Bridging the Week by Gary DeWaal


Bridging the Weeks by Gary DeWaal: August 31 to September 11 and September 14, 2015 (Spoofing, Individual Accountability, Cybersecurity, Audit Opinions, Hedging and Reporting)

Bitcoin Ecosystem    Block Trades and EFRPs    Bridging the Week    Compliance Weeds    Cybersecurity    Manipulation    My View    Position and Trade Reporting    Position Limits    Retail Forex and Metals    Supervision    Systems and Controls    Trade Practices (including Disruptive Trading)    Uncleared Swaps   
Published Date: September 13, 2015

During the past two weeks, Navinder Singh Sarao – the individual both the US Department of Justice and the Commodity Futures Trading Commission claim was at least partly responsible for the May 6,2010 “Flash Crash” – was formally indicted for alleged spoofing-type trading, while the National Futures Association submitted to the CFTC for its approval proposed guidance to members regarding cybersecurity. Meanwhile, the US Department of Justice suggested it will proceed more fervently against employees of alleged corporate wrongdoers going forward. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Video Version:

Article Version:

Alleged Flash Crasher's Formal Indictment Provides More Details Regarding His Purported Spoofing

The US Department of Justice filed a formal indictment against Navinder Singh Sarao in a US federal court in Chicago on September 2, 2015, alleging that he engaged in commodities fraud, manipulation, attempted manipulation and spoofing, in violation of federal law, in connection with his trading of E-mini S&P 500 futures contracts on the Chicago Mercantile Exchange between approximately January 2009 through April 2014 (although some charges relate to conduct only from April 27, 2010, through March 10, 2014).

Mr. Sarao was previously accused of engaging in the same unlawful activities in a criminal complaint filed in the same court by the Department of Justice on February 11, 2015, and made public on April 21. This occurred shortly after Mr. Sarao was arrested at his home in the United Kingdom on April 21, in connection with his US criminal charges.

Since that time, Mr. Sarao has been opposing extradition to the United States in hearings in the United Kingdom.

In a civil lawsuit filed in a US federal court in Chicago on April 17, 2015, but made public on April 21, too, the Commodity Futures Trading Commission also charged Mr. Sarao and his trading company, Nav Sarao Futures Limited PLC, with engaging in the same core wrongful conduct as did the Department of Justice. The CFTC alleged that Mr. Sarao’s disruptive trading netted him profits in excess of US $40 million between April 2010 and April 2015

The Department of Justice and the CFTC claimed that Mr. Sarao engaged in layering activity on multiple occasions on the sell side of the market with the intent to mislead other market participants and artificially lower the price of E-mini futures contracts. Mr. Sarao accomplished this, said both the Department of Justice and CFTC, utilizing an automated trading program that frequently placed and cancelled large sell orders at a set increment away from the prevailing best bid price. Mr. Sarao typically sold E-mini futures contracts at a higher price and bought them back at a lower price in conjunction with his supposed “dynamic layering technique,” realizing profits, claimed both the Department of Justice and the CFTC.

In the indictment, the Department of Justice provided greater insight into its version of Mr. Sarao’s alleged wrongful conduct. Among other things, the Department of Justice referenced specific emails where Mr. Sarao expressly discussed his desire to “spoof [the market] down;” his need to have software to enter orders of different sizes to avoid other traders becoming aware of his activity and “rendering my spoofing pointless;” and contacting a programmer to know whether he could make software adjustments “because at the moment I’m getting hit on my spoofs all the time.”

The Department of Justice also alleged that on approximately May 21, 2013, Mr. Sarao’s then-clearing broker provided him with a copy of the CFTC’s interpretive guidance and policy statement regarding the Commission’s anti-market disruptive practices authority published just a few days previously. In response, Mr. Sarao allegedly responded to his clearing broker, “Lol, guarantee if I switch on my computer I’ll see the same people breaking all those rules, day in, day out.” (Click here to access a copy of the CFTC’s interpretive guidance and policy statement regarding its anti-market disruptive practices authority.)

Both the CFTC and the Department of Justice claimed that Mr. Sarao’s conduct contributed to the May 6, 2010 “Flash Crash.” (The Flash Crash refers to events on May 6, 2010, when major US-equities indices in the futures and securities markets suddenly declined 5-6 percent in the afternoon in a few minutes before recovering within a similarly short time period.)

(Click here for additional details regarding Mr. Sarao’s alleged wrongful conduct in the article “London-Based Futures Trader Arrested, Sued by CFTC and Criminally Charged With Contributing to the May 2010 “Flash Crash” Through Spoofing” in the April 22, 2015 edition of Between Bridges.)

My View: I continue to struggle how an individual might have known what is “commonly known to the trade as spoofing” – one of the specific activities prohibited by the federal law that outlaws market disruptive practices (click here to access the relevant law, Commodity Exchange Act §4c(a)(5)(C))– prior to the release of the CFTC’s interpretive guidance and policy statement in May 2013. Even today, prohibitions on disruptive trading practices are not uniform among exchanges. Moreover, it seems to me likely there are many legitimate reasons to place orders with the intent that they be cancelled before execution. For example, a trader might place a stop loss order or an order for a deep out of the money option far away from the current market solely as catastrophic insurance with the intent (and prayer) that it not be executed. Although it could be argued that such an order is legitimate because it is “the intent of the market participant that the order will be executed if the specific condition is met” (click here to access the answer to question 8 to CME Group’s Market Regulation Advisory Notice RA1405-5R, “Disruptive Practices Prohibited”), a trader engaging in purported layering might equivalently argue that it was his/her intent and expectation to be filled if his/her orders were hit – and he/she set aside the financial resources to demonstrate that. Mr. Sarao’s choice of words in his electronic communications may come back to haunt him, but it will also be interesting to see whether his language has been taken out of context in the criminal indictment.

Briefly:

My View: The National Futures Association has taken a measured approach in requiring firms to have information systems security programs. Rather than specify a one-size-fits-all approach, NFA proposes to provide relevant member firms the flexibility to devise ISSPs commensurate with their size, customer base and product access. Moreover, recognizing that some firms already have ISSPs and other do not, NFA proposes to provide additional, more detailed guidance to certain smaller members. Relevant firms should not wait until the Commodity Futures Trading Commission approves the NFA’s proposed Interpretive Notice, which surely it will, to conduct a gap analysis between NFA’s recommendations and their current practices, and to try to begin to close any gap by drafting and implementing enhanced provisions to their ISSPs as necessary. (Click here to an access an overview of the financial services industry’s regulatory landscape regarding cybersecurity, and a helpful checklist to assist in developing an ISSP, in the article “Cyber-Attacks: Threats, Regulatory Reaction and Practical Proactive Measures to Help Avoid Risks” in a June 24, 2015 Financial Services Advisory by Katten Muchin Rosenman LLP.)

Compliance Weeds: CFE’s disciplinary actions regarding late filings of CFTC Forms 102 serve as a reminder that the deadline for futures commission merchants to begin filing electronically revised Forms 102A and 102B (information regarding large traders and volume threshold traders) is rapidly approaching. Temporary relief by the Commodity Futures Trading Commission from filing the new forms expires as of September 30, 2015. A helpful reminder to clients of what information they should be providing to FCMs either directly or through a Futures Industry Association portal can be found on the FIA’s website (click here to access). (Click here for further information on CFTC ownership and control reporting in the article “CFTC Postpones OCR Roll-out; CME Group and ICE Futures U.S. Adopt Conforming Amendments” in the February 15, 2015 edition of Bridging the Week.)

And more briefly:

For more information, see:

Alleged Flash Crasher's Formal Indictment Provides More Details Regarding His Purported Spoofing:
/ckfinder/userfiles/files/Sarao%20Amended%20Complaint.pdf

BDO and Five Partners Charged by SEC for Issuing Misleading Unqualified Audit Opinions:
http://www.sec.gov/litigation/admin/2015/34-75862.pdf
http://www.sec.gov/litigation/admin/2015/34-75859.pdf

Bitcoin Options Exchange Receives CFTC Temporary Designation as SEF:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/15-49.pdf

CFE Sanctions FCMs for Failing to Timely File Form 102s and Submit Large Trader Reporter Data Properly:

Banco Santander:
http://cfe.cboe.com/framed/PDFframed.aspx?content=/publish/CFEDisDecision/CFE%2015-0006.pdf&section=SEC_ABOUT_CFE&title=CFE+15-0006+Banco+Santander+SA
Eagle Seven:
http://cfe.cboe.com/framed/PDFframed.aspx?content=/publish/CFEDisDecision/CFE%2015-0004.pdf&section=SEC_ABOUT_CFE&title=CFE+15
0004+Eagle+Seven+LLC%2c

Macquarie:
http://cfe.cboe.com/framed/PDFframed.aspx?content=/publish/CFEDisDecision/CFE%2015-0013.pdf&section=SEC_ABOUT_CFE&title=CFE+15-0013+Macquarie+Bank+Ltd.
Philip Futures:
http://cfe.cboe.com/framed/PDFframed.aspx?content=/publish/CFEDisDecision/CFE%2015-0013%20(2).pdf&section=SEC_ABOUT_CFE&title=CFE+15-0013+Phillip+Futures+PTE+Ltd.
Raiffeisen Bank:
http://cfe.cboe.com/framed/PDFframed.aspx?content=/publish/CFEDisDecision/CFE%2015-0012.pdf&section=SEC_ABOUT_CFE&title=CFE+15-0012+Raiffeisen+Bank+International+AG

CFTC Chairman Considers Delegating Non-Enumerated Hedging Exemptions to Exchanges; Aggregation Proposal on the Table:
http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-27

ESMA Consults on Final Draft Requirements Related to Position Reporting for Commodity Derivatives and Other Matters:
http://www.esma.europa.eu/system/files/2015-esma-1301_consultation_paper_on_mifid_ii_its.pdf

FCA Says Commodities Trading Firms’ and Brokers’ Awareness of Market Abuse Risk Is Poor:
http://www.fca.org.uk/static/documents/newsletters/market-watch-49.pdf

Forex Capital Markets Settles With CFTC for Allegedly Not Providing Adequate Oversight of Fraudulent Pool:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfforexcapitalorder090815.pdf

ICE Futures Canada Issues Guidance on Subsequent EFRPs to Correct Original EFRPs:
https://www.theice.com/publicdocs/futures_canada/member_notices/2015_08_28_EFP_EFS_EOO_Guidance.pdf

ICE Futures U.S. Settles Disciplinary Actions for Position Limits and Block Trade Violations:

ICAP Energy:
/ckfinder/userfiles/files/Gmail%20-%20Settlement%20of%20Charges%20Against%20ICAP%20Energy%2c%20LLC.pdf
Representative Block Trade Violation: J.P. Morgan Securities:
/ckfinder/userfiles/files/Gmail%20-%20Settlement%20of%20Charges%20Against%20J_P_%20Morgan%20Securities%20LLC.pdf

Representative Position Limit Violation: J. Aron & Company:
/ckfinder/userfiles/files/Gmail%20-%20Settlement%20of%20Charges%20Against%20J_%20Aron%20%26%20Company.pdf

NFA Announces Effective Dates for New Forex Member Requirements:
http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4632

NFA Proposes Cybersecurity Guidance:
http://www.nfa.futures.org/news/PDF/CFTC/InterpNotc_CR2-9_2-36_2-49_InfoSystemsSecurityPrograms_Aug_2015.pdf

US Justice Department to Emphasize Naming Individuals in Corporate Misconduct Civil and Criminal Actions:
http://www.justice.gov/dag/file/769036/download

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of September 12, 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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