The Commodity Futures Trading Commission determined not to appeal the December decision of a federal court in New York, holding that the Commission failed to meet its burden of proof in an enforcement action against DRW Investments, LLC and Don Wilson, its chief executive officer, charging the defendants with manipulation and attempted manipulation of the IDEX USD Three-Month Interest Rate Swap Futures Contract from January 24 through August 12, 2011. The court ruled against the CFTC following a bench trial that concluded in December 2016.
Although the CFTC did not announce the reason for its decision, it noted that “[w]hile the agency will not move forward with this case, it will continue to vigorously enforce the Commission’s anti-manipulation provisions and prosecute cases through trial where necessary.”
In its complaint and during the trial, the CFTC claimed that the defendants engaged in their prohibited conduct by placing bids involving the relevant futures contract “that DRW knew would never be accepted” to artificially influence the settlement prices in their favor on at least 118 trading days in a “banging the close” scheme. However, the court said that it was not manipulation or attempted manipulation for defendants to take advantage of flawed exchange rules that were public information where their bids reflected their bona fide perception of fair value and were designed to induce liquidity.
(Click here for further background on the DRW decision in the article “Being Smarter Than Your Counterparties Is Not Manipulation Rules Judge in CFTC Enforcement Action” in the December 9, 2018 edition of Bridging the Week.)
Legal Weeds and My View: In its complaint against defendants, the CFTC solely relied on the traditional provisions in relevant law prohibiting manipulation and attempted manipulation. (Click here to access 7 U.S.C. § 9(3) (prior to D0dd-Frank, effectively 7 U.S.C. § 9) and here for 7 U.S.C. § 13(a)(2) – the CFTC’s traditional anti-manipulation authorities.) In order to prove manipulation, said the court, the CFTC had to show that (1) the defendants had the ability to influence market price, (2) an artificial price existed, (3) defendants caused the non-bona fide price, and (4) defendants intended to cause the non-legitimate price. The court noted that, to show attempted manipulation, the Commission did not have to prove an artificial price existed, but had to demonstrate that defendants intended to cause an artificial price. The court ruled that the CFTC did not prove that the defendants violated either provision of law.
In its DRW complaint, the CFTC did not charge the defendants with violating the fraud-based manipulation prohibition enacted under the Dodd-Frank Wall Street Reform and Consumer Protection Act. This was because defendants’ purported wrongful trading predated the effective date of this provision. Under this law and a rule promulgated by the CFTC in conjunction with this statute, it is prohibited for any person to intentionally or recklessly engage in “any manipulative device, scheme or artifice to defraud.” (Click here to access 7 U.S.C. § 9(1); click here for CFTC Rule 180.1.)
For factual situations arising on or after August 15, 2011 – the effective date of CFTC fraud-based manipulation rule –, nothing precludes the CFTC from charging a defendant with both a violation of the traditional manipulation provisions of law and with a violation of the new fraud-based manipulation prohibitions.
In determining not to appeal the DRW decision, the CFTC may very well have considered that, since it now has the authority to prosecute alleged manipulation and attempted manipulation under the lesser requirements of fraud-based manipulation, its overall enforcement program is less harmed by an adverse decision of a federal trial court grounded on a discrete fact pattern (e.g., a purportedly flawed futures contract), than a potential adverse outcome in a federal court of appeals that would have greater precedential weight.
Indeed, contemporaneously with publication of the DRW decision, CFTC Chairman J. Christopher Giancarlo issued a statement noting that the court’s decision in DRW solely involved “CFTC’s pre-Dodd-Frank legal authority.” (Click here to access the chairman’s December 3, 2018 statement.)
In any case, the Commission's decision not to appeal was correct. The bottom-line message of the trial court hearing DRW was compelling: it's not illegal to be smarter than your competitors!