Careless whispers have a cost

CFTC redefines insider trading for the swaps market

The cost of careless whispersThere are lots of ways a derivatives business can slip up, but insider trading has not traditionally been one of them.

In securities markets, an issuer of equity has a de facto duty of care to its investors, so an insider's use of non-public information to trade the stock will breach that duty. There are no comparable ties in the trading of interest rate swaps, variance swaps, or crude oil swaps, so while the Securities and Exchange Commission (SEC) has taken aim at more than 250 cases of insider trading since 2010, the Commodity Futures Trading Commission (CFTC) has struggled to make charges stick.

But in Rule 180.1, the CFTC has redefined what insider trading means, and – emboldened by a first, successful prosecution in December last year – is warning the industry it stands ready to use its new powers more widely. A number of behaviours that would previously have been out of the regulator's reach could now invite trouble.

The CFTC's powers are based on so-called misappropriation theory, in which even outsiders could be guilty of a crime if they trade on information obtained under conditions where they have some kind of duty of loyalty or trust.

"The SEC and Department of Justice have successfully brought misappropriation cases where there was no relationship at all between the defendant and the entity whose stock was traded. The misappropriation theory applies equally to the securities and derivatives worlds," says Joan Manley, a deputy director of enforcement with the CFTC.

So, according to Manley and her boss – director of enforcement, Aitan Goelman – if a bank's trader reveals a position to a hedge fund client, and the fund trades on that basis, both parties might be deemed to have misappropriated the information.

Bank trading floors are far from watertight, and some hedge funds employ people whose job it is to find out what other market participants are up to. Careless whispers could now have a cost.

The new approach also raises questions about what's known as pre-hedging: the practice of building a position ahead of a big client order so the dealer does not face higher costs when trying to cover itself after the order has been executed. This looks prudent, but risks driving up the client's trading costs – and often does, according to angry bank customers who spoke to last December.

Lawyers who are familiar with the CFTC's thinking on the subject say the best way to mitigate the risk would be for the dealer to tell the client it planned to hedge the order in advance; disclosure changes the game and ought to mean there has been no breach of trust. This is precisely the advice lawyers have been giving to dealers for at least a couple of years. Whether it is being followed to the letter, only the dealers know.

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact or view our subscription options here:

You are currently unable to copy this content. Please contact to find out more.

Financial crime and compliance50 2024

The detailed analysis for the Financial crime and compliance50 considers firms’ technological advances and strategic direction to provide a complete view of how market leaders are driving transformation in this sector

Investment banks: the future of risk control

This survey report explores the current state of risk controls in investment banks, the challenges of effective engagement across the three lines of defence, and the opportunity to develop a more dynamic approach to first-line risk control

Op risk outlook 2022: the legal perspective

Christoph Kurth, partner of the global financial institutions leadership team at Baker McKenzie, discusses the key themes emerging from’s Top 10 op risks 2022 survey and how financial firms can better manage and mitigate the impact of…

Emerging trends in op risk

Karen Man, partner and member of the global financial institutions leadership team at Baker McKenzie, discusses emerging op risks in the wake of the Covid‑19 pandemic, a rise in cyber attacks, concerns around conduct and culture, and the complexities of…

Moving targets: the new rules of conduct risk

How are capital markets firms adapting their approaches to monitoring and managing conduct risk following the Covid‑19 pandemic? In a webinar in association with NICE Actimize, the panel discusses changing regulatory requirements, the essentials…

Most read articles loading...

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here