Bridging the Week by Gary DeWaal


Bridging the Week by Gary DeWaal: September 26 to 30 and October 3, 2016 (Futures Insider Trading; Artificial Prices; Theft by Convention; Whistleblowing)

Bridging the Week    Compliance Weeds    My View    Culture and Ethics    Managed Money    Trade Practices (including Disruptive Trading)    AML and Bribery    Exchanges and Clearing Houses    Insider Trading    Manipulation    Position and Trade Reporting    Uncleared Swaps    Supervision    Legal Weeds    Cleared Swaps    EMEA Regulation (sans Capital and Liquidity)    APAC Regulation (sans Capital and Liquidity)    Introducing Brokers    Whistleblowing    Follow-Up    Regulation MAR   
Published Date: October 02, 2016

Last week, the Commodity Futures Trading brought and resolved its second enforcement action based on the securities industry’s concept of insider trading, while a federal court ruled in response to a motion for partial summary judgment that the CFTC must show that a price was intended to be artificial to ultimately prevail in a lawsuit alleging manipulation and attempted manipulation. In addition, the Securities and Exchange Commission agreed to settle an enforcement action with a publicly-traded company for terminating a whistleblower where an internal investigation found the whistleblower’s complaints were unfounded. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Video Version:

Article Version

Briefly:

Legal Weeds: This is the second time the CFTC has brought and settled an enforcement action that sounds in the securities concept of insider trading, relying on the relatively new provision of law and CFTC rule that prohibits employment of a manipulative or deceptive device or contrivance in connection with futures or swaps trading. (Click here to access Commodity Exchange Act Section 6(c)(1), US Code § 9(1), and here to access CFTC Rule 180.1.) In the first action brought in 2015, the CFTC alleged that Arya Motazedi, a gasoline trader for an unnamed large, publicly traded corporation, similarly misappropriated trading information of his employer for his own benefit. The CFTC charged that Mr. Motazedi breached his duty of confidentiality to his employer by trading opposite the firm on 34 occasions to effectively transfer funds from his employer to himself, and in front of his employer’s orders on 12 other occasions. (Click here for information regarding the CFTC’s enforcement action against Mr. Motazedi in the article, “CFTC Brings First Insider Trading-Type Enforcement Action Based on New Anti-Manipulation Authority” in the December 6, 2015 edition of Bridging the Week.) The CFTC has used its manipulative or deceptive device or contrivance authority in a wide range of enforcement actions stemming from its first use in the JP Morgan “London Whale” episode to subsequent allegations of illegal off-exchange metals transactions, claims of more traditional manipulation of wheat, allegations of spoofing and insider trading. The CFTC has made clear it sees its new 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” and will use it whenever possible – including for allegations of trading on the basis of material nonpublic information obtained as a result of a breach of a duty of confidentiality, or through fraud or deception. (Click here to access the CFTC’s views on the reach its authority under CFTC Rule 180.1 in the Federal Register adopting release for this provision.)

My View: As I observed earlier this year, the CFTC defines manipulation as “[a]ny planned operation, transaction, or practice that causes or maintains an artificial price” on its own website (emphasis added). (Click here to access CFTC definitions on its website.) As the CFTC recently acknowledged in adopting its new anti-manipulation and anti-fraud rules, one of the cornerstones for proving manipulation or attempted manipulation is “that the accused specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand” to wit, an artificial price. (Click here to access the CFTC Fact Sheet related to its anti-manipulation and anti-fraud rules, Rule 180.1 and 180.2.) Setting aside the long-established case law as capsulized in the decisions cited in the five organizations’ friends of the court brief and the court's decision in this matter, it was very surprising that the CFTC argued that an attempted manipulation could be an attempt to cause anything less than an artificial price in light of the agency’s own published plain words.

My View: From the SEC’s Order in this matter, it is not clear how reasonable were the complaining employee’s allegations, or in what manner he presented his concerns, other than to note that he and his executive supervisor had a “heated disagreement” on the issue. Apparently, the executive supervisor considered a slide the employee had prepared stating his views to be “inflammatory” and was concerned his statements had “no basis in fact.” An internal investigation helped by outside counsel appeared to confirm the executive supervisor’s view. Although whistleblowing is and should be protected, all complaints should have some legitimate basis, and companies should not be penalized for terminating employees who abuse a whistleblowing process for illegitimate purposes or who engage in improper conduct even in connection with a legitimate complaint. Otherwise employees are empowered to extort their employers for their own inappropriate actions or conduct. It’s a fine line. (Click here for background on the SEC’s whistleblower protections in the article, “Another Publicly Traded Firm Sanctioned by SEC for Allegedly Undercutting Whistleblower Protections Through Severance Agreements” in the August 21, 2016 edition of Bridging the Week.)

Compliance Weeds: In April 2014, the Securities and Exchange Commission’s Division of Trading and Markets issued helpful answers to frequently asked questions related to Regulation MAR (click here to access). This regulation, adopted in 2010, generally requires a broker or dealer with access to trading securities directly on an exchange or alternative trading system to have procedures and controls that limit their financial exposure as a result of such access, and ensure compliance with all applicable regulatory requirements. In its Q&As, the SEC provides a concise summary of the relevant regulation as well as answers to 19 questions regarding it. These questions include: does MAR apply to quotes (yes, MAR applies to all orders, including market maker quotes); and security futures products (yes, for broker-dealers that trade security futures on an exchange or alternative trading system but not for Notice-registered futures broker-dealers); and may a broker-dealer that provides access to an affiliate broker-dealer grant the affiliate control over its risk management controls and supervisory procedures (no).

Compliance Weeds: The CFTC maintains an extensive large trader reporting program that must be strictly complied with by reporting entities. For futures and related options, large trader data must be provided to the Commission by futures commission merchants and foreign brokers. Generally, if at the end of a day a reporting firm has a customer with a position at or exceeding the Commission’s reporting level in any single futures or options expiration month, the firm must report all of the customer’s positions in futures and options in that commodity no matter the size positions in the other months. (Click here for current CFTC reporting levels for futures.) Rules related to large trader reports were amended in 2013 and some changes were effective last week for the first time. (Click here for details in the article, “CFTC Again Extends Deadlines for New OCR Compliance; Puts Pressure on FCM Clients Who Will Not Provide Adequate Information Regarding Trading Control” in the April 10, 2016 edition of Bridging the Week”) Similarly, clearing members and swap dealers are required to file daily with the CFTC large trader reports for physical commodity swaps and swaptions when their positions exceed the equivalent of 50 related futures contracts (such swaps and swaptions must relate to certain covered agricultural and exempt futures contracts; click here to access a list of relevant covered contracts). The report must include certain required information in a format mandated by the Commission – including converting swap positions to futures contracts equivalent levels. (Click here to access the helpful CFTC publication “Large Trader Reporting for Physical Commodity Swaps: Division of Market Oversight Guidebook for Part 20 Reports” published June 22, 2015.)

Follow-Up: In August, the CFTC 
filed charges in a federal court in New York City against Deutsche Bank AG, a registered swap dealer, for its alleged failure to accurately report information regarding its swap transactions, as required by law, from April 16, 2016, through the current time. (Click here for details regarding the CFTC's enforcement action against Deutsche Bank in the article, "Swap Dealer Sued in Federal Court by CFTC for Recidivist Reporting Violations; Acknowledges Bank’s Cooperation" in the August 21, 2016 edition of Bridging the Week.) In conjunction with the CFTC’s enforcement action, the CFTC and Deutsche Bank filed a joint motion seeking the appointment of a monitor to help ensure the bank’s ongoing compliance with its swaps reporting requirements. However, on September 22, the federal court hearing the CFTC's enforcement action unexpectedly declined to automatically approve and enter a proposed consent order appointing a monitor, finding that the "CFTC's application is bereft of any authorities explaining why the proposed Consent Order is 'fair, reasonable, adequate, and in the public interest'." Last week the CFTC submitted a memorandum of points and authorities in support of its motion for entry of the proposed consent order that endavored to address the court's concerns. A hearing on the Commission's application is scheduled for October 6.

My View: CFTC Regulation 166.3 is a broadly drafted provision that has been used by the Commission in diverse circumstances (click here to access CFTC Rule 166.3). However, in this complaint is a worrisome suggestion that the CFTC may also consider it a failure to supervise trading accounts if a registrant does not memorialize in a written procedure an obligation imposed on it by contract or otherwise by a third party that is not grounded in a law or regulation. This is suggested by the CFTC’s EFT enforcement action because there is no existing regulation requiring introducing brokers to make margin calls on customers they introduce to futures commission merchants. Indeed, some FCMs preclude their IBs from making margin calls at all. Although a requirement that an IB call customers introduced to an FCM for margin under certain circumstances may be a measure imposed by a particular FCM, it seems a stretch to argue that the failure to memorialize that obligation into a procedure constitutes a violation of a registrant’s duty to supervise.

And more briefly:

For more information, see:

Brokerage Firm Agrees to Pay US $12.5 Million Fine to SEC for Trading Controls Failure; Six Exchanges to Assess an Additional US $3 Million Penalty:

SEC:
https://www.sec.gov/litigation/admin/2016/34-78929.pdf
Six Exchanges:
http://www.nasdaq.com/press-release/six-exchanges-collectively-fine-merrill-lynch-3-million-for-violating-the-secs-market-access-rule-20160926-00803

CFTC Mandates More Interest Rate Swaps to Be Centrally Cleared:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/irsclearing_qa092816.pdf
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister092816.pdf

Ex-Airline Employee Sued by CFTC for Insider Trading of Futures Based on Misappropriated Information:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfrugglesorder092916.pdf

Federal Court Holds That CFTC Must Show Artificial Price to Prevail in Traditional Manipulation Lawsuit:
/ckfinder/userfiles/files/DRW%20Memorandum%20and%20Order.pdf

Firm Sanctioned by SEC for Firing Whistleblower Who Allegedly Made False Allegations:
https://www.sec.gov/litigation/admin/2016/34-78991.pdf

Hedge Advisor to Retailers of Fuel Products Settles With CFTC Over Charges It Acted as an Unregistered CTA:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfangusorder092916.pdf

Hedge Fund Resolves SEC Charges That It Impermissibly Bribed Foreign Governments to Obtain and Retain Business; Owner of King of Beers Also Sanctioned:

Anheuser-Busch InBev SA/NV:
https://www.sec.gov/litigation/admin/2016/34-78957.pdf
Och-Ziff Capital Management Group LLC:
https://www.justice.gov/opa/file/899306/download
https://www.justice.gov/opa/file/899316/download
https://www.sec.gov/litigation/admin/2016/34-78989.pdf

ICE Futures U.S. Traders Barred for Prearranging Trades to Transfer Funds Between Accounts:
/ckfinder/userfiles/files/IFUS%20-%20Respondents%20Li%20Wei%20and%20Chen%20Yun%20Zhen%20Found%20To%20Have%20Exchange%20Rules%204_02(c)%2c%204_02(f)%20and%204_04.pdf
/ckfinder/userfiles/files/IFUS%20-%20Respondents%20Yang%20Fan%2c%20Haibang%20Huang%20and%20Jiaoqing%20Zhang%20Found%20to%20have%20Violated%20Exchange%20Rule%204_04(3).pdf

Introducing Broker and Principal Sued by CFTC for Recordkeeping and Supervision Breakdowns:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfefloortradecomplaint092716.pdf

NFA Amends Form PQRs Again, and Reminds CTAs and CPOs Regarding Late Fees:
https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4745

SEC Calls for T+2 Securities Transactions Settlement:
https://www.sec.gov/rules/proposed/2016/34-78962.pdf

SEC Adopts Enhanced Regulatory Framework for Systemically Important Clearing Agencies:
https://www.sec.gov/rules/final/2016/34-78961.pdf
https://www.sec.gov/rules/proposed/2016/34-78963.pdf

See also OCC Comment:
http://www.optionsclearing.com/about/newsroom/releases/2016/September-28-OCC-Supports-SEC-Decision-on-Covered-Clearing-Agency-Rules.jsp

SGX Encourages Collaboration to Address Market Misconduct:
http://www.sgx.com/wps/wcm/connect/sgx_en/home/higlights/news_releases/sgx_collaborates_with_member_firms_to_address_market_misconduct

Swap Dealer Settles Enforcement Action by CFTC for Not Filing Daily Large Trader Reports of Commodity Swaps Positions:

Deutsche Bank:
/ckfinder/userfiles/files/Memorandum%20Deutscvhe%20Bank.pdf
/ckfinder/userfiles/files/CFTC%20Memorandum%20Deutsche%20Bank.pdf
Well's Fargo:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfwellsfargobankorder092716.pdf

Trader Indicted for Exploiting Minimum Futures Pricing Convention to Hide Trading Losses and Causing Firm Collapse; CFTC Also Files Civil Charges:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enflindstromcomplaint092916.pdf

UK FCA Considers Regulatory Obligations of Head of Legal Function at Investment Firms:
https://www.fca.org.uk/sites/default/files/ps16-22.pdf
https://www.fca.org.uk/sites/default/files/cp16-26.pdf
https://www.fca.org.uk/sites/default/files/dp16-4.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of October 1, 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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