The US Commodity Futures Trading Commission recently settled its first-ever insider-trading case, relying on new powers granted to it under the Dodd-Frank Act and embodied in CFTC Regulation § 180.1 (“Rule 180.1”).
This development should be examined closely by all private fund managers that trade or engage in transactions that include “commodity interests” (i.e., futures, options on futures and related swaps), irrespective of whether they are registered with the CFTC and irrespective of whether they are trading for their own account or for clients. Among other things, managers should consider extending the scope of their current insider-trading protection efforts to commodities interest trading and broadening their personal trading disclosure requirements and review practices to cover commodity interest trading.
The CFTC brought this action against Arya Motazedi, a proprietary gasoline and energy trader at an unnamed public company in Chicago. According to the CFTC, Motazedi had access to confidential, proprietary information concerning his employer’s proprietary trading in energy commodities (e.g., timing, amounts and prices) and he used that knowledge:
The CFTC noted that, of the two accounts that Motazedi controlled and utilised in these activities, he only owned one of them.
The Motazedi matter was resolved in a settlement order (the “Order”)1 in which the CFTC:
Rule 180.1 Liability
Motazedi is noteworthy because it is a “plant the flag” case for the use of Rule 180.1 as a source of liability in general and for insider trading in particular.2 In the Order, the CFTC reiterated its intent to interpret CEA Section 6(c)(1), which permits the CFTC to prosecute fraud in connection with any contract of sale of any commodity for future delivery, as a “broad, catch-all provision reaching fraud in all its forms — that is, intentional or reckless conduct that deceives or defrauds market participants.” Rule 180.1, which is the means for carrying out this interpretation, was promulgated under Section 6(c)(1) and demonstrates the extent of the CFTC’s efforts to extend its anti-fraud powers. Prior to the promulgation of Rule 180.1, CFTC enforcement efforts generally were subject to a requirement that the CFTC show actual price manipulation, which historically has been difficult to prove; the use of Rule 180.1 in the Motazedi case may make it possible for the CFTC to bring, and win, more cases.
Taken together, Section 6(c)(1) and Rule 180.1 establish a CFTC prohibition on deceptive or manipulative conduct that is expressly modelled on theSEC’s use of Securities Exchange Act Rule 10b-5.3 Both regimes are utilised to sanction insider-trading activity under a “misappropriation theory,” that is, “trading on the basis of material nonpublic information in breach of a pre-existing duty (established by another law or rule, or agreement, understanding or some other source), or by trading on the basis of material nonpublic information that was obtained through fraud or deception.”
The Motazedi case also confirms that the CFTC and the SEC insider-trading regimes share a mental state requirement: while Section 6(c)(1) is silent with respect to scienter, Rule 180.1 allows the CFTC to pursue traders who act “recklessly,” defined as an act or omission that “departs so far from the standards of ordinary care that it is very difficult to believe the actor was not aware of what he was doing.” Applying Rule 180.1 to Motazedi’s alleged conduct, the Order highlights several facts that demonstrate Motazedi’s recklessness:
Thus, the CFTC found that Motazedi’s misappropriation and misuse of his employer’s material nonpublic trading information was “knowing or reckless” and that he breached his duty to his employer, violating both Section 6(c)(1) and Rule 180.1.4 However, it appears from the Order that the CFTC would have found a violation of Rule 180.1 even without a company policy prohibiting personal trading, based on the duties inherent in the employment relationship.
Implications of Motazedi for managers
Motazedi has several clear and direct implications for private fund managers:
Motazedi shows that the franchise risk posed by an insider-trading allegation is not limited to managers that are registered with the CFTC and the National Futures Association (as, e.g., commodity pool operators or commodity trading advisors); any individual or entity can be sued under Section 6(c)(1) and Rule 180.1.
Therefore, all private fund managers that trade commodity interests (in any quantity) should consider taking steps to expand the insider-trading protections on the securities side of their businesses to trading in futures commodity options and swaps markets. These measuresshould include specific policies, targeted training and surveillance. Managers that do not request records of personal trading (including records of accounts that are controlled, but not owned, by firm personnel) in futures and options and that do not surveil those trading records to the same degree as equity trading should begin doing so.
1. In the Matter of Arya Motazedi, CFTC Docket No. 16-02 (Dec. 2, 2015).
2. In addition to the Rule 180.1 allegations, the CFTC also deemed Motazedi’s alleged conduct to be a violation of multiple other provisions of the Commodities Exchange Act and CFTC regulations, including the CEA’s anti-fraud provision (Section 4b), the CEA’s prohibitions on illegitimate, prearranged trading (Section 4c(a)), and the CFTC rule against non-competitive trades (Regulation § 1.38(a)).
3. In the final rule adopting new Rule 180.1, the CFTC stated that “[t]o account for the differences between the securities markets and the derivatives markets, the Commission will be guided, but not controlled, by the substantial body of judicial precedent applying the comparable language of SEC Rule 10b-5.” Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation, 76 Fed. Reg. 41398, 41399 (July 14, 2011).
4. Separately, the CME entered an order against Motazedi based upon the same conduct. The order was based on a violation of CME’s anti-fraud provision (NYMEX Rule 432.B) and the prohibition on prearranged execution of transactions for the purpose of transferring equity between accounts (NYMEX Rule 432.G).