The Scienter Requirement and Wash Trading in Commodity Futures : The Knowledge Lost in Knowing

The commodity futures markets perform a number of essential functions in the financial sector. These markets provide risk intermediation services and in the process of doing so, generate information concerning supply, demand, and future price of the commodities traded on these markets. This information is used by market participants to hedge the risk of adverse price movements and to speculate on hoped for, or anticipated changes in price. In addition to pricing information, these markets also provide technical data used by speculators and commercial traders, including volume, and open interest. However, the information produced by these markets can only be viewed as accurate and reliable when it results from trades being executed in a competitive manner on the exchanges. If the trades are not executed in a competitive manner because the trading process has been corrupted by noncompetitive trading, then the information produced that will guide the conduct of market participants is inaccurate and unreliable and when used by market participants it results in misguided allocations of assets and resources at a cost to society generally.This paper looks at one form of noncompetitive market activity, wash trades: the simultaneous buying and selling of futures contracts in a way that gives the appearance of being a purchase and sale but which avoids any actual change in ownership. Wash trading permits traders to realize illegal profit and is inimical to the pricing and risk-shifting functions of the futures markets because it results in the dissemination of price information that is incorrect. Although wash trading is illegal, the mens rea requirement, knowledge, limits the success of enforcement actions against wash traders. This article argues that the scienter requirement as articulated by the Commodity Futures Trading Commission (CFTC) has evolved into a formulation that protects questionable trading activities at the expense of market integrity. Instead, the CFTC should determine the quantitative impact of noncompetitive trading on the markets and use that information to determine whether the risks created by wash trading are best addressed by instituting a market maker function or by utilizing a scienter analysis that will protect the integrity of these markets