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Gregory Scopino

Abstract

This Article seeks to determine if the CFTC needs new tools to combat disruptive, manipulative, or otherwise harmful trading practices that originate solely from the “minds” of ATSs. Part I of this Article provides a brief regulatory background of the derivatives markets, then examines the increased automation in those markets today, and concludes by looking at the CFTC’s initial responses to the issues raised by automation. Part II briefly looks at the law concerning different mental states for causes of action. Part III examines the CFTC’s pre and post-Dodd–Frank Act tools to police disruptive and manipulative trading practices, which are causes of action that, generally speaking, have scienter or culpable mental state requirements. This makes these tools ineffective in situations where none of the prospective defendants acted with the requisite mental state.

Part IV analyzes the failure-to-supervise cause of action under CFTC Regulation 166.3. It determines that this regulation potentially could be an effective weapon against ATS-initiated behavior that disrupts or manipulates derivative markets because: (1) a Regulation 166.3 claim does not require proof of an underlying violation of the CEA or CFTC Regulations, and (2) decisions analyzing Regulation 166.3 appear to apply a reasonableness standard (as opposed to a scienter requirement) in scrutinizing whether a firm diligently supervised its employees and agents in connection with its business as a CFTC registrant. More specifically, although never explicitly stated, Regulation 166.3 violation decisions appear to apply a reasonableness standard that analyzes whether a reasonably prudent registrant—as opposed to a reasonably prudent person—would have acted the same in similar circumstances. Part IV also suggests that, to ensure that Regulation 166.3 will effectively deter disruptive and manipulative trading practices by registrants’ ATSs, the CFTC could promulgate a rule making clear that a registrant’s duty to diligently supervise its employees in connection with its business as a registrant includes making sure that employees monitor ATSs for improper trading practices.

This Article is the first to: (1) suggest that Regulation 166.3 is most likely the best tool for combatting improper trading practices by ATSs where no human connected to the activities had the requisite scienter; (2) contend that Regulation 166.3 uses a reasonableness standard that is best viewed as a reasonably prudent registrant (as opposed to a reasonably prudent person) standard for diligence in connection with supervisory duties; and (3) point out that this standard establishes, as a baseline, mandatory awareness of requirements in the CEA and applicable CFTC and self-regulatory organization (SRO) rules and guidelines.

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