Regulation Automated Trading

On November 24, 2015, the U.S. Commodity Futures Trading Commission (CFTC) proposed Regulation Automated Trading (Reg AT), a set of rules now in the process of industry review and comment.  It represents “a series of risk controls, transparency measures, and other safeguards to enhance the U.S. regulatory regime for automated trading.”  In essence, it is recognition that the commodities and futures markets are increasingly served by high frequency trading firms.  Therefore, the rules governing those markets need to be updated to better suit electronic markets.

Modern Markets Initiative (MMI) largely supports Reg AT and most HFT firms already comply with most of its provisions.  We believe it is in the interest of all investors that participants are accountable to act in support of stable and resilient markets.

However, MMI has written three comment letters to the CFTC, a letter to the CFTC Technical Advisory Committee and contributed to a joint industry letter in opposition to the proposed rules within Reg AT allowing inspection of a trading firm’s source code under the provision of “book and records” because it makes the code accessible outside the existing, highly-regulated subpoena process.  Source code is the “secret sauce” of technology firms such as high frequency trading firms, Google and Apple, for example.  It is unprecedented for regulators to have routine access to this sensitive intellectual property.

MMI believes the Reg AT’s establishment of strict rules, regulations and guidelines will help instill investor confidence in the futures and commodities markets.  But it should not come at the cost of the legal protections of the market participants serving them.

What Lawmakers, Regulators and Others are Saying About Reg AT:

January 12, 2017: Amendment to the Commodity End-User Relief Act
Amendment sponsored by Rep. Sean P. Duffy [R-WI-7] prohibits the CFTC from compelling the production of algorithmic trading source code and similar intellectual property unless it has issued a subpoena.

January 11, 2017: Letter from the U.S. Chamber of Commerce to the U.S. House of Representatives
“The Chamber also supports the amendment sponsored by Congressman Duffy and Congressman Scott to clarify that the CFTC shall not have the authority to access proprietary source code without a subpoena. Their amendment would protect highly sensitive intellectual property, which would respect established due process rights and ensure that proprietary source code does not fall into the wrong hands as a result of a cyberattack or wrongdoing.”

November 18, 2016: Letter from K. Michael Conaway, Chairman of the House Committee on Agriculture to CFTC Chairman Timothy Massad
“President Obama told the public that he was looking forward to doing everything he could to make sure the next administration is successful. That must include preserving difficult and controversial rulemaking for the next chairman to complete. I urge you to extend the Reg AT comment period by 180 days, which will provide the new chairman time to plan and announce a new agenda to the public and allow commenters the opportunity to file one comment letter on the supplemental and any additional proposed changes.”

November 4, 2016: Statement of Dissent by Commissioner J. Christopher Giancarlo Regarding Supplemental Notice of Proposed Rulemaking on Regulation Automated Trading
“The subpoena process provides property owners with due process of law before the government can seize their property. It protects owners of property – not the government that already has abundant power. It allows property owners an opportunity to challenge the scope, timing and manner of discovery and whether any legal privileges apply to the process of surrendering property to the government … Abrogating the legal rights of property owners is not assuaged by imposing a few additional procedural burdens on the government agency seizing their property.”

August 10, 2016: Letter from Representative Sean P. Duffy to the U.S. SEC
Representative Sean P. Duffy (WI-7), Chairman for the House Financial Services Subcommittee on Oversight & Investigations, wrote to the Chairman of the SEC expressing concern over the CFTC proposal to maintain a source code repository and make it available for inspection by the Commission or the Department of Justice without a subpoena. He wrote “as a former prosecutor, I take very seriously the due process rights of Americans under the Fifth Amendment which I believe would be undercut by the source code provision of the CFTC’s proposed rule.”

August 3, 2016: Letter from Congressmen Scott Garrett & Randy Neugebauer to CFTC
Representative Scott Garrett (NJ-05), Chairman of the Subcommittee on Capital Markets for the House Financial Services Committee and Representative Randy Neugebauer (TX-19), majority member of the House Committee on Agriculture which oversees the CFTC, wrote to the CFTC expressing concern over the prospect of the CFTC having subpoena-less access to source code. They wrote “it will create a due process ‘race to the bottom’ as other regulators, both in the United States and overseas, would be tempted to follow the CFTC’s lead.”

June 10, 2016: Letter from seven Congressmen on the House Committee on Agriculture and one from the Homeland Security Committee to the CFTC
Representatives Sean P. Duffy (WI-7), David Scott (GA-13), Austin Scott (GA-8), Bob Frank Lucas (OK-3), Rodney Davis (IL-13), Bob Goodlatte, and Randy Neugebauer (TX-19) of the House Committee on Agriculture which oversees the CFTC, and Representative Michael McCaul (TX-10), Chairman, Committee on Homeland Security, wrote to the CFTC to express concern over the prospect of the CFTC having subpoena-less access to source code. They wrote “we question whether the proper security and due process safeguards are in place to prevent such information from being compromised or mishandled.”

Further Resources:

December 28, 2016: ValueWalk – Why Did Regulator Have Computer Trading Code On Personal PC?
Mark Melin writes that a 2016 SEC Office of Inspector General (OIG) report contains a little-noticed reprimand of an SEC quantitative analyst charged with improperly requesting and downloading confidential computer code to his personal computer.  This as measures in the CFTC’s pending Reg AT call for regulators to have subpoena-less access to source code used by professional traders.

November 10, 2016: Financial News – Possible Consequences of the Pending Trump Presidency on Reg AT
Tim Cave reports Bill Harts, chief executive of New York-based HFT advocacy group Modern Markets Initiative, said that as a result of the election of Trump, the 2005 equity trading regulation Regulation NMS may be reviewed.  He also pointed out that Regulation AT – the CFTC’s new rules overseeing algorithmic trading which include a controversial provision for regulators to freely access firms’ computer code – could also be stalled. “It has yet to enter its 60 day comment period and the inauguration is only 71 days away. It seems unlikely you will see something happen on this issue in that time frame.”

November 8, 2016: WSJ – Wall Street Frets About Cybersecurity as U.S. Demands More Data
Andrew Ackerman reports Federal regulators are demanding a vast trove of private data to help them better monitor markets. But in the age of routine, sophisticated hacks, many in the financial industry worry the government will be unable to keep that sensitive information secure.  Investment firms cite numerous breaches at federal agencies, most recently the late-October admission by the national bank overseer that a former employee had downloaded 10,000 records with two thumb drives and took them home.

November 4, 2016: ValueWalk – CFTC One Step Closer To Reg AT Requiring Algo Access
Mark Melin reports the CFTC proposed rulemaking changes to issue a “special call” notice to registered participant as opposed to a legal subpoena, when seeking access to the source code of automated traders. CFTC Chairman Tim Massad said engaging in market manipulation “should not be able to hide behind machines.” Modern Markets Initiative CEO Bill Harts said, “The only thing hidden is the CFTCs reason for not using a procedure that has served it well.” “We live in the United States of America,” Harts said. “We have due process rights guaranteed by the Constitution.” Harts wants to specifically understand why subpoena power is not enough for investigators. “We are disappointed the CFTC voted to propose a new process that ignores due process and private property rights of US citizens, while not stating if or why the current subpoena process doesn’t work,” Harts said. “Why is there a necessity to bypass these important Constitutional protections and put US businesses’ intellectual property at risk?”

November 4, 2016: Financial Times – CFTC set to tweak rules for automated trading
Gregory Meyer and Joe Rennison report The Commodity Futures Trading Commission’s proposal, known as Regulation AT, seeks subpoena-less access to source code as part of its oversight of markets. Bill Harts, chief executive of Modern Markets Initiative, a trading industry group, said: “It would not remediate the problems. We are still frankly in the dark. The CFTC still hasn’t said why the current process of obtaining a subpoena doesn’t work. If they don’t say why that isn’t working then how can we propose meaningful revisions to what they want to do?”

October 20, 2016: ValueWalk – CFTC’s Giancarlo Says Regulators Should Keep Hands Off Source Code
Mark Melin reports CFTC Commissioner Christopher Giancarlo, speaking at the Futures Industry Association conference in Chicago, expressed steadfast opposition to the subpoena-less access to source code provision in the proposed Regulation Automated Trading. He said requiring traders to provide their source code to regulators prior to a market destabilizing event fundamentally violates fundamental property rights “and is bigger than just a CFTC issue.”

October 19, 2016: Waters – Reg AT Source Code Proposal Remains Lighting Rod
Dan DeFrancesco reports panelists at the North American Buy-Side Technology Summit discussed the merits of Reg AT calling for subpoena-less access to source code. Bill Harts, CEO of Modern Markets Initiative said the CFTC can already access a firm’s source code through a subpoena, which, because it’s a legal procedure, implies a higher standard of what a regulator is going to do with the data and why it would want it. “So what we’re talking about here is not that regulators shouldn’t have access to it,” said Harts. “What we’re saying is that there should be a higher standard for obtaining access to it.”

October 11, 2016: Bloomberg – Algorithmic Traders Might Keep Trade Code Secret as CFTC Mulls Tweaks
Commodity Futures Trading Commission Chairman Timothy Massad said his commission is considering modifying its push for access to computer code after high-speed traders said the effort would be unprecedented and could put the industry’s secret trading formulas at risk. “We can think of no other circumstance where market participants have been required to reveal, to a regulator, their thoughts, words or actions regarding future automated or manual trading intent,” the Modern Markets Initiative wrote in a June letter to the CFTC. Forcing firms to provide their code without a subpoena “constitutes an unlawful seizure of protected intellectual property,” the industry trade group said in its letter.

September 13, 2016: Yahoo Finance Op-Ed: New CFTC proposal could jeopardize the IP lifeblood of many businesses
Countless companies around the world have developed and perfected sophisticated and multifaceted algorithms which are the intellectual property (IP) lifeblood of their business. Imagination and innovation have enabled thousands of these companies to conquer the free market and be prosperous. In the US, however, that extremely valuable commodity—intellectual property—could be jeopardized if a government agency (ironically, the Commodity Futures Trading Commission—CFTC) succeeds in doing what they propose.

August 26, 2016: MMI Blog – A “Source” of Serious Concern
The goal of the CFTC’s proposed regulation is a good one.  Namely, to codify the best practices and risk controls of electronic trading firms to ensure the stability of the markets.  MMI stands in broad support of just about all the proposed measures.  But I firmly believe that intellectual property belongs under the care of companies for whom stealing the source code is stealing the company.

July 7, 2012: Op-Ed Pensions & Investments: CFTC reaches too far on source code
Attorneys Jason P. Gottlieb and Daniel C. Isaacs write that the proposed source code requirements of Regulation Automated Trading would be a huge cost to government and industry alike, and an intellectual property risk, with little corresponding benefit to the CFTC, which after all can already obtain code by subpoena when necessary.

June 24, 2016: MMI Second Comment Letter to the CFTC Regarding Reg AT
As previously stated, MMI stands in broad support of the CFTC’s proactive efforts to codify industry best practices and enforce high standards for automated trading. However, the Agency’s Proposal to move source code inspection from a judicial process to books and records provisions (Commission Regulation 1.31) unduly imperils sensitive intellectual property and violates the Fourth Amendment.

June 24, 2016: Letter from U.S. Chamber of Commerce Center for Capital Markets Competitiveness and Seven other Associations to the CFTC regarding Reg AT
“In short, if not significantly amended, the proprietary source code provisions of Regulation AT will: (1) compromise the established and expected due process rights of our members; (2) increase the threat of “copycat” measures from other countries and contradict established U.S. policy on intellectual property disclosure; (3) heighten the possibility of cyberattacks against government-mandated data repositories; and (4) do little to assist the CFTC in its market surveillance activities.”

June 21, 2016: – Former CFTC Commissioner – CFTC rule ‘extreme overkill’
Former CFTC Commissioner Bart Chilton writes that one would not expect Coca-Cola to divulge their secret recipe for the world-renowned soft drink…nor is it required by government. The same is true for other proprietary trade secrets and intellectual property. That, however, could all change by the end of the year if the U.S. Commodity Futures Trading Commission — where I previously served as a commissioner for seven years, is allowed to obtain such secret formulas known as “source code” from traders and trading venue operators (exchanges).

June 14, 2016: Breakingviews: Regulator’s Plan to Rein In Trading Risks Raises Concerns
Columnist Gina Chon writes that the Commodity Futures Trading Commission is overreaching in its quest for market safety and soundness.  The agency wants the power to obtain access to the source codes of trading companies without a subpoena. Record retention is a worthy goal, but it is unclear whether the strapped regulator can protect such intellectual property. Worse, it may open the door for other officials to ask for the same gateway.

June 10, 2016: Opening Statement of Commissioner J. Christopher Giancarlo before the CFTC Staff Roundtable on Regulation Automated Trading
“As a lawyer, I am aware of no legal foundation on which to haphazardly set aside long-established, due process protections afforded by agency subpoena practice.   It is for the people’s representatives in Congress, and not an unelected agency, to decide whether valuable private property may be taken without specific authority arising from a legal proceeding.”

June 10, 2016: POLITICO Pro – Massad eyes flexibility ahead for algorithmic trading rule
Patrick Temple-West reports the CFTC proposed rule that includes a provision to obtain traders’ computer codes for algorithms, has angered high-frequency traders who argue that the CFTC should get a subpoena for their sensitive information.  Speaking to reporters at a CFTC event on Friday about the proposal, Chairman Timothy Massad did not rule out re-proposing the rule once the latest comment period expires on June 24.

March 16, 2016: Bloomberg News: Regulator Pledges to Keep Secrets for High-Frequency Traders
The U.S. regulator for derivatives said it will look after high-frequency traders’ code once planned new rules oblige them to share their algorithms with the authorities. CFTC Chairman Timothy Massad said that the regulator wouldn’t jeopardize the security of traders’ proprietary source code. Massad also said he expects to finalize the rule by the end of this year.

March 15, 2016: Hudson River Trading Comment Letter to the CFTC Regarding Reg AT
(MMI Founding Member) Hudson River Trading supports the Commission’s objective of updating regulations to recognize and adapt to modern, automated markets.  Although these requirements will pose an additional cost and staffing burden on automated trading firms, they will provide important safeguards for the market.  Although we are broadly supportive of the Commission’s objectives, we are concerned about the requirement of proposed Regulation AT that AT Persons provide unfettered access to their Algorithmic Trading Systems (“ATS”) source code to both the Commission and the U.S. Department of Justice.

February 25, 2016: John Lothian News: Reg AT “Precarious, Unwarranted and Unnecessary Risk”
At the CFTC’s Technology Advisory Committee meeting the most contentious aspect of the discussion was whether or not the CFTC should be allowed to look at firms’ computer code for their automated trading systems and hold them in a repository.  Richard Gorelick, co-founder and CEO of RGM Advisors, said it would violate standards of due process.  One comment letter submitted by the Modern Markets Initiative said the rule would “place the trade secrets and intellectual property of algorithmic trading firms at precarious, unwarranted and unnecessary risk.”

February 19, 2016: Letter from MMI to the CFTC Technology Advisory Committee Regarding Reg AT
“While MMI supports most elements of the Proposed Rule, we have grave concerns with the proposed requirement under section § 1.81(a) that AT Persons must produce for inspection ‘a source code repository to manage source code access, persistence, copies of all code used in the production environment, and changes to such code.’”

January 27, 2016: MMI CEO Op-Ed in Modern Trader: Source code, it’s the real thing
When Coca-Cola abruptly withdrew from India in 1977, where it had been operating profitably for more than 20 years, it did so because it did not want to comply with a new government order to reveal its “secret formula.” Today, a proposal by the U.S. Commodity Futures Trading Commission seeks to require automated trading firms to reveal their source code to them. MMI opposed the measure as overreach and a threat to the “secret formula” of these firms.

January 15, 2016: MMI Comment Letter to the CFTC Regarding Reg AT
We believe updating Commission rules in response to the evolution from pit trading to electronic trading is not only needed, but can ensure that the Agency is at the forefront of establishing a suitable regulatory regime reflecting contemporary market circumstances. That support stated, which covers the vast majority of the Proposal, we have grave concerns with section § 1.81(a), that AT Persons must produce for inspection “a source code repository.”  We believe this will place the trade secrets and intellectual property of algorithmic trading firms at precarious, unwarranted and unnecessary risk.

December 1, 2015: Financial Times: US regulators propose powers to scrutinise algo traders’ source code
The idea of sharing source code with government officials is emerging as the most controversial element of the CFTC’s new regulation on automated trading which attempts to catch up with the explosion in automated trading over the past 10 years. “While we think that the CFTC’s goal is perfectly reasonable, it’s inconceivable that any firm should be expected to leave its intellectual property on the doorstep of the government,” says Bill Harts, chief executive of Modern Markets Initiative, a trading industry group, whose members include Hudson River Trading and Tower Research Capital.

“High-frequency trading in general has been good for the retail investor."


Bloomberg News, April 24, 2014

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