Timothy Massad, Chairman of the Commodity Futures Trading Commission, indicated last week that he continues to support a federal registration requirement for certain algorithmic traders not currently required to be registered with the CFTC – as currently proposed in the agency’s November 2015 Regulation Automated Trading. However, Chairman Massad suggested that, in a forthcoming CFTC-issued supplemental proposal he supports, the universe of affected traders would be limited by an unspecified “volume-based” quantitative test.
Mr. Massad made his comments regarding Regulation AT before the Managed Funds Association’s Outlook 2016 Conference. In his presentation, Mr. Massad did not reveal when the Commission might issue a supplemental proposal but expressed his “hope” that the CFTC would act on it very soon.
Regulation AT, as proposed, is a comprehensive set of new rules that, if adopted, would potentially impose many new risk controls and other obligations on certain CFTC registrants (termed “AT Persons”) that use algorithmic trading systems – including both black box trade origination systems and smart automated order routing systems – to trade futures, related options or swaps on designated contract markets. Under the CFTC’s proposed initiative, any person that uses an algorithmic trading system that electronically and directly routes orders to a DCM other than first through a clearing-member futures commission merchant must be registered with the CFTC as a floor trader unless such person is otherwise registered with the CFTC in another capacity. Once registered as a floor trader, such person would be subject to all requirements of other AT Persons. As currently proposed, there is no volume or other quantitative threshold to limit the potential universe of new registrants and many commentators warned that, as a result, the universe of potential new registrants could be in the thousands. (Click here for background on the requirements of proposed Regulation AT in the article, “CFTC’s Proposed New Algorithmic Trading Rules Augur Potential Increased Obligations and Costs, and a New Registration Requirement” in the November 29, 2015 edition of Between Bridges.)
Chairman Massad suggested that the purpose of introducing a quantitative threshold would be to ensure that the number of persons newly required to register as floor traders would not be “too broad” but would solely capture “the most active firms.”
In addition, Mr. Massad indicated that a controversial provision of proposed Regulation AT obligating AT Persons to produce algorithmic systems’ source code upon request by the CFTC or the Department of Justice (as opposed to pursuant to subpoena) would likely remain in the supplemental proposal but would include measures “that respect the proprietary value and confidentiality of source code.” He did not indicate what those measures might be.
Finally, Chairman Massad indicated that he agreed with commentators to Regulation AT who argued that requiring all algorithmic traders, FCMs and DCMs to be responsible for maintaining risk controls – as proposed – was too redundant. He said he now supported a proposal that DCMs and either FCMs or traders be responsible for risk controls. He noted that he also supported suggestions that risk controls should pertain to all electronic trading – not just algorithmic trading.
A supplemental proposal to an existing proposed new regulation should be subject to a period of public comment following its issuance. (Click here, for example, for an article regarding the CFTC’s supplemental proposal regarding non-enumerated hedging exemptions entitled, “CFTC Proposes to Authorize Exchanges to Grant Physical Commodity Users Non-Enumerated Hedging Exemptions and Other Relief Related to Speculative Position Limits” in the May 27, 2016 edition of Between Bridges.)
My View: It is ironic that, shortly after the CFTC proposed Regulation AT, President Obama signed into law the Defend Trade Secrets Act that heightened the protections afforded all intellectual properly. As proposed, Regulation AT provides the CFTC and the DoJ an unfettered right of access to an AT Person’s algorithmic systems’ source code – whether developed proprietarily or by a third party – without any protections against inadvertent or even purposeful misappropriation. In response, many commentators questioned the practical benefit for the CFTC ever to obtain source code from an AT Person in the first place. However, even if the CFTC could effectively utilize source code, many commentators also questioned the fairness (let alone constitutionality) of the agency obtaining source code through its inspection authority, rather than through a subpoena. It appears that Chairman Massad believes that the CFTC should not relent on its goal of having the authority to acquire source code through the Commission’s inspection powers, although he seems to acknowledge that this authority should not be unfettered and should afford certain protections. However, as recognized by the Defend Trade Secrets Act, all intellectual property, including source code, should be afforded the highest protections. Consistent with the objective of this new law, if the CFTC or the DoJ seeks access to source code, at a minimum, they should be permitted to do so only through a subpoena that can be challenged and negotiated before an independent federal court to ensure adequate protections. (Click here for background on the Defend Trade Secrets Act in the article, “Landmark Trade Secrets Law Creates New Federal Civil Cause of Action and Compliance Obligations for All Employers” in a May 11 2016 Advisory by Katten Muchin Rosenman LLP. Click here for a summary of public comments to Regulation AT in the article, “Industry Comments to Regulation AT Argue CFTC Proposed Rules Too Prescriptive; Registration and Source Code Requirements Particularly Objectionable” in the March 20, 2016 edition of Bridging the Week.)