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CFTC unveils new tools to stop market manipulation

Section: Daily Dispatches

By Roberta Rampton and Ayesha Rascoe
Tuesday, October 26, 2010

WASHINGTON -- The U.S. futures regulator laid out plans on Tuesday for how it could use new and beefed-up legal tools to foil traders who seek to manipulate prices or defraud investors.

The Commodity Futures Trading Commission said it also wants to ask for comments on whether to crack down on certain practices used by high-frequency traders -- such as "quote stuffing" -- but it stopped short of immediately proposing new rules specifically aimed at algorithmic trading.

In its latest set of proposed regulations following a sprawling Wall Street reform law, the CFTC sought to clear up some confusion about its traditional test for price manipulation, an effort to improve on its dismal record of having won only one such case in its 36-year history.

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The rule, which will apply to all markets overseen by the CFTC, including swaps, also creates a "broad, catch-all anti-fraud provision" that does not require the CFTC to prove a trader fully intended to cause fraud, CFTC officials said.

The agency's only successful manipulation prosecution was against a broker charged with manipulating settlement prices for electricity futures in 1998.

More recently, manipulation charges against four propane traders with BP were dismissed by a judge, who called the law "confusing and incomplete." BP agreed to pay a record $303 million to settle related charges.

CFTC officials who briefed reporters on the new package of proposed regulations declined to say whether the rules would have helped them make their case against the propane traders.

The agency's five commissioners, including Chairman Gary Gensler, will vote at a public hearing today on whether to advance the proposal for public comment for 60 days.

After staff consider whether to make changes based on comments, the commissioners will need to vote again to finalize the plan by next July.

The new rule seeks to marry existing anti-fraud and anti-manipulation authorities together with a new section that "fills in all the gaps," an official told reporters.

Existing regulations address "plain vanilla" person-to-person fraud, and price manipulation, such as market "corners" or "squeezes," he said.

But the new provision could capture manipulative trading activity that "could potentially fall out of one of those two buckets," he said.

Before, price manipulation cases required the agency to prove traders had the intent and ability to manipulate prices, tried to do so, and caused an "artificial price."

That four-part standard will continue to exist, but the CFTC included guidance that "artificial price" means a price affected by illegitimate market forces, the official said.

The Dodd-Frank law also requires the CFTC specifically to ban three disruptive trading practices as of July 16, 2011 -- a ban that does not require new regulations to take effect.

Included are "spoofing," whereby traders make bids or offers but cancel them before execution, and "banging the close" -- acquiring a substantial position leading up to the close of trade, then offsetting the position in the final moments to manipulate the closing price.

The agency has no obligation on whether to go further, but wants to gather more comments during the next two months about whether it should close a potential loophole in the spoofing ban, or prohibit any other practices deemed disruptive.

That will include "quote stuffing" -- flooding the market with large numbers of rapid-fire orders and then canceling them almost immediately -- a practice that some have argued contributed to the May 6 stock market "flash crash."

The agency will also ask whether it needs to write rules requiring traders to test and monitor their algorithms.

For months CFTC commissioners have said the agency needs to use its new powers to counter disruptive trades made by high-frequency algorithms.

Bart Chilton, a Democratic commissioner, and Scott O'Malia, a Republican, have said regulators should hold traders responsible for "rogue algos" that hurt markets.

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