On August 29, the CME Group issued a new rule prohibiting certain disruptive trading practices that largely mirrors prohibitions in the Dodd-Frank Act. Most basically, the rule requires that all orders “must be entered in good faith for legitimate purposes.”
In addition, CME issued 22 frequently asked questions and answers regarding prohibited and non-prohibited conduct, and nine non-exclusive examples of prohibited activity.
Importantly, the new rule and FAQs do not prohibit disruptive conduct for the first time. Generally, the practices articulated in the new rule have previously been considered by CME as acts in violation of “just and equitable principles of trade” or equivalent high-level catch-all prohibitions. (Click here to see, for example, the article “CFTC, UK FCA and CME File Charges and Settle with Proprietary Trading Company and Principal for Spoofing,” in a Between Bridges Commentary posted on July 22, 2013.) What CME’s new rule and FAQs accomplish is to inform the marketplace of the precise types of disruptive trade practices that the exchange considers problematic and tries to give specific examples.
The new rule, CME Rule 575, is effective September 15, absent objection from the Commodity Futures Trading Commission.
Specifically, CME now explicitly makes it unlawful to (1) enter an order “with the intent, at the time of order entry, to cancel the order before execution or to modify the order to avoid execution;” (2) “enter or cause to be entered an actionable or non-actionable message or messages with intent to mislead other market participants,” or "to overload, delay, or disrupt the systems of the Exchange or other market participants;” or (3) “enter or cause to be entered an actionable or non-actionable message with intent to disrupt, or with reckless disregard for the adverse impact on, the orderly conduct of trading or the fair execution of transactions.” Under this rule, messages generally are the same as orders, but also could include requests for quotes, creation of user defined spreads or administrative messages.
The new rule applies to open outcry and electronic trading during all times of trading sessions.
CME’s new rule and FAQs build upon trading practices that were outlawed by Dodd-Frank. These prohibited practices include any trading, practice or conduct that (1) “violates bids or offers;” (2) shows “intentional or reckless disregard for the orderly execution of transactions during the closing period;” or (3) is or is commonly known to the industry as spoofing —which Dodd-Frank defines as “bidding or offering with the intent to cancel the bid or offer before execution.” (Click here to see the CFTC’s May 2013 interpretive guidance and policy statement regarding the prohibition of disruptive practices under Dodd-Frank.)
In general, as stated in the FAQs, CME will consider misleading any order where the intent of the trades was to create “the false impression of market depth or market interest.”
CME makes it clear that intent may be inferred:
Proof of intent is not limited to circumstances in which a market participant admits its state of mind. Where the conduct was such that it more likely than not was intended to produce a prohibited disruptive consequence without justification, intent may be found. Claims of ignorance, or lack of knowledge, are not acceptable defenses to intentional or reckless conduct. Recklessness has been commonly defined as conduct that "departs to far from the standards of ordinary care that it is very difficult to believe the actor was not aware of what he or she was doing."
In the FAQs, CME provides many examples of specific factors it may consider in assessing a violation, including whether the purpose of an order was to prompt other persons to trade when they otherwise would not; whether the purpose of an order was for the trader to influence the price rather than change the trader’s position; or whether the trader’s intent was to mislead the market, among other matters.
CME also indicates that a partial fill in response to an order does not “automatically” render an order compliant with its new rules, although it may be one indication that the order was entered in “good faith.” Likewise, it is permissible under certain circumstances for a trader to place an order for a quantity larger than it actually wants (knowing that the amount executed may be reduced by CME Globex’s pro-rata matching algorithm), provided the purpose of the order is to achieve an execution. However "[p]articipants should be prepared to, and capable of, handling the financial obligations attendant to the full execution of their orders."
In its FAQs, CME makes clear that entering orders into Globex solely for the purpose of testing connectivity would be prohibited by its new rule, unless there also was intent to consummate a bona fide transaction. CME also warns in its examples that, if a trader discovers how algorithmic trading activity might be triggered in one market (Market B) because of orders in another market (Market A), the trader cannot place orders in Market A solely to induce activity in Market B from which it can profit—unless it intends the orders in Market A to be executed.
CME’s new rule prohibits only “certain” of the trading practices prohibited by Dodd-Frank. However, CME may continue to prosecute disruptive practices not specified in its new rule under its existing high-level catch-all prohibitions (e.g., the prohibition against engaging in “dishonorable or un-commercial conduct”).
Under the plain language of Dodd-Frank, conduct that demonstrates intentional or reckless disregard for the orderly execution of transactions is only expressly illegal during the closing period. CME’s new rule prohibits intentional or reckless disruptive conduct at all times.
Compliance Weeds: CME’s new rule 575, its FAQs and its examples mostly provide specific guidance regarding the type of activity staff would consider disruptive, rather than prohibit such conduct for the first time. The text of CME’s new rule, FAQs and examples speaks for itself, but, in a nutshell, it appears that if the intent of a trader’s order or series of orders (or other messages) is solely to induce other traders to trade when they otherwise would not or solely to influence prices—such practices would be prohibited. There must always be intent to achieve an execution when placing an order.