As the Obama administration winds down, its regulators are showing no signs of letting up. Last week the Commodities Futures Trading Commission (CFTC) decided that it should no longer be constrained by its subpoena power when it seeks to obtain highly confidential and propriety algorithms used by electronic trading firms. In a 2-1 vote, the CFTC commissioners proposed a new rule under which a majority of the commissioners could vote to issue an order that requires CFTC-regulated companies to hand over the source code to their complex mathematical models that drive their trading decisions. The power would allow the agency to force automatic trading companies to hand over what is seemingly their most valuable assets and closely held secrets upon the mere suspicion of wrongdoing and without the need to show any probable cause. As noted in the Wall Street Journal, “[t]his is like asking Apple to turn over the source code for the iPhone.”
The majority vote was led by Chairman Timothy Massad and Commissioner Sharon Bowen, with Commissioner Christopher Giancarlo dissenting. Massad reasoned that the current rules favor automatic trading firms over traditional trading companies, as the former are able to simply “hide behind their machines” to avoid agency surveillance. Dissenting Commissioner Giancarlo criticized the majority for seeking to go above and beyond the subpoena process, thereby eliminating any due process protection that the companies may have under the Constitution.
The new rule would also require algorithmic trading firms to register with the CFTC if they trade on average 20,000 futures contracts a day over a six-month period. This would broaden the agency’s coverage and potentially its ability to obtain highly coveted secrets that form the foundation for some firms. And there is reason for concern. Some may recall in 2001 when Senator Bernie Sanders released confidential CFTC data on oil trading positions, and it is not a far reach to think that a firm’s proprietary algorithms could similarly be used for political purposes.
While this proposed rule may only impact a small industry at the moment, that other agencies may now seek the same power is worrisome. With Obama on his way out the door and Trump on the way in, it is yet to be seen whether this type of power grab will continue. We will continue to monitor and report the development and public comment on this proposed rule.