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Dodd-Frank Focus: The CFTC’s New 10b-5 Authority

July 8, 2011

On July 7th, the CFTC unanimously voted to adopt two new final rules which together implement the agency’s expanded authority, under Section 753 of the Dodd-Frank Act, to enforce the Commodity Exchange Act’s (“CEA”) prohibition against manipulation and fraud in connection with swaps, commodities and futures.

Overview

Modeled on Rule 10b-5 of the Securities and Exchange Act, the new rules:

  • Expand the reach of the CFTC to prohibit manipulative and fraudulent behavior by eliminating the requirement that it show an artificial price.
  • Lower the scienter standard to recklessness for fraud-based manipulations.
  • Preserve the CFTC’s existing authority to prohibit the manipulation of prices in the absence of fraud.
  • Add a special provision for manipulation by false reporting, including an exception for good faith mistakes.
  • Make it unlawful to provide materially false information to the CFTC.

Rule 180.1

The adopting release emphasizes Rule 180.1’s similarities to SEC Rule 10b-5, noting that the CFTC “will be guided, but not controlled, by the substantial body of judicial precedent applying the comparable language of SEC Rule 10b-5.” Rule 180.1 prohibits fraud and fraud-based manipulations, and attempts (i) by any person (ii) acting intentionally or recklessly (iii) in connection with (iv) 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 (as defined in the CEA).

No new disclosure obligations

The adopting release clearly provides that Rule 180.1 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 Rule 180.1. Similarly, fraud-by-partial-omission or half-truths could violate final Rule 180.1.

Good faith mistakes

Rule 180.1 also includes a limited good faith exception to the mistaken transmission of false or misleading or inaccurate information to a price reporting service. The scienter requirement of final Rule 180.1, final Rule 180.2, and CEA Section 9(a)(2) functions to ensure that good-faith mistakes or negligence will not constitute a violation of the new rules.

Penalties 

Rule 180.1’s penalty provisions track CEA Section 6(c)(10)(C)(ii), which states that the CFTC may assess  a civil penalty of not more than an amount equal to the greater of $1,000,000 or triple the monetary gain for each violation.

Private right of action

The adopting release specifically declines to opine on whether the required elements of a private right of action exist under CEA section 6(c)(1) and final Rule 180.1.

Rule 180.2

New Rule 180.2 implements the provision of CEA Section 6(c)(3) which makes 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. In applying Rule 180.2, the CFTC will be guided by the traditional four-part test for manipulation that has developed in case law arising under CEA Sections 6(c) and 9(a)(2): (i)that the accused had the ability to influence market prices; (ii) that the accused specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand; (iii) that artificial prices existed; and (iv) that the accused caused the artificial prices

A violation of Rule 180.2 requires specific intent; recklessness will not suffice.

The new rule will be effective 30 days after publication in the Federal Register, which is expected during the week of July 11. View the adopting release and text here.

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