New proposed rules and an amended proposed guidance regarding an old rule: 2014 ended with two affiliated exchanges proposing slightly different new rules on disruptive trading (which themselves were each slightly different from a new rule adopted earlier in 2014 by another exchange and under US law), while one exchange amended proposed new FAQs related to an existing rule on block trades just days after its initial proposal. Also, both futures and securities regulators brought enforcement proceedings against firms for violating customer assets protection rules, while one legacy action involving MF Global was finally resolved. As a result, the following matters are covered in this week’s Bridging the Weeks:
- ICE Futures U.S. and Canada Amend Rules to Expressly Prohibit Disruptive Trading Practices (includes My View);
- In Time for Christmas, CFTC Gives FCMs, SDs and MSPs Gift of Time Extension to File CCO Annual Report; However, Adds Content Requirements As the Price;
- FCM Fined US $3 Million by CFTC for Improper Investment of Customer Funds and Financial Reporting, Recordkeeping and Supervision Violations;
- Broker-Dealer Fined US $3 Million by FINRA for Customer Protection Rule Violations (includes My View);
- CME Group Amends Proposed Guidance Related to Wash Trade Rules and Block Trades;
- CFTC Advisory Subcommittee Recommends Globally Coordinated NDF Clearing Mandate With a Clear Timeline (includes My View);
- Monex Securities Sanctioned by FINRA for Not Registering and Supervising Non-US Personnel; President and Chief Compliance Officer Suspended;
- MF Global Holding Company Settles With CFTC Related to Subsidiary’s Collapse;
- Investment Company and Former CEO Charged With Defrauding Investors Related to Sale of Index Products Using ETFs; Firm Settles by Payment of US $35 Million;
- BIS Proposes Changes to Standardized Approach to Credit Risk;
- UK FCA Consults on Potentially Overseeing Other Benchmarks; and more.
ICE Futures U.S. and Canada Amend Rules to Expressly Prohibit Disruptive Trading Practices
ICE Futures U.S. and ICE Futures Canada proposed new rules expressly prohibiting disruptive trading practices and simultaneously issued proposed frequently asked questions. The new rules are scheduled to be effective January 14, 2015.
ICE’s new rules are generally similar to a recently adopted CME Group rule—Rule 575—prohibiting disruptive trading practices, while its FAQs are also similar to the CME Group FAQs related to Rule 575 that were effective September 15, 2014—however, there are some differences. ICE Futures Canada’s disruptive trading practices rules are also somewhat different than those of ICE Futures U.S.
ICE Futures U.S.’s proposed new rule not only prohibits its own expressly enumerated disruptive trading practices, but “any other manipulative or disruptive trading practices” prohibited under the Commodity Exchange Act or by the Commodity Futures Trading Commission. This likely captures not only the express provisions of the CEA that address disruptive trading practices, but may also capture the prohibitions of the very broad CFTC Rule 180.1 that precludes manipulative and deceptive devices, as well as traditonal proscrptions against manipulation.
Like CME Group, ICE Futures U.S.’s own enumerated prohibited activities include the placement of orders or market messages with the intent (1) to cancel orders before execution, or to modify orders to avoid execution; (2) to overload, delay or disrupt exchange or other market participants’ systems; and (3) “to disrupt the orderly conduct of trading, the fair execution of transactions or mislead other market participants.” At the CME Group, however, actions to disrupt the orderly conduct of trading or the fair execution of transactions are subject to an intent or recklessness standard—a broader criterion.
On the other hand, while orders or messages entered with the intent to mislead other market participants are prohibited at CME Group, under ICE Futures U.S.’s proposed rule, entering orders or market messages with “reckless disregard” for the adverse impact of such orders or messages is prohibited. This standard may capture more activity.
Also, while CME Group’s disruptive practices rule has a general preamble requiring all orders to be entered “for the purpose of executing bona fide transactions,” ICE Futures U.S.’s proposed new rule contains a catch-all provision that appears a bit broader. It prohibits:
[k]nowingly entering any bid or offer for the purpose of making a market price which does not reflect the true state of the market, or knowingly entering, or causing to be entered, bids or offers other than in good faith for the purpose of executing bona fide transactions.
ICE Futures Canada’s catch-all provision to its disruptive trading rule—Rule 8A.10—is more similar to that of the CME Group, while its specific prohibitions parallel those of its sister US exchange. However, like CME Group, ICE Futures Canada also prohibits orders or market messages entered with the express “intent to mislead other market participants”; ICE Futures U.S.'s proposed rule does not contain this precise prohibition.
Finally, the ICE exchanges’ and CME Group’s related FAQs are similar in that both list virtually the identical factors staff will consider in assessing a potential violation. However, the ICE exchanges do not give examples of prohibited activity as does CME Group. The ICE exchanges’ FAQs contain fewer questions and answers.
(Click here to access a discussion of CME Group's Rule 575 in the article "CME Group Issues New Rule Regarding Disruptive Trading Practices" in the September 4, 2014 edition of Between Bridges. Click here to access CEA Section 4c(a)(5), which prohibits disruptive trading practices and CEA section 6(c)(3), the CFTC's traditional anti-manipulation authority. Click here to access CFTC Rule 180.1 and here to access an article describing the CFTC’s first significant use of Rule 180.1 entitled “CFTC Files and Settles Charges Against JP Morgan Chase Bank Employing Its New Anti-Manipulation Authority Related to Certain of the Bank’s London Whale Trading” in the October 14 to 18 and 21, 2013 edition of Bridging the Week.)
My View: When even a single international exchange such as ICE proposes to prohibit disruptive trading by applying different tests at two affiliates, and when different exchanges and regulators apply not only different tests but different standards to the same essential tests, it is hard to determine in advance whether contemplated trading activity is prohibited or not. Purposely placing and pulling bids or offers on one side of a market solely to move the market to effectuate an execution on the other side is likely a problem. But there can be circumstances where bluffing the market is a necessary precursor to executing bona fide hedge transactions at fair prices in an otherwise illiquid market. This area of regulation will continue to evolve, but in the interim, unfortunately, trader beware!
In Time for Christmas, CFTC Gives FCMs, SDs and MSPs Gift of Time Extension to File CCO Annual Report; However, Adds Content Requirements As the Price
Just prior to Christmas 2014, the Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight issued no-action relief extending the deadline by when chief compliance officer annual reports must be filed with the CFTC by futures commission merchants, swap dealers and major swap participants with fiscal years ending on or before January 31, 2015, At the same time DSIO published a separate advisory of “best practices” regarding the content of such reports.
In its no-action relief, DSIO staff granted relevant firms whose fiscal year ends on or before January 31, 2015, an extra 30 days—or 90 days in total following their fiscal year-end—to file their CCO annual report.
Moreover, FCMs, SDs and MSPs may have an additional 30 days to file their CCO annual report—or 120 days in total—if, by no later than 90 days following their fiscal year-end, they “inform” DSIO “of any material non-compliance events that occurred during the fiscal year that is the subject of the annual report. Again, this additional relief is available only to FCMs, SDs and MSPs whose fiscal year ends on or before January 31, 2015.
In its advisory, DSIO provides insight into what it expects to be included in CCO annual reports. Although staff states that its recommendations “are not requirements and do not need to be used,” it makes clear that it “expects CCOs to make efforts to incorporate [the] advisory into their current annual report.” Accordingly, to minimize potential issues with CFTC staff, firms should incorporate as many of DSIO’s recommendations as practical into their CCO annual reports.
(Click here to access a discussion of DSIO’s content recommendations in a separate January 2, 2015 edition of Between Bridges.)
- FCM Fined US $3 Million by CFTC for Improper Investment of Customer Funds and Financial Reporting, Recordkeeping and Supervision Violations: The Commodity Futures Trading Commission fined Deutsche Bank Securities Inc.—a registered futures commission merchant—US $3 million for violations of its requirements related to recordkeeping, investment of segregated customer funds, financial reporting and supervision from October 1, 2009, through March 14, 2013. According to the CFTC, between June 18 and August 15, 2012, DBSI failed to comply with newly adopted CFTC regulations that restricted the amount of customer funds it could invest in money market mutual funds. However, the CFTC noted that at all times DBSI maintained sufficient funds in segregation for its customers. In addition, the CFTC cited DBSI for inaccurately reporting its financial condition in various required financial reports filed with it between June 2011 and August 2012. During this time, claimed the CFTC, DBSI was “well aware” that its “ongoing problems with its [financial] reports were unacceptable to the Commission.” In response, the FCM retained an independent consultant to help it prepare its financial reports and “assured” the CFTC that the problems that caused its problematic reports would be fixed. However, the firm subsequently submitted three more financial reports to the CFTC that the Commission claimed had “unacceptable errors.” The CFTC also charged DBSI with failing to create and retain order tickets for various block trades it cleared for customers from October 1, 2009, through March 16, 2012. In February 2014, according to the CFTC, DBSI paid a fine of US $900,000 assessed by CME’s Clearing House Risk Committee “for financial reporting deficiencies related to the firm’s computation, recording, and reporting of segregated and secured customer fund balances.” In settling the CFTC’s complaint, DBSI did not admit or deny any of the Commission’s findings or conclusions. (Click here to access more information on DBSI's CME Clearing House Risk Committee fine.)
- Broker-Dealer Fined US $3 Million by FINRA for Customer Protection Rule Violations: Pershing LLC—a registered broker-dealer—was fined US $3 million by the Financial Industry Regulatory Authority for not complying with Securities and Exchange Commission rules and its own rule related to the protection of customer assets. Specifically, the firm was charged with failing to maintain adequate funds segregated from its own operations to meet its reserve deposit requirement for the benefit of its customers from November 30, 2010, to August 5, 2011. The amounts of Pershing’s deficiency ranged from US $4 million to US $22o million. The firm’s failure came about because it mistakenly included in its reserve formula calculation certain items as debits, thus reducing the excess of customer credits over debits that the firm was required to deposit in a reserve bank account. The firm was also charged with failing to maintain as required physical possession or control of all its customers’ fully paid and excess margin securities in certain accounts from July 2010 to September 2011. This problem arose because Pershing incorrectly reflected three clearance accounts it maintained to facilitate the settlement of transactions with one European broker-dealer client as good control locations; this is not permitted under the applicable SEC rule. FINRA charged that these failures resulted from Pershing’s failure to have an adequate supervisory system addressing its customer protection requirements. FINRA also charged Pershing with financial reporting violations related to these matters. Pershing did not admit or deny any of FINRA’s findings. Pershing is a wholly-owned indirect subsidiary of The Bank of New York Mellon Corporation.
My View: One of the unfortunate consequences of the US failing to have a single overseer of financial markets and products, is that there is a material dichotomy between the customer assets protection regimes of futures commission merchants—regulated by the Commodity Futures Trading Commission— and broker-dealers—regulated by the SEC. This is even the case for combined FCMs and BDs. For those entities there could be as many as five different ways to protect customer assets with many material and subtle differences. This may have been quaint once upon a time, but not any longer. The CFTC and SEC should work together to derive a more common approach to customer funds protection and seek legislative change, where necessary.
- CME Group Amends Proposed Guidance Related to Wash Trade Rules and Block Trades: On Christmas Eve, CME Group amended its proposed market regulation advisory notice previously issued on December 17, 2014 (containing frequently asked questions), that would have prohibited block trades between accounts with the same beneficial ownership under all circumstances. Such transactions would have constituted illegal wash trades under the CME Group’s proposal. CME Group’s amendment reinstates the language of its currently prevailing wash trade MRAN (dated November 19, 2013), which provides that block trades between accounts with the same beneficial owner and accounts with common beneficial ownership that is less than 100 percent are prohibited unless each account’s decision to enter into the transaction (1) is made by an independent decision maker; (2) is the result of a “legal and bona fide business purpose;” and (3) the block trade is executed at a “fair and reasonable price.” The revised MRAN now solely updates CME’s prior wash trades MRAN to caution against engaging in wash trades to freshen position dates in physically delivered futures contracts and to reflect changes in the CME Group’s self-match prevention functionality on CME Globex being rolled out by January 11, 2015. (Click here to see more on the originally proposed and remaining contents of CME Group’s revised MRAN in the article, “CME Explicitly Prohibits Block Trades Between Accounts With the Same Beneficial Ownership,” in the December 15 to 19 and 22, 2014 edition of Bridging the Week.)
- CFTC Advisory Subcommittee Recommends Globally Coordinated NDF Clearing Mandate With a Clear Timeline: The Foreign Exchange Markets Subcommittee—a subcommittee of the Commodity Futures Trading Commission’s Global Markets Advisory Committee composed of private company representatives—made recommendations to GMAC related to the mandatory clearing of foreign exchange non-deliverable forwards. Most critically, FEM recommended that the roll-out of mandatory NDF clearing be coordinated by the CFTC with European regulators in order to maintain “a robust liquidity pool.” Among other matters, there should be harmonization of products to be cleared (e.g., currency pairs and tenors), counterparty categories and a timeline for mandatory clearing. FEM recommended that, if the CFTC implements a clearing mandate for NDFs, it should be limited to outstanding maturities no longer than 12 months. This, said FEM, is “to ensure that [clearinghouses] are only exposed to liquid NDFs.” Likewise, FEM advised that, in light of expected proposals by the European Securities and Markets Authority, NDF clearing determinations should be proposed by the CFTC by no later than August 1, 2015, with the first category of participants being subject to mandatory clearing on February 1, 2016. Finally, FEM requested that the CFTC consider the implications of mandatory clearing determinations on NDFs that might be traded on swap execution facilities even before such trading is mandated. As these transactions would be subject to CFTC-required pre-trade risk checking and clearing certainty requirements, there could be disruptions of liquidity if SEFs and their participants were not adequately prepared. Accordingly, said FEM, “the readiness of SEFs and their participants for …pre- and post-trade processes for NDF trading, including support for FCM credit checks, pre-allocated trades and post-clearing allocations (“Bunched Orders”) should be considered when implementing the Subcommittee’s recommended timeline.”
My View: The reference by FEM to promoting a “robust liquidity pool,” reminded me of one of the hidden dangers of exchange-traded derivatives clearing: unfortunately, there is sometimes a belief that because it is cleared it is liquid. Unfortunately, as a few futures commission merchants have experienced, this is not necessarily true. An FCM that maintains customer positions can sadly find out after a customer default, that the customer’s short positions in some specific option strike prices, swap futures, or even cleared swaps are not as liquid as initially thought, or became materially less liquid over time. This is discovered when an effort is made to liquidate the client’s portfolio and the FCM also discovers that the initial margin posted for the positions is not remotely sufficient to cover the duration of the actual liquidation in light of real market conditions.
- Monex Securities Sanctioned by FINRA for Not Registering and Supervising Non-US Personnel; President and Chief Compliance Officer Suspended: Monex Securities Inc.—a registered broker-dealer—was ordered by the Financial Industry Regulatory Authority to disgorge US $1.1 million and to pay a fine of US $175,000 for not registering foreign persons who sold securities on behalf of the firm. In addition, Jorge Martin Ramos Landero, the firm’s president and chief compliance officer, was suspended from acting as a principal of the firm for 45 days and fined US $15,000. According to FINRA, from January 1, 201o, through at least May 31, 2012, Monex Securities paid transaction-related compensation to foreign persons associated with its Mexican parent company, Monex Casa de Bolsa, which referred non-US customers to open accounts with Monex Securities and handled orders for these accounts. These individuals were required to be registered under applicable regulation, but were not. As a result, FINRA charged Monex Securities and Mr. Ramos with violations of its registration requirements, as well as failure to have adequate written supervisory procedures to help it comply with its regulatory requirements related to registration obligations. Monex Securities and Mr. Ramos settled FINRA’s charges without admitting or denying any allegations.
- MF Global Holding Company Settles With CFTC Related to Subsidiary’s Collapse: The Commodity Futures Trading Commission settled its outstanding complaint against MF Global Holdings Ltd.—the parent of MF Global Inc.—related to the collapse of MFGI during October 2011. In settling, MFGH agreed to pay restitution of US $1.212 billion to customers of MFGI or such other amount as necessary to ensure that claims against MFGI are satisfied in full, although the CFTC already has acknowledged that a substantial portion of this amount previously has been satisfied (click here to access the relevant CFTC press release). MFGH also agreed to pay a US $100 million penalty; however, this amount will not be satisfied until the claims of all customers and certain creditors are satisfied. In June 2013, the CFTC filed a complaint against MFGH, MFGI, John Corzine and Edith O’Brien based on the firm’s alleged unlawful use of customer funds; the complaint was amended in December 2013. The claims against Mr. Corzine, the former chief executive officer of both MFGH and MFGI, and Ms. O’Brien, the former assistant treasurer of MFGI, are still pending in a United States federal court in New York City. (Click here to access the initial CFTC complaint; click here to access the article "CFTC Files Long Awaited Enforcement Action Related to MF Global Collapse" in the June 27, 2013 edition of what is now known as Between Bridges.)
- Investment Company and Former CEO Charged With Defrauding Investors Related to Sale of Index Products Using ETFs; Firm Settles by Payment of US $35 Million: The Securities and Exchange Commission filed charges against F‑Squared Investments, claiming it defrauded investors by falsely advertising a successful seven-year track record for its core investment strategy, reflecting actual investments for actual customers, when performance data was actually “materially inflated and hypothetical.” Simultaneously, the SEC announced a settlement with F-Squared related to these charges, pursuant to which the firm will pay US $35 million and admit to its wrongdoing. Separately, the SEC charged Howard Present, the firm’s co-founder and former chief executive officer, for also making false and misleading statements to the public about F‑Squared. This case is still pending. The SEC claimed that, from October 2008 to September 2013, F-Squared marketed an exchange-traded funds sector rotation strategy named “AlphaSector” that was based on an algorithm that determined to buy or sell nine industry ETFs. F-Squared marketed AlphaSector through an index. Today, claimed the SEC, “AlphaSector is the largest ETF strategy in the market.” In consenting to its settlement with F-Squared, the SEC noted “the remedial acts undertaken by Respondent and Respondent’s cooperation with the Commission,” including its separation from Mr. Present in 2014 and its retention of an independent compliance consultant during the same year. In addition to agreeing to pay a fine, F-Squared agreed to continue its retention of the independent consultant and to adopt its recommendations.
- BIS Proposes Changes to Standardized Approach to Credit Risk: The Bank for International Settlements is proposing modifications to one of the two ways banks can compute their regulatory capital—the so-called “standardized approach” to measure risk. (The other approach is based on a bank’s use of an internal model approved by the bank’s supervisor.) In connection with this, BIS is proposing specific modifications to the way banks measure their credit risk. Among other things, BIS proposes that banks reduce reliance on external credit ratings, and instead evaluate exposure by referencing more meaningful measures. For example, instead of risk weighting exposure to other banks by reference to their credit rating or sovereign of incorporation, reference would be to the other banks’ capital adequacy and asset quality. The risk weight would be derived from a look-up table applying these two criteria. Likewise, corporate exposure would no longer be measured by reference to the borrowing firm’s credit rating, but instead be a function of the borrower’s revenue and leverage. Similarly, the risk weight would be determined from a look-up table using these two drivers. Comments on BIS’s proposals are due by March 27, 2015.
- UK FCA Consults on Potentially Overseeing Other Benchmarks: The UK Financial Conduct Authority will commence the regulation of seven additional benchmarks (in addition to the London Inter-Bank Offered Rate benchmark) beginning April 2015. These additional benchmarks are the Sterling Overnight Index Average (SONIA), the Repurchase Overnight Index Average (RONIA), ISDAFIX, WM/Reuters London 4 p.m. Closing Spot Rate, London Gold Fixing (soon to be replaced by the LBMA Gold Price), LBMA Silver Price and the ICE Brent Index. Among other things, FCA proposes that benchmark administrators will be required to put in place “credible” governance and oversight measures; maintain a “proper” audit trail to help identify potentially manipulative behavior; maintain sufficient financial resources to cover operating costs for six months plus a three-month buffer period; and appoint an individual, approved by FCA, to ensure the firm’s compliance with FCA’s requirements. Comments to the FCA’s proposals will be accepted through January 30, 2015.
And more briefly:
- CBOE and C2 Delegate Market Surveillance and Certain Other Oversight Functions to FINRA: The Chicago Board Options Exchange and C2 Options Exchange agreed to retain the Financial Industry Regulatory Authority to provide market and financial surveillance, examinations and investigations, as well as disciplinary and other services. FINRA commenced performing these services on January 1. In October 2014, NYSE Group announced that it would take over similar regulatory functions that FINRA currently performs for it as of January 1, 2016. (Click here to see more in the article “NYSE to Resume Market Surveillance, Investigation and Enforcement Functions,” in the October 12, 2014 edition of Bridging the Week.)
- CFTC Staff Extends Time for FCMs to Acquire Certain Depository Acknowledgement Letters: The Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight has extended until April 30, 2015, the expiration date of previously granted no-action relief to futures commission merchants who cannot obtain required acknowledgement letters from their depositories holding customer funds because of the Commission’s failure to enter into a standard online access agreement with such depositories. Under CFTC rules, FCMs ordinarily may only deposit customer funds with approved depositories who provide them with standard acknowledgement letters.
- Fed Publishes Volker Rule FAQs; CFTC Too: The Board of Governors of the Federal Reserve System is publishing frequently asked questions and answers related to what is commonly referred to as the “Volker Rule” on its website. These FAQs were last updated on December 23, 2014. The Commodity Futures Trading Commission and the Securities and Exchange Commission also publish on their websites Volker Rule FAQs.
For more information, see:
BIS Proposes Changes to Standardized Approach to Credit Risk:
Broker-Dealer Fined US $3 Million by FINRA for Customer Protection Rule Violations:
CBOE and C2 Delegate Market Surveillance and Certain Other Oversight Functions to FINRA:
CFTC Staff Extends Time for FCMs to Acquire Certain Depository Acknowledgement Letters:
CFTC Advisory Subcommittee Recommends Globally Coordinated NDF Clearing Mandate With a Clear Timeline:
CME Group Amends Proposed Guidance Related to Wash Trade Rules and Block Trades:
Fed Publishes Volker Rules FAQs; CFTC Too:
CFTC Volker Rule FAQs:
SEC Volker Rule FAQs:
FCM Fined US $3 Million by CFTC for Improper Investment of Customer Funds and Financial Reporting, Recordkeeping and Supervision Violations:
ICE Futures U.S. and Canada Amend Rules to Expressly Prohibit Disruptive Trading Practices:
In Time for Christmas, CFTC Gives FCMs, SDs and MSPs Gift of Time Extension to File CCO Annual Report; However, Adds Content Requirements As the Price:
Filing Extension Relief:
Investment Company and Former CEO Charged With Defrauding Investors Related to Sale of Index Products Using ETFs; Firm Settles by Payment of US $35 Million:
MF Global Holding Company Settles With CFTC Related to Subsidiary’s Collapse:
Monex Securities Sanctioned by FINRA for Not Registering and Supervising Non-US Personnel; President and Chief Compliance Officer Suspended:
UK FCA Consults on Potentially Overseeing Other Benchmarks:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of December 31, 2014. 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 and/or Gary DeWaal 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.
© 2020 Katten Muchin Rosenman and Gary DeWaal. All Rights Reserved.