Federal District Court Dismisses CFTC Price Manipulation Claims And Resets The Standard Of Intent Debate

Few price manipulation cases brought by the Commodity Futures Trading Commission (CFTC) ever go to trial. The CFTC case filed against the trading firm DRW Investments LLC (and its CEO) was the exception to that rule and would be noteworthy for that reason alone. But there is more. Following a bench trial conducted in December 2016, on November 30, 2018, Judge Richard J. Sullivan dismissed the CFTC's complaint that DRW engaged in price manipulation and attempted price manipulation of interest rate swap futures contracts.1 Judge Sullivan observed that "[t]here is no disagreement: the Defendants knew that their trading practices ... would result in a higher settlement price" inuring to DRW's benefit. Nevertheless, he found that the CFTC failed to prove that the defendants intended to create an artificial price. In so ruling, Judge Sullivan clarified that the intent standard for CFTC's price manipulation or attempted manipulation claims under the Commodity Exchange Act (CEA) requires a specific intent to create an artificial price and not merely an intent to affect price.

This decision is significant because:

Judge Sullivan rejected the CFTC's legal theory that trading activity that is intended to influence price is per se illegitimate and by definition "artificial." After finding that the defendants' trading patterns were "supported by a legitimate economic rationale," Judge Sullivan held that such activity cannot be the basis for manipulation or attempted manipulation liability. The decision is squarely at odds with several recent CFTC speaking orders in major settlements with financial institutions that concluded that trading conduct constitutes attempted manipulation if the trading activity is intended to affect settlement prices, even if the same trading conduct had another legitimate purpose — i.e., hedging. Background

In CFTC v. Wilson & DRW Investments,2 the CFTC alleged that the defendants manipulated and attempted to manipulate the price of the IDEX USD Three-Month Interest Rate Swap Futures Contract (Three-Month Contract) cleared at the International Derivatives Clearinghouse (IDCH). The Three-Month Contract was a cleared derivative contract that largely mirrored the economics of an uncleared, over-the-counter (OTC) interest rate swap. IDCH calculated settlement prices of the Three-Month Contract according to a formula that was dependent, in part, on electronic bids and offers placed during a daily settlement window, or in the absence of bids and offers, tied to the value of comparable uncleared OTC swaps. But the settlement methodology ignored a key valuation distinction between uncleared swaps and the cleared Three-Month Contract: The margin payments made a long position in the Three-Month contract more valuable than a short position unless an adjustment was applied to the settlement calculation. IDCH's calculation did not include an adjustment. DRW identified this important distinction and speculated that the market had not yet taken into account this pricing...

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