Commentaries

Bridging the Week by Gary DeWaal: July 11-15 and July 18, 2016 (Spoofing; Physical Position Reporting; Administrative Proceedings; Blue Sheets; Reg AT; Order Handling Disclosure; Hedge Exemptions)

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Published Date: July 17, 2016

Last week, Michael Coscia, the first individual prosecuted and convicted under the provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act that prohibits spoofing, was sentenced to three years in prison. Meanwhile, committee members and witnesses appearing before the House Committee on Agriculture’s hearing on the Commodity Futures Trading Commission proposed Regulation Automated Trading attacked the proposal’s requirements related to source code and registration while commentators also criticized in writing many aspects of the CFTC’s recently proposed amendments regarding non-enumerated hedge exemptions to its November 2013 position limits rules proposals. This was despite generally supporting the agency’s willingness to permit exchanges to grant such exemptions in the first instance. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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Michael Coscia Sentenced to Three Years’ Imprisonment for Spoofing and Commodity Fraud:

Michael Coscia, the first person prosecuted and convicted under a law prohibiting spoofing that was enacted after the 2007-2008 financial crisis, was sentenced to three years’ imprisonment last week for illicit futures trading he engaged in during three months in 2011.

In July 2013, Mr. Coscia settled civil actions related to the same conduct with the Commodity Futures Trading Commission, the Financial Conduct Authority and the CME Group by payments of aggregate fines of approximately US $3.1 million; disgorgement of profits; and a one-year trading suspension. (Click here for details in the article, “CFTC, UK FCA and CME File Charges and Settle with Proprietary Trading Company and Principal for Spoofing” in the July 22, 2013 edition of Between Bridges.) Mr. Coscia was convicted of six counts of commodities fraud and six counts of spoofing for his prohibited trading activities in November 2015. (Click here for details of Mr. Coscia's conviction in the article, "Jury Convicts Michael Coscia of Commodities Fraud and Spoofing" in the November 8, 2015 edition of Bridging the Week.)

Leading up to the sentencing, the United States Attorney’s Office in Chicago had requested that the judge presiding over Mr. Coscia’s criminal trial impose the maximum sentence recommended by applicable guidelines of between 70 and 87 months in prison, while Mr. Coscia’s counsel had argued for a lesser term of between no more than 4 to 10 months’ imprisonment. (Click here for details in the article, “Government Seeks Maximum Sentence in Coscia Criminal Action" in the July 10, 2016 edition of Bridging the Weeks.) It appears likely that Mr. Coscia will appeal his conviction.

Separately, the Chicago-based federal judge hearing the CFTC’s enforcement action against a trader and his company for alleged spoofing through posting and flipping trading conduct denied the agency’s request for preliminary injunction, saying that surveillance reports and compliance tools already put in place by the defendants, as well as certain additional trading restrictions imposed by the judge herself, would restrict the defendants’ capability to engage in any potentially prohibited spoofing-type trading activities. As a result, said the judge, “a preliminary injunction is inappropriate at this time.”

Under the judge’s order, the trading firm’s chief compliance officer is obligated to file a sworn affidavit with the court every month between now and the conclusion of the relevant trial “affirming that all of [the enumerated] trading restrictions and compliance tools remain in place and that neither [of the defendants] have violated any of them.” (Click here for background on this enforcement action in the article, “CFTC Enforcement Action Introduces New Theory of Spoofing” in the October 25, 2013 edition of Bridging the Week.)

My View: It seems somewhat draconian that Mr. Coscia was sentenced to three years in prison for violating a new law for which he already paid substantial civil sanctions; which on its face appears to prohibit at least some legitimate trading practices; and which may not have given him adequate notice of prohibited conduct. Recently, in announcing its issuance of its first cross-market equities report cards aimed at helping member firms identify potential spoofing and layering activity, the Financial Industry Regulatory Authority defined spoofing as “entering orders to entice other participants to join on the same side of the market at a price at which they would not ordinarily trade, and then trading against the other market participants’ orders.” This is a comprehensive practical definition. Contrariwise, the relevant provision under which Mr. Coscia was convicted prohibits “spoofing” but defines it as “bidding or offering with the intent to cancel the bid or offer before execution.” However, many legitimate orders, including stop loss orders, are placed with the goal or hope not to have the order executed, as that would mean the value of a position is declining. Unfortunately for Mr. Coscia, the judge hearing his case did not have a problem with the clarity of the relevant statute and, in any case, believed that Mr. Coscia should have known his specific trading was prohibited. It will likely be up to an appeals court to again consider the constitutional validity of the relevant law.

Briefly:

Compliance Weeds: CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bona fide hedging position under CFTC rules. These documents must be made as of the close of business on the last Friday of the relevant month. Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report. Part III of Form 304 (Unfixed Price Cotton “On-Call”) must be filed by any cotton merchant or dealer that holds a so-called reportable position in cotton (i.e., pursuant to large trader reportable levels; click here to access CFTC Rule 15.03) regardless of whether or not it constitutes a bona fide hedge. Form 304 (Part III) must be made as of the close of business on Friday every week, and received by the CFTC in New York by no later than the second business day following the date of the report.

My View: There seems to be a disproportionate percentage of non-US-based market participants caught up in CFTC enforcement actions for alleged breaches of Form 204 and 304 filing requirements. In fact, the relevant rules related to the requirements for filing such forms are a model of imprecision and are likely unclear to most domestic market participants let alone foreigners (click here to access the relevant CFTC Part 19 rules). Reference to the term “reportable” positions in connection with filing requirements as meaning positions in excess of speculative position limits in one circumstance and in excess of large trader reportable levels in another is not easy to follow. Posting of clear instructions in both English and foreign languages on the CFTC’s website would be helpful.

Compliance Weeds: Just two weeks ago, Deutsche Bank Securities Inc. agreed to pay a fine of US $6 million to resolve charges brought by the Financial Industry Regulatory Authority that it filed “thousands” of deficient blue sheets with it and the Securities and Exchange Commission from 2008 through 2015. (Click here for details in the article, “Broker-Dealer Settles FINRA Blue Sheets Violation Allegation by Payment of US $6 Million Fine” in the July 10, 2016 edition of Bridging the Week.) Other broker-dealers have settled enforcement actions by the SEC for fines between $2.5 and $4.25 million related to alleged blue sheet violations. (Click here for an article about one of these matters in the article, “Broker-Dealer Assessed US $4.25 Million Fine for Two Years of Flawed Blue Sheets” in the October 4, 2015 edition of Bridging the Week.) Accurate blue sheet reporting is clearly on both the SEC’s and FINRA’s radar.

My View: Reg AT should be broken apart, and solely nonprescriptive measures dealing with risk and other controls should be adopted first. A multi-industry organizations’ proposal that all algorithmic orders should be subject to risk controls capable of being administered either by the routing or sponsoring futures commission merchant or another registrant makes sense. It is not too difficult to implement and addresses a major flaw in the current proposed Regulation AT that it excludes from coverage, algorithmic trading systems of many non-registrants, except for certain algorithmic traders that trade through direct electronic access to exchanges and would be required to register with the CFTC for the first time. (Click here for a summary of comment letters received by the CFTC in response to its recently conducted roundtable in the article, “CFTC Receives 18 Formal Comment Letters in Response to Staff Reg AT Roundtable; Myriad of Issues Raised” in the June 26, 2016 edition of Bridging the Week.)

And more briefly:

Legal Weeds: In its summary of its Anti-Manipulation and Anti Fraud Final Rules (click here to access CFTC Regulations 180.1 and 180.2), the CFTC indicated that in connection with its “long-standing authority” to prohibit price manipulation “by making it unlawful … to manipulate or attempt to manipulate” (emphasis added) the price of any swap or futures contract it would be guided by its traditional four-part test for manipulation:

Certainly in a situation where the CFTC is charging only an attempt to manipulate, it is not required to prove the last two elements of its acknowledged “traditional” four-part test. But it seems disingenuous to argue that it does not have to demonstrate the first two elements. This is the CFTC’s own publication. (Click here to access the CFTC summary.)

And finally:

Regulations of the Commodity Futures Trading Commission have equivalent requirements as FINRA regarding accounts of “affiliated persons” of futures commission merchants and introducing brokers (Click here to access CFTC Rule 155.3 and 155.4). In general, an affiliated person of such registrants needs to obtain the written authorization of his or her employer to maintain an account with a third-party FCM. Moreover, the third-party FCM must afterwards on a “regular basis” send copies of all account statements related to such an account and “all written records prepared upon receipt of orders for such account.” FCMs receiving such orders must prepare immediately upon receipt of an order for such account a written record of such order, including the account identification and order number that includes the date and time to the nearest minute when the order is received. Under relevant rules, “affiliated persons” of FCMs and IBs is broadly defined to include any general partner, director, owner of more than 10 percent, registered associated person or employee, any relative or spouse, or any relative of a spouse, who share the same home as the person directly affiliated with the relevant registrant.

For more information, see:

Comment Period for ICE Proposed Block Trade Rule Amendment Extended by CFTC:
http://www.cftc.gov/PressRoom/PressReleases/pr7406-16

CFTC Rejects Amici Arguments in Alleged Manipulation Case:
/ckfinder/userfiles/files/CFTC%20DRW%20Amici%20Response.pdf

CME Group Sanctions Two Firms for Purported Transitory EFRPs and One Individual for Non-Bona Fide Transactions:

Dale Fisher:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CBOT-14-9995-BC-DALE-WILLIAM-FISHER-II.html#pageNumber=1
JBS USA:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CBOT-15-0204-BC-JBS-USA-LLC.html#pageNumber=1
JP Morgan Chase:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CBOT-15-0204-BC-2-JPMORGAN-CHASE-BANK-NA.html#pageNumber=1

Computer Coding Error Results in Broker-Dealer Blue Sheets’ Errors Over 15 Years and US $7 Million SEC Fine:
https://www.sec.gov/litigation/admin/2016/34-78291.pdf

See also, Amended FINRA Blue Sheets Data Elements:
http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-16-24.pdf

ESMA Proposes to Delay Mandatory Swaps Clearing for Small Counterparties:
https://www.esma.europa.eu/press-news/esma-news/esma-consults-proposed-central-clearing-delay-small-financial-counterparties

Enhancement of Broker-Dealer Disclosure Obligations Regarding Customer Order Handling Goal of SEC Proposed New Rules:
https://www.sec.gov/rules/proposed/2016/34-78309.pdf

EUREX Reduces Time Required From Cross Request to Mutual Executable Orders From Five to One Second:
https://www.eurexchange.com/blob/2649232/5cf5b477fa07b6f4f772dd4393d947d1/data/er16063e.pdf

HK Regulators Seek Forth Advice on Mandatory Clearing and Reporting Requirements for OTC Derivatives:

Industry Participants Generally Applaud Proposed Amendments to CFTC Position Limit Proposal But Criticize Ability to Undo Exchanges’ Determinations:
http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=16CP1

Sample comments:
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60950&SearchText=
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60946&SearchText=
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60937&SearchText=
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60926&SearchText=
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60941&SearchText=
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60940&SearchText=

Introducing Broker Settles CFTC Action for Solicitation Fraud and Lying to NFA:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfhysniorder071416.pdf

Michael Coscia Sentenced to Three Years’ Imprisonment for Spoofing and Commodity Fraud:
https://www.justice.gov/usao-ndil/pr/high-frequency-trader-sentenced-three-years-prison-disrupting-futures-market-first

/ckfinder/userfiles/files/Oystacher%20Prelim%20Injunction%20Denied(2).pdf

OCIE Begins IA Sweep to Detect Possible Conflict of Interest Related to Recommendations of Mutual Fund Shares Classes With High Charges:

https://www.sec.gov/ocie/announcement/ocie-risk-alert-2016-share-class-initiative.pdf

SEC Amends Rules of Practice for Administrative Proceedings to Make More Court-Like:
https://www.sec.gov/rules/final/2016/34-78319.pdf

SEC Enacts Further Rules Governing Security-Based Swaps Transaction Reporting:
https://www.sec.gov/rules/final/2016/34-78321.pdf

Speakers Attack Source Code and Registration Provisions of Proposed Reg AT Before Congressional Committee:

Opening Statement – Chairman K. Michael Conaway:
http://agriculture.house.gov/news/documentsingle.aspx?DocumentID=3490
Statements of Witnesses:
http://agriculture.house.gov/uploadedfiles/wood_testimony.pdf
http://agriculture.house.gov/uploadedfiles/gorelick_testimony.pdf
http://agriculture.house.gov/uploadedfiles/vrabel_testimony.pdf
http://agriculture.house.gov/uploadedfiles/ryan_testimony.pdf

Two Foreign Agribusinesses Agree to Resolve CFTC Charges for Their Alleged Failure to Report Physical Positions:

Agrocorp International:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfagrocorporder071116.pdf
Golden Agri International:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfagriorder071116.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 16, 2016. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.


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