The Commodity Futures Trading Commission Issues Sweeping New Rules To Prohibit Fraud And Manipulation In The Swaps, Cash, And Futures Markets

Article by Paul M. Architzel , Harry J. Weiss , Yoon-Young Lee , Elizabeth Mitchell , Douglas J. Davison and Gail C. Bernstein

SUMMARY

Signaling its intent to utilize the sweeping new powers granted to it by Dodd-Frank,1 on July 14, 2011, the Commodity Futures Trading Commission ("Commission") unanimously adopted two final rules to prohibit fraud and manipulation, and attempted fraud and manipulation, in connection with any swap, commodity contract for sale in interstate commerce ("cash contract") or futures contract on or subject to the rules of a registered exchange ("futures contract").2 New Rules 180.1 and 180.2 were adopted pursuant to Section 753 of Dodd-Frank, which grants the Commission broad new authority to implement Section 6(c) of the Commodity Exchange Act ("CEA"), as amended. Section 6(c) and these implementing rules augment the Commission's pre-existing fraud and manipulation enforcement authority.

New Rule 180.1, implementing CEA Section 6(c)(1), and new Rule 180.2, implementing CEA Section 6(c)(3), have been adopted virtually unchanged from the Commission's earlier rule proposal.3 The new rules, which will not apply retroactively, are effective on August 15, 2011.

CEA Section 6(c)(1) broadly prohibits the use or attempted use of "any manipulative or deceptive device or contrivance," "in connection with" a swap, future or cash contract, in contravention of the rules and regulations required to be promulgated by the Commission within one year after Dodd-Frank's enactment. As explained more fully below, this new authority expands the Commission's antifraud authority under CEA Section 4b which itself was broadened by Dodd-Frank. In addition, Section 753 expands the Commission's anti-manipulation authority under CEA Section 9(a)(2).

Given the similarities between CEA Section 6(c)(1) and Securities Exchange Act ("Exchange Act") Section 10(b), the Commission expressly modeled new Rule 180.1(a)(1)-(3) on Exchange Act Rule 10b-5.4 Consistent with Rule 10b-5 precedent, Rule 180.1 includes recklessness as satisfying the scienter required to prove a violation. However, as we discuss more fully below, these sections of Rule 180.1(a) are significantly broader than Rule 10b-5 in two important respects: (1) Rule 180.1(a), unlike Rule 10b-5, covers attempts, and (2) Rule 180.1(a) reaches a far broader range of conduct than does Rule 10b-5.

New Rule 180.2, which covers non-fraud-based price manipulation, adopts the text of new CEA Section 6(c)(3) verbatim and provides that:

It shall be 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.

The scope of new Rule 180.2 differs from the CEA's pre-Dodd Frank anti-manipulation authority by prohibiting manipulation and attempted manipulation that is either direct or indirect. It also clearly and distinctly applies to swaps.

However, the Commission has indicated that its application of new Rule 180.2 will not depart from current standards of proving a manipulation. The Commission will look to "the traditional four-part test for manipulation that has developed in case law arising under [CEA Sections] 6(c) and 9(a)(2)"5 in its interpretation of Rule 180.2. Under this test, (1) a person must have had the ability to influence market prices; (2) he or she must have specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand (recklessness will not be sufficient); (3) artificial prices must have existed; and (4) the person must have caused the artificial prices. Attempted manipulation under Rule 180.2 may be found if a person has the requisite intent and commits an overt act in furtherance of that intent.

Section 753 of Dodd-Frank contains a number of additional provisions, including a prohibition against false reporting or provision of false information to the Commission and additional enforcement authorities. These provisions were automatically effective upon the effective date of Title VII of Dodd-Frank (July 16, 2011) and do not require implementing rules.

DISCUSSION

New Rule 180.1 – Prohibition on the Employment, or Attempted Employment, of Manipulative or Deceptive Devices

Rule 180.1 prohibits fraud and fraud-based manipulation, as well as attempted fraud or manipulation, by any person, acting intentionally or recklessly, directly or indirectly, in connection with any swap or cash or futures contract. Specifically, Rule 180.1(a) makes it unlawful to:

use or employ, or attempt to use or employ, any "manipulative device, scheme or artifice to defraud"; make, or attempt to make, any "untrue or misleading statement of a material fact or to omit to state a material fact necessary in order to make the statements made not untrue or misleading"; engage, or attempt to engage, in any "act, practice, or...