Bridging the Week by Gary DeWaal


Bridging the Week by Gary DeWaal: July 20 - 24 and 27, 2015 (27 Enforcement Actions; More MF Global; Lawyer Settles with CFTC; Dodd-Frank Five Years Later)

AML and Bribery    Block Trades and EFRPs    Bridging the Week    Cleared Swaps    Managed Money    MF Global    Position Limits    Trade Practices (including Disruptive Trading)   
Published Date: July 26, 2015

Twenty-seven disciplinary proceedings brought by the CME Group – touching upon EFRPs, transfer trades, money passes, position limits, block trades and disruptive practices – provided an abrupt reminder that a failure to comply with relatively technical rules can result in fines as well as corporate distraction while employees address regulatory inquiries and actions. Moreover, the book on the fate of customers, secured creditors and unsecured creditors of MF Global, Inc., the defunct FCM that went belly-up in 2011, appears to be finally closing with a relatively good outcome under the circumstances. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • FC Stone Companies and Goldman Sachs Receive Largest Fines in CME Group’s 27 Disciplinary Actions Cascade (includes Compliance Weeds);
  • Defunct FCM MF Global to Pay Unsecured Creditors up to 95% of Their Allowed Claims (includes My View);
  • Florida Lawyer Settles CFTC Complaint Charging He Aided and Abetted His Clients’ Unlawful Precious Metals Schemes;
  • optionsXpress Sanctioned by FINRA for Not Adjusting Open Share Orders to Reflect Dividends;
  • ISDA Reflects on Dodd-Frank Implementation Five Years Later (includes My View);
  • Three Industry Organizations Warn of Potential Negative Impact of Extending Capital Requirements to European Commodity Dealers; and more.

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FC Stone Companies and Goldman Sachs Receive Largest Fines in CME Group’s 27 Disciplinary Actions Cascade:

CME Group handed down sanctions in 27 separate disciplinary actions last week for alleged violations of rules related to exchange for related positions, transfer trades, money passes, position limits, block trades and disruptive practices.

Wholly owned subsidiaries of INTL FC Stone Inc., including INTL FC Stone Markets LLC and INTL Commodities, Inc., received the largest number of individual sanctions (eight) and total fines (US $160,000). Generally, the entities were charged by CME Group exchanges with violating rules related to EFRPs, typically by having no or insufficient documentation for the related position component of the EFRP  (e.g., cash, swap) or, in one case, by not transferring ownership of the related position. The alleged violations occurred on various dates in 2013 and 2014. With limited exception for EFRPs involving foreign exchange, all EFRPs on CME Group must involve the bona fide transfer of a related position from one party to another documented in accordance with market custom.

Gavilon, LLC also was fined US $15,000 by the Chicago Board of Trade for allegedly violating its EFRP rules. According to the CBOT, on March 7, 2013, Gavilon supposedly sold an OTC put swaption contract opposite another party, and then entered into an exchange-traded wheat calendar spread put option through an exchange of options for options transaction against the same opposite party. The EOO liquidated the first swaption, leaving Gavilon with a long futures position. The CBoT claimed this was a transitory EFRP, which is prohibited under CME Group rules.

Goldman Sachs Execution & Clearing, LP was sanctioned US $110,000 by the Commodity Exchange, Inc., for allegedly facilitating the transfer of gold futures and options positions between two customers with different beneficial ownership without exchange approval on February 27, 2013. A CME Group exchange must approve the transfer of positions between accounts of different beneficial owners when the transfer is in connection with a merger, asset purchase, consolidation or other non-repetitive transaction between two or more entities.

Kanat Khussainov was sanctioned US $35,000 in total by each of the four CME Group exchanges in connection with an alleged money pass from an account owned by his employer to his own account. According to CME Group, Khussainov organized this transfer through 23 round-turn transactions across the four exchanges between May 27 and 30, 2014. CME Group prohibits executing transactions to transfer equity between accounts. In connection with this matter, Mr. Khussainov was also prohibited from trading any CME Group products for 10 business days.

Chopper Trading LLC was fined US $25,000 by the Chicago Board of Trade for allegedly violating position limits on the July 2014 corn futures contract on June 30, 2014, apparently for less than 12 minutes. Similarly, the Pacific Investment Management Company, LLC was fined US $35,000 by the CBoT for supposedly violating a single month and all months position limits in the soybean meal futures contract on two consecutive business days in November 2014; it liquidated the violative positions on the following business day.

Newedge USA, LLC was sanctioned US $20,000 in two separate matters for allegedly not reporting a few block trades within required time frames on a few occasions from 2010 through 2012, and, in one of the matters, for also not reporting accurate execution times.

Finally, James Groth was fined US $55,000 and prohibited from trading any CME Group products for 10 business days for allegedly engaging in conduct that the exchange likely considered “spoofing.” CME Group claimed it found a pattern of trading from May through October 2011 where Mr. Groth placed a smaller order on one side of the market while subsequently entering multiple larger orders on the opposite side of the market at or near the best bid or offer. The exchange’s disciplinary panel found that Mr. Groth “entered these large orders for the purpose of inducing other market participants to trade opposite his smaller resting orders.” CME Group requires that all orders be entered for the purpose of executing bona fide transactions.

Each of these matters was resolved voluntarily by settlement by the respondent.

Compliance Weeds: Exchange for related position transactions and block trades are subject to strict rules governing the lawful parties to such transactions, how such transactions must be executed and documented, and by when and how such transactions must be reported. Traders must be reminded of these rules frequently and follow them meticulously. Violations of relevant exchange rules render the transactions non-bona fide and may constitute unlawful non-competitive trades under applicable rules of the Commodity Futures Trading Commission. (Click here for a somewhat dated overview of the requirements EFRPs in the article “Alphabet Soup Under CFTC Scrutiny: CFTC Review of CME Handling of EFRPs (EFPs, EFRs, and EOOs) Suggest Tougher Times for Traders and FCMs – Time to Be Pro-active” in the August 6, 2013 edition of Between Bridges. Click here for more recent articles in block trades and EFRPs in the category “Block Trades and EFRPs” on the bridgingtheweek.com website.)

Briefly:

  • Defunct FCM MF Global to Pay Unsecured Creditors up to 95% of Their Allowed Claims: Unsecured general creditors of defunct MF Global, Inc. (other than those of its parent company MF Global Holdings Ltd.) will receive a final payment from the firm, giving them a total recovery of 95 percent of their approved claims, under a proposal made last week by the overseers of the liquidation of the firm and its parent company. Customers of MF Global previously received back US $6.7 billion (100 percent) of their allowed claims; secured, administrative and priority claimants received US $22.3 million (100 percent) of their allowed claims; and unsecured general creditors received back US $991.6 million (74 percent) of their unsecured claims. Under last week’s proposal  which is subject to court approval  MF Global will make a final, additional payment of approximately US $41 million to general creditors other than Holdings. MF Global and Holdings filed for bankruptcy protection on October 31, 2011. The CFTC previously filed an enforcement action – which is still pending – against John Corzine, CEO of MF Global, and Edith O’Brien, Assistant Treasurer of the firm, claiming that MF Global, Holdings and the two individuals failed to segregate and misused MF Global customer funds. (Click here for details of the CFTC enforcement action in the article “CFTC Files Long Awaited Enforcement Action Related to MF Global Collapse” in the June 27, 2013 edition of Between Bridges.) As part of the proposed transaction to fund the payment by MF Global to its general creditors, the firm would transfer certain of its current rights and obligations to Holdings.

My View: It is very good that the financial repercussions of the collapse of MF Global Inc. on customers and creditors appear likely to be mostly resolved by year-end. However, this resolution does not lessen the near-hysteria experienced by customers and creditors that followed in the days immediately following the demise of the firm –a demise apparently instigated by an apparently unanticipated regulatory capital treatment related to proprietary investments and the catastrophic breakdown of systems and controls. The collapse of MF Global in 2011 and Peregrine Financial Group less than one year later prompted the adoption of new rules by the Commodity Futures Trading Commission aimed at enhancing the protection of customer funds. Although industry participants (including me) can quibble on whether all these new rules were necessary or are entirely effective or whether, in fact, there are better alternatives, overall the new rules have likely achieved their objective of making customer funds safer, albeit at substantially increased costs to futures commission merchants.

  • Florida Lawyer Settles CFTC Complaint Charging He Aided and Abetted His Clients’ Unlawful Precious Metals Schemes: Jay Grossman, a Florida-based attorney, settled an enforcement action brought by the Commodity Futures Trading Commission related to his alleged aiding and abetting of multiple clients in their operation of illegal precious metal schemes for retail clients. These firms included Hunter Wise Commodities, LLC and related entities. (Each of the firms assisted by Mr. Grossman previously has been subject to orders by federal courts finding that their precious metals transactions violated applicable law.) Among other matters, the CFTC charged that Mr. Grossman “helped defraud retail customers by preparing documents, including account agreements … that he knew would deceive customers throughout the lifecycle of their retail commodity transactions.” (Click here for additional details regarding the CFTC allegations in the article “CFTC Sues Lawyer in Federal Court for Aiding and Abetting Clients’ Legal Violations” in the September 14, 2014 edition of Bridging the Week.) Mr. Grossman settled his action with the CFTC by agreeing to pay a fine of US $150,000 and restitution of US $733,000. However, Mr. Grossman’s obligation to pay restitution will be reduced by any amount of the US $733,000 his insurance carrier pays to the corporate-appointed receiver for Hunter Wise to settle a lawsuit she brought in September 2014. In that lawsuit, the receiver claimed that Mr. Grossman engaged in legal malpractice when he provided advice to the Hunter Wise entities when he never fully understood their business and failed to base his advice in any case on changed developments in law that made the conduct of their business illegal. (Click here to access the complaint in the lawsuit Damian v. Grossman filed in the United States District Court, Southern District of Florida.)
     
  • optionsXpress Sanctioned by FINRA for Not Adjusting Open Share Orders to Reflect Dividends: optionsXpress, Inc. – a subsidiary of The Charles Schwab Corporation  – agreed to pay a fine of US $165,000 to the Financial Industry Regulatory Authority to resolve a disciplinary action related to the firm’s failure to adjust the number of shares on open orders to reflect dividends, payments or distributions prior to executing or permitting the orders to be executed, at various times from September 11, 2006, through October 28, 2013. The firm was also sanctioned for not advising its customers that it had a practice of failing to adjust customer orders, as well as for supervisory violations. optionsXpress self-reported its violations to FINRA and corrected the violative activity prior to the termination of the investigation that gave rise to the FINRA disciplinary action.
     
  • ISDA Reflects on Dodd-Frank Implementation Five Years Later: The International Swaps and Derivatives Association published an overview of milestones in connection with requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act that was enacted over five years ago last week. Among other things, the report highlighted that during the first half of 2015, 75 percent of the average daily notional volume of interest rate swaps and 78 percent of the average daily credit default swap index notional value was cleared. In addition, 55 percent of interest rate derivatives and 65 percent of CDS index average daily notional volumes are now executed on swap execution facilities. In addition, as a result of Dodd-Frank, all swaps transactions involving a US person are now required to be reported to a swap data repository, and large swap dealers are required to be registered with the Commodity Futures Trading Commission and are subject to strict business conduct standards. Going forward, says ISDA, there needs to be better global harmonization of national rules to avoid market fragmentation; more work needs to be done to ensure central counterparties are resilient; greater flexibility in execution methods should be introduced to the SEF regime; and standardized product and transaction identifiers and reporting formats must be adopted globally to help regulators gain a clearer picture of global risk exposure and concentrations, among other recommendations.

My View: Perhaps because I was very busy, somehow last week I missed the toasts and parties celebrating the five-year anniversary of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Many of the objectives of Dodd-Frank and the equivalent laws of many international jurisdictions regarding the handling of over-the-count derivatives transactions are laudable and addressed material weaknesses in the system that contributed to the 2008-9 financial crisis. However, the failure of international lawmakers and regulators to better coordinate their responses and to consider holistically the implication of their overly proscriptive laws and rules threatens to decrease and fragment market liquidity, ultimately hurting the ability of end users to effectively mitigate their risks. ISDA is an industry organization, acts for the self-interest of its members and, as a result, at least some lawmakers and regulators may be skeptical of its suggested areas of focus in its publication on Dodd-Frank released last week. However, if anything, ISDA’s recommended areas of focus are understated and are all topics that must be addressed to ensure the continued effectiveness of important markets and the viability of their participants.

  • Three Industry Organizations Warn of Potential Negative Impact of Extending Capital Requirements to European Commodity Dealers: Three industry organizations published a white paper requesting a delay in the possible application of onerous capital and other requirements to commodity dealers that may be required to be licensed by national authorities in Europe for the first time in January 2017. This possible requirement is apparently triggered by the impending effective date of the Markets in Financial Instruments Directive II. The three industry organizations are FIA Europe, the International Swaps and Derivatives Association and the European Federation of Energy Traders. The organizations specifically asked for an extension until 2020 for two current principal exemptions for commodity dealers under the European Capital Requirements Regulation. These relate to capital requirements generally and reporting, risk mitigation and possible additional capital requirements when exposure to a counterparty exceeds 10 percent of a firm’s capital.

And more briefly:

  • FinCEN Updates List of Jurisdictions With Material AML/CFT Deficiencies: The Financial Action Task Force identified jurisdictions with anti-money laundering and counter-terrorist financing deficiencies: Afghanistan, Angola, Bosnia and Herzegovina, Ecuador, Guyana, Iraq, Lao PDR, Panama, Papua New Guinea, Sudan, Syria, Uganda and Yemen. FATF additionally requested its members to impose countermeasures on Iran and the Democratic People’s Republic of Korea, and advised financial institutions to apply enhanced due diligence for Algeria and Myanmar because of the deficiencies in the countries’ AML/CFT regimes. Indonesia has been removed from FATF’s listing and monitoring process. FATF is a 36-member intergovernmental policy-making body that establishes international standards to address money laundering and terrorist financing. The United States is a member of FATF.
     
  • ESMA Publishes New Q&As on AIFMD: The European Securities and Markets Authority updated its periodically published Questions and Answers related to the Alternative Investment Fund Managers Directive. The revised Q&As relate to reporting obligations by non-AIFMs, including the calculation of the total value of assets under management. (Click here for additional information in the article “ESMA Updates Q&A on the AIFMD” in the July 24, 2015 edition of Corporate & Financial Weekly Digest by Katten Muchin Roseman LLP.) The AIFMD is an EU directive that was implemented in 2013 and regulates entities that manage or market alternative investment funds within the European Union.
     
  • CFTC Exempts CTAs Not Directing the Trading of Client Accounts From Certain Filing Requirements: The Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight issued a letter that exempts all registered commodity trading advisors from filing with it annual reports on Form CTA-PR, where the CTA does not direct any trading of commodity interest accounts. (Click here for information on NFA reporting requirements generally for CTAs and commodity pool operators.)

For more information, see:

CFTC Exempts CTAs Not Directing the Trading of Client Accounts From Certain Filing Requirements:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/15-47.pdf

Defunct FCM MF Global to Pay Unsecured Creditors up to 95% of Their Allowed Claims:
Press release and court papers at:
http://dm.epiq11.com/MFG/Project

ESMA Publishes New Q&As on AIFMD:
http://www.esma.europa.eu/system/files/2015-1137_qa_on_the_application_of_the_aifmd.pdf

FC Stone Companies and Goldman Sachs Receive Largest Fines in CME Group’s 27 Disciplinary Actions Cascade (Sample Disciplinary Actions):

FC Stone Entities:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CME-14-9709-BC-1-FC-STONE-LLC.html
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9700-BC-2-INTL-COMMODITIES-INC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9700-BC-1-INTL-FC-STONE-MARKETS-LLC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-13-9641-BC-1-INTL-FC-STONE-MARKETS-LLC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-13-9641-BC-2-INTL-COMMODITIES-INC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9729-BC-INTL-FC-STONE-MARKETS-LLC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-15-0121-BC-INTL-FC-STONE-MARKETS-LLC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9968-BC-INTL-FC-STONE-MARKETS-LLC.html#pageNumber=1
Gavilon, LLC:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CBOT-13-9350-BC-GAVILON-LLC.html#pageNumber=1
Goldman Sachs Execution & Clearing L.P.:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/COMEX-14-9777-BC-GOLDMAN-SACHS-EXECUTION-AND-CLEARING-LP.html
Kanat Khussainov:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9915-BC-KANAT-KHUSSAINOV.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CBOT-14-9915-BC-KANAT-KHUSSAINOV.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CME-14-9915-BC-KANAT-KHUSSAINOV.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/COMEX-14-9915-BC-KANAT-KHUSSAINOV.html
Newedge USA, LLC:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-11-8193-BC-NEWEDGE-USA-LLC.html#pageNumber=1
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CME-11-8193-BC-NEWEDGE-USA-LLC.html#pageNumber=1
Pacific Investment Management Company LLC:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/CBOT-14-0035-BC-PACIFI-INVESTMENT-MANAGEMENT-COMPANY-LLC.html#pageNumber=1

FinCEN Updates List of Jurisdictions With Material AML/CFT Deficiencies:
http://www.fincen.gov/statutes_regs/guidance/pdf/FIN-2015-A002.pdf

Florida Lawyer Settles CFTC Complaint Charging He Aided and Abetted His Clients’ Unlawful Precious Metals Schemes:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfjbgrossmanorder072215.pdf

ISDA Reflects on Dodd-Frank Implementation Five Years Later:
Press release and article found at:
http://www2.isda.org/newsroom/press-releases/

optionsXpress Sanctioned by FINRA for Not Adjusting Open Share Orders to Reflect Dividends:
http://disciplinaryactions.finra.org/Search/ViewDocument/63244

Three Industry Organizations Warn of Potential Negative Impact of Extending Capital Requirements to European Commodity Dealers:
https://europe.fia.org/articles/fia-europe-efet-and-isda-joint-position-paper-capital-regime-commodities

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 25, 2015. 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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