Bridging the Week by Gary DeWaal


Bridging the Weeks by Gary DeWaal: November 23 – December 4 and 7, 2015 (Insider Trading in Futures; Newer, Tougher AML Requirements; New CCO Obligations; Possible Bitcoin Fraud)

Bridging the Week    My View    Trade Practices (including Disruptive Trading)    Block Trades and EFRPs    AML and Bribery    Exchanges and Clearing Houses    Position Limits    Cybersecurity    Systems and Controls    Insider Trading    Digital Currencies and Distributed Ledger Technology    Manipulation    Uncleared Swaps    Cleared Swaps    EMEA Regulation (sans Capital and Liquidity)    Canadian Regulation (sans Capital and Liquidity)    Regulation AT   
Published Date: December 06, 2015

Compliance officers may be in the bullseye again as a result of new regulatory proposals introduced during the prior two weeks by the New York State Department of Financial Services and the Commodity Futures Trading Commission. Meanwhile, another compliance officer put himself in the bullseye of the Securities and Exchange Commission by purportedly trading on confidential information his employer entrusted him to safeguard and not to profit from. Finally, the CFTC, for the first time, used its new Dodd-Frank anti-manipulation authority to sue and obtain a settlement from an individual charged with a securities law-type insider trading violation in connection with his personal futures trading. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:

Video Version:

Article Version:

CFTC Brings First Insider Trading-Type Enforcement Action Based on New Anti-Manipulation Authority:

Last week the Commodity Futures Trading Commission brought and settled its first enforcement action sounding in the securities concept of insider trading, relying on the relatively new Dodd-Frank Wall Street Reform and Consumer Protection Act’s prohibition against employment of a manipulative or deceptive device in connection with futures trading.

According to the CFTC, from September 3 through November 26, 2013, Arya Motazedi, a gasoline trader employed by an unnamed “large, publicly traded corporation” misappropriated “non-public, confidential and material information” of his employer to benefit his own trading of energy futures contracts listed on the New York Mercantile Exchange, Inc. Specifically, on 34 occasions Mr. Motazedi allegedly traded opposite his employer’s accounts to effectively and illicitly transfer funds from the firm to himself, and on 12 other occasions he traded in advance of orders he placed for the firm to generate “additional profits for himself to the detriment of the company.”

The CFTC claimed that Mr. Motazedi owed a duty of confidentiality to his employer. This duty arose, said the Commission, because he and his employer “shared a relationship of trust and confidence,” and because his employer had express policies that prohibited him from engaging in personal transactions that “created an actual or potential conflict of interest.”

The CFTC charged that Mr. Motazedi’s trading constituted fraud, as well as impermissible fictitious sales and non-competitive trades.

The CFTC also claimed that Mr. Motazedi’s trading violated the relatively new Dodd-Frank provision (click here to access Commodity Exchange Act Section 6(c)(1)), US Code §9(1), and the corresponding CFTC rule (click here to access CFTC Rule 180.1) that prohibit any person from engaging in “any manipulative or deceptive device or contrivance” in connection with futures trading that uses, attempts to use, or employs “any manipulative device, scheme or artifice to defraud” or operates “as a fraud or deceit upon any person.” The CFTC said that Mr. Motazedi’s “knowing or reckless misappropriation and misuse" of his employer's proprietary trading information to trade his personal accounts breached his duty to his employer and thus was a violation of the relevant law and CFTC rule.

To resolve this matter, Mr. Motazedi agreed to pay restitution of almost US $217,000 to his employer and a fine of US $100,000, and agreed to be permanently banned from trading CFTC-supervised products subject to the rules of a registered trading facility.

On the same day the CFTC action and settlement were announced, the CME Group and Mr. Motazedi also settled a disciplinary action brought by NYMEX related to the same essential facts at issue in the CFTC matter. Mr. Motazedi also agreed to pay restitution to his former employer, a trading suspension and another fine of US $100,000 to resolve the NYMEX action.

My View: Once again, the Commodity Futures Trading Commission’s Division of Enforcement has pushed the envelope on the application of Dodd-Frank’s prohibition against employment of a manipulative or deceptive device in connection with futures trading, and its parallel rule 180.1. Here the CFTC used these provisions to prosecute an individual who allegedly traded based on the confidential information of his employer to his employer’s detriment. The CFTC has used these provisions previously in a wide range of enforcement actions stemming from its first use in the JP Morgan “London Whale” episode to allegations of illegal off-exchange metals transactions, claims of more traditional manipulation of wheat and allegations of spoofing. The CFTC clearly regards its new Dodd-Frank authority “as a broad, catch-all provision reaching fraud in all its forms – that is, intentional or reckless conduct that deceives or defrauds market participants.” Because it is not clear what limits, if any, a court may ultimately place on the CFTC in using these provisions, they are a powerful tool for the Commission to pressure settlements from potential respondents. This is worrisome for the industry, which can only hope the Division uses its new tools judiciously.

Briefly:

My View: Compliance officers will be placed in an impossible circumstance if they must certify that their firms comply with all laws, even if just to the best of their knowledge. It is one thing to require a chief compliance officer to prepare a firm’s annual compliance report, relying on sub-certifications from various corporate officers; however, the obligation to certify its accuracy should more appropriately lie with the chief executive officer. This is because, ultimately, all corporate officers report to the CEO, not the CCO. The CCO is not a supervisor. Moreover, CCOs are employees of a firm, not of the State of NY, and should not be viewed as adjuncts to government enforcement staff.

My View: As I reflected in my initial commentary on proposed Regulation AT, the Commodity Future Trading Commission's proposed rules were designed with noble objectives – to prevent and ameliorate the potential impact of algorithmic trading systems breaking down and causing widespread adverse market impact or being used for nefarious purposes. The proposed rules generally are not prescriptive, but attempt to federalize already existing best practices and, in many cases, rules of exchanges and the National Futures Association. That being said, there are material provisions in the proposed regulation that hopefully will be fixed in any final rule. Among other things, source code should not be required to be made available as easily as contemplated to the Commodity Futures Trading Commission or US Department of Justice staff. Moreover, the role of compliance officers at so-called “AT Persons” must be clarified. The CFTC must make it clear that compliance officers are not potentially exposed to liability if an algorithmic trading program goes haywire simply because AT persons are required to ensure that non-compliance staff and compliance staff have a plan “of internal coordination and communication between [such persons] regarding design, changes, testing and controls,” which plan should be constructed “to detect and prevent” breaches of law and rules by algorithmic systems. Finally, threshold issues must be considered: is there a better way to build upon best practices already adopted by many algorithmic traders and other industry participants, rather than to create a new federal infrastructure? Might the implications under proposed Regulation AT of a breach of internal procedures by AT persons prompt AT persons to formally lessen already implemented best practices to avoid potential regulatory issues? Finally, under the proposed regulation, the National Futures Association is potentially required to “establish and maintain a program,” among other things, for “perfecting the mechanisms of trading on designated contract markets by adopting rules for each category of member” dealing with pre-trade risk controls, standards for system development, testing and other matters, and training of staff” (emphasis added). NFA may have very talented staff, but it might be a bit too much to expect even these highly qualified professionals to come up with measures that “perfect” a process! Moreover, as one of my colleagues at Katten Muchin Rosenman has pointed out to me, it appears unlikely that NFA has the current authority to create any such program – perfect or less than perfect – under its prevailing Articles of Incorporation (click here to access the relevant potentially problematic provision – Article III, Section 2(b)).

And more briefly:

For more information, see:

Canadian Securities Regulators Implement Best Practice Principles for CCPs and Equivalents:
http://www.osc.gov.on.ca/en/SecuritiesLaw_ni_20151203_24-102_rfc-proposed-clearing-agency.htm

See also Agreement to Cooperate:
http://www.osc.gov.on.ca/en/SecuritiesLaw_irps_index.htm

CFTC Brings First Insider Trading-Type Enforcement Action Based on New Anti-Manipulation Authority:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfmotazediorder120215.pdf

See also, CME action against Arya Motazedi:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9723-BC-ARYA-MOTAZEDI.html#pageNumber=1

CFTC Proposes Regulation of Automated and Algorithmic Trading Systems and Registration of Certain Proprietary Traders:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister112415.pdf

Copper Trader Ordered to Disgorge US $3 Million to Settle CME Group Disciplinary Action for Two-Day Position Limit Violation:

Cornerstone Futures:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-14-9792-BC-CORNERSTONE-FUTURES-LLC.html#pageNumber=1
Han Lin:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/COMEX-14-0042-BC-HAN-LIN.html#pageNumber=1
Eric Mlak:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-13-9565-BC-ERIC-MLAK.html#pageNumber=1
Toronto Dominion Bank:
http://www.cmegroup.com/tools-information/lookups/advisories/disciplinary/NYMEX-15-0130-BC-2-TORONTO-DOMINION-BANK.html#pageNumber=1

European Interest Rate Swap Clearing to Begin June 2016:
http://www.esma.europa.eu/system/files/2015-1798_pr_central_swap_clearing_to_start_jun_2016.pdf

Ex-Compliance Officer Charged With Trading Stocks Based on Information His Employer Expected Him to Protect:
http://www.sec.gov/litigation/complaints/2015/comp-pr2015-267.pdf

Flash Boys Lawsuit Against CME Group Dismissed:
/ckfinder/userfiles/files/Braman%20v_%20CME.pdf

IOSCO and BIS Issue Best Practices to Promote Cybersecurity by Financial Market Infrastructures:
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD513.pdf

Members of European Parliament Ask for Delay in MiFID II Roll-Out:

Letter to Jonathan Hill:
https://europe.fia.org/sites/default/files/content_attachments/D56697_Hill_postponement%20date%20of%20application%20MiFID%20II_MiFIR%20-%20ND.PDF
Statement of Steven Maijoor:
http://www.esma.europa.eu/system/files/2015-1639_steven_maijoor_-_esma_econ_scrutiny_speech_10_nov_2015_0.pdf

Multiple Swap Dealers Entities Sued for Allegedly Impeding Roll-Out of Centrally Executed Interest Rate Swaps; EU Shuts Down Inquiry Regarding Credit Default Swaps:

Complaint:
/ckfinder/userfiles/files/Public%20School%20Retirement.pdf
EU Announcement:
http://europa.eu/rapid/press-release_MEX-15-6254_en.htm

NYS Proposes Tough New AML Requirements; International Bank Sanctioned by UK FCA for Alleged AML Breakdown:
http://www.dfs.ny.gov/legal/regulations/proposed/rp504t.pdf

See also FCA fine of Barclays Bank:
http://www.fca.org.uk/static/documents/final-notices/barclays-bank-nov-2015.pdf

NFA Provides Guidance on Annual Affirmation Requirement for Persons Claiming Exemption or Exclusion from CPO or CTA Registration Requirements:
https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4663

SEC Sues Promoters of Investments in Bitcoin Mining Power for Offering and Selling a Ponzi Scheme:
http://www.sec.gov/litigation/complaints/2015/comp23415.pdf

SEC Currently Investigating a Possible Offer and Sale of OTC Security-Based Swaps to Non-Qualified Counterparties:
/ckfinder/userfiles/files/NetCirq.pdf

Spoofing Case Filed by SEC:
http://www.sec.gov/litigation/admin/2015/33-9983.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of December 5, 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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