission has asked how various aspects
of algorithmic and automated trading systems fit within the antidisruptive practices authority in
Section 747. Specifically, the Commission asked whether it should consider promulgating rules
to regulate the use of algorithmic or automated trading systems to prevent disruptive trading
practices and if so, what kind of rules it should consider. Additionally, the Commission asks
whether there should be supervision and monitoring of such trading systems and whether
additional rules reasonably necessary to prevent disruptions by these systems should be
promulgated by the Commission.

As a general matter, MFA is concerned that the Commission‟s rulemaking in the

context of algorithmic or high-frequency trading will stifle financial innovation. Technology has
changed the financial industry for the better. Algorithmic trading strategies and low latency
technology have delivered important benefits to the markets, including the dramatic
improvement of bid-ask spreads, faster execution speeds, reduced commissions and transaction
costs, greater liquidity and increased market depth and increases in efficiency and pricing
transparency and reliability.19 Additionally, technology has enhanced risk management among
market participants and the markets generally. For example, the use of pre- and post-trade
checks, fat finger controls and other reasonable limitations to trading have added to the stability
of the markets. The importance of financial innovation should not be underestimated when
considering the substantial competitive advantages that technology has given the American

18
Antidisruptive Practices Authority Contained in the Dodd-Frank Wall Street Reform and Consumer
Protections Act, 75 Fed. Reg. 67301, 67302 (Nov. 2, 2010).
19
MFA‟s comment letter to the SEC on its concept release on Equity Market Structure discusses empirical
data on the benefits of technology to the markets and is available at:
http://www.managedfunds.org/downloads/MFA%20Mkt%20Structure%20Ltr.5.7.10.pdf.

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
Page 9 of 10

futures and derivatives markets. We strongly urge the Commission not to proceed down a
rulemaking process without having a full understanding of the very serious potential adverse
consequences that a vague, indefinite and potentially broad rule might cause.

Rather than implementing prescriptive rules that are inflexible and not suitable to
the constantly-evolving nature of technology, we believe the Commission should adopt a
principles-based approach. This would afford the Commission flexibility as the industry
develops new technological methods of preventing disruptions and renders old methods obsolete.
Additionally, we believe any proposed rulemaking should be grounded in empirical data to
reduce the potential for any proposed rules to have unintended consequences. Without empirical
data, any rule-making could become a vehicle for costly, unintended detrimental consequences
and could reverse the global leadership status that the United States has earned. MFA
recommends to the Commission that any rule-making should be limited to ensuring:
(i) economically efficient execution; (ii) fair competition; and (iii) the availability of information
with respect to quotations and transactions.

Finally, MFA respectfully urges that the Commission leverage the resources of
the exchanges to its advantage in this area, as was discussed above. Indeed, many of the major
exchanges have kept up with the increased technological demands of market participants and
have put in place their own infrastructure not only to handle this demand, but also to properly
monitor trading and prevent disruptions. We believe the Commission should look to the
exchanges to take a leading supervisory role in this effort, as they have historically possessed the
expertise, tools and capabilities to prevent market disruptions.

****

MFA thanks the Commission for the opportunity to provide comments regarding
the proposed roles on its new anti-manipulation authority. MFA is of the view that “[n]otice is
said not only to improve the quality of rulemaking through exposure of a proposed rule to
comment, but also to provide fairness to interested parties and to enhance judicial review by the
development of a record through the commentary process.”20 In that spirit, we look forward to
the Commission‟s final rule.

We would be pleased to discuss questions or comments the Commission or its

staff might have regarding any aspects of this letter. Please feel free to contact Jennifer Han or
the undersigned at (202) 730-2600.

Respectfully submitted,

/s/ Stuart J. Kaswell

Stuart J. Kaswell

20
Nat. Black Media Coal. v. FCC, 791 F.2d 1016, 1022 (2d Cir. 1986).

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org
Mr. Stawick
December 28, 2010
Page 10 of 10

cc: The Hon. Gary Gensler, CFTC Chairman

The Hon. Michael Dunn, CFTC Commissioner
The Hon. Bart Chilton, CFTC Commissioner
The Hon. Jill E. Sommers, CFTC Commissioner
The Hon. Scott D. O‟Malia, CFTC Commissioner

600 14th Street, NW, Suite 900 Washington, DC 20005 Phone: 202.730.2600 Fax: 202.730.2601 www.managedfunds.org