Bridging the Week by Gary DeWaal

Bridging the Weeks by Gary DeWaal: January 17 to 27 and January 30, 2017 (Priorities; Whistleblowing; How Could They Know?; AML Officer Sued)

AML and Bribery    APAC Regulation (sans Capital and Liquidity)    Bitcoin Ecosystem    Bridging the Week    Chief Compliance Officers    Compliance Weeds    Customer Protection    Managed Money    My View    Position and Trade Reporting    Trade Practices (including Disruptive Trading)    Whistleblowing   
Published Date: January 29, 2017

During the past two weeks, the new acting Chairman of the Commodity Futures Trading Commission, J. Christopher Giancarlo, provided a preview of his priorities, while the Securities and Exchange Commission brought two more enforcement actions against publicly traded companies for including in standard severance agreements language that the SEC considered to impede potential whistleblowing. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:

  • New Acting CFTC Chairman Provides Insight Into Priorities (includes My View);
  • More Firms Sanctioned For Whistleblower Offenses by SEC (includes Compliance Weeds);
  • Alleged Failure of HK Trading Firm to File Reports Regarding Physical Cotton Results in Enforcement Action by CFTC (includes Compliance Weeds and My View);
  • SEC Files Charges Against Broker-Dealer and Chief AML Officer for Failure to File Suspicious Activity Reports (includes Compliance Weeds);
  • Affiliated FCMs Settle CFTC Enforcement Action Related to Alleged Non-Preservation of Customer Orders Audit Trail Records (includes Compliance Weeds);
  • Cooperate and Maybe Benefit Says CFTC Division of Enforcement; and more.

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  • New Acting CFTC Chairman Provides Insight Into Priorities: In a speech before SEFCON VII on January 18, J. Christopher Giancarlo, the new acting chairman of the Commodity Futures Trading Commission, laid out his priorities for the Commission as part of an agenda he termed “Making Market Reform Work for America.” These priorities include (1) enabling swaps traders to choose the method of trade execution appropriate for their trading and liquidity needs as opposed to inflexible regulator-imposed methods; (2) fixing swap data reporting to better ensure “the important objective of full visibility into swaps counterparty exposure;” (3) appropriately limiting the application of US swaps rules in cross-border transactions to achieve consistent global rules – not necessarily identical requirements; (4) encouraging financial technology innovation so that FinTech businesses working with the CFTC “have appropriate ‘space to breathe’ in order to develop and test innovative solutions without fear of enforcement action and regulatory fines;” and (5) encouraging a regulatory culture of “forward thinking” to help the CFTC buttress its effectiveness “in overseeing the safety and soundness” of rapidly evolving global trading markets. Among specific initiatives, Mr. Giancarlo indicated that the CFTC would “have more to say” about the impending March 1 deadline requiring swap dealers and other so-called “Covered Swap Entities” to post and collect variation margin with respect to uncleared swaps and security-based swaps entered into with Financial End Users (e.g., registered investment companies, private funds, commodity pools, employee benefit plans, investment advisers, future commission merchants, broker-dealers and proprietary traders). He said he is aware that “market participants continue to face hard challenges in meeting this deadline.” In addition, since Mr. Giancarlo became acting chairman, the deadline for persons to submit comments in response to the CFTC’s supplemental notice of proposed rulemaking for Regulation Automated Trading has been extended to May 1, 2017.

My View: Since I began practicing derivatives law in 1982, the so-called “white book” containing the Commodity Exchange Act and CFTC regulations has become considerably thicker, and the requirements more obtuse. Moreover, too often regulations seem drafted for a different age – let alone different technology. The CFTC’s proposed overhaul of its current recordkeeping rule – which still references microfiche – provides a stark reminder of how outdated many existing rules have become. Moreover, the Commission’s proposed Regulation Automated Trading – which in many cases replicates already existing exchange requirements and contains unconstitutional (let alone unworkable) authority for CFTC and Department of Justice staff to take trading firms’ source code without subpoena (whether proprietarily or third-party developed) – is a stark example of the type of proscriptive regulation that should not be adopted in its current form. (Click here for background on the CFTC’s latest proposal regarding Regulation AT in the article “Proposed Regulation AT Amended by CFTC; Attempts to Reduce Universe of Most Affected to No More Than 120 Persons” in the November 6, 2016 edition of Bridging the Week.) Additionally, the Division of Enforcement – while continuing to bring many important cases – has too often been distracted by investigating and bringing cases of questionable merit and theory. The CFTC’s recent action against a HK cotton merchant or dealer for not filing CFTC reports of its physical positions – when the requirement for such reports is poorly publicized by the Commission in the first place – and against JP Morgan Chase Securities for miscomputing exchange fee rebates for customers – in the face of admittedly very complicated and confusing exchange processes regarding the assessment of exchange and clearing fees – are just two examples where the CFTC’s use of its enforcement hammer seems misplaced. (Click here to access the article in this edition of Bridging the Week regarding the HK cotton trading firm, and here to access the article on JP Morgan Securities’ fine for miscalculating exchange fees rebates, entitled “FCM Agrees to Settle With CFTC Related to Purported Exchange Fees Overcharges” in the January 16, 2017 edition of Bridging the Week.) The Commission has an important mission: to help ensure that the important commodity markets under its jurisdictions function fairly and that customers are protected against fraud and other malfeasance. However, regulations should be principals-based, to allow for the rapid evolution of technology, and enforcement must be meaningful and fair. Anything less compromises the mission of the CFTC. That being said, it’s also appropriate at this time to consider the organization of the Commission. Off and on for many years, proposals have floated to create a single financial services regulator that oversees both our securities and commodity markets and participants – much as now exists in most of the developed world. Now is the time to re-evaluate these proposals and implement a path to more holistically regulate financial services in the United States.

  • More Firms Sanctioned For Whistleblower Offenses by SEC: The Securities and Exchange Commission brought and settled two enforcement actions against publicly traded companies for including in at least some of their severance agreements language that required employees to waive monetary recovery for discussing any matter regarding their employment with a government agency with jurisdiction over the companies. The SEC claimed that this language violated applicable whistleblower protections under law and its rules. In one action, BlackRock Inc. agreed to pay US $340,000 to the SEC for including in a separation agreement from October 14, 2011, through March 31, 2016, language that required departing employees to “waive any right to recovery of, incentives for reporting of misconduct, including without limitation, under the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Sarbanes-Oxley Act of 2002, relating to conduct occurring prior to the date of th[e] Agreement.” According to the SEC, 1067 BlackRock employees executed separation agreements containing this language although the SEC conceded it was not aware of a single former employee who did not communicate with it because of this language or against whom BlackRock took action of any kind to prevent communication. In a separate action, HomeStreet Inc., another publicly traded company, agreed to pay a US $500,000 fine to settle charges that it engaged in improper accounting practices; took affirmative steps to impede employees from communicating with SEC staff regarding their knowledge of these practices; and included language in some severance agreements to preclude employees from receiving financial incentives from the SEC for cooperating with it. Among other things, the SEC charged that, following a document request by the SEC to HomeStreet in 2015 regarding its accounting issues, the firm pro-actively questioned some employees to determine if they were the source of information to the SEC. The SEC said this conduct “acted to impede individuals from communicating directly with Commission staff about a possible security law violation.” The SEC also charged that, on at least two occasions, HomeStreet used a severance agreement that expressly stated that “[t]his release shall not prohibit Employee from … discussing any matter relevant to Employee’s employment with any government agency … but shall be considered a waiver of any damages or monetary recovery therefrom.” The SEC charged this language attempted to discourage employees from cooperating with it. Under the applicable SEC rule (click here to access SEC Rule 21F-17(a)), no person can take any action “to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communication.”

Compliance Weeds: In 2016, the SEC brought and settled a number of enforcement actions against firms that included in their standard severance agreements language that the Commission determined potentially impeded an employee from disclosing to the SEC a possible securities law violation. (Click here for background in the article “Two Companies Charged by SEC for Whistleblower Infractions” in the January 8, 2017 edition of Bridging the Week.) It is clear that the SEC reads its anti-retaliation clause broadly. All persons subject to SEC and Commodity Futures Trading Commission oversight should review their form employment and severance agreements to ensure they are consistent with regulatory requirements regarding employee whistleblower rights. (Click here to access existing CFTC whistleblower protections in Part 165 of its rules.) In 2016 the CFTC proposed to amend its whistleblower program to more closely emulate that of the SEC. Among other things, the CFTC proposed (1) new procedures to review whistleblower claims; (2) to clarify that the CFTC may bring enforcement actions against any employer that violates its anti-retaliation provisions; and (3) to prohibit any agreement or condition of employment, including a confidentiality or pre-dispute arbitration agreement, from containing a provision that might “impede” an individual from communicating a possible violation of law to CFTC staff. No final action on the CFTC's proposed amended rules has been taken. (Click here to access the CFTC proposal.)

  • Alleged Failure of HK Trading Firm to File Reports Regarding Physical Cotton Results in Enforcement Action by CFTC: CNCGC Hong Kong Ltd., a cotton merchant or dealer, agreed to settle charges brought by the Commodity Futures Trading Commission that, on 53 occasions from March 2014 through August 2015 the firm failed to file CFTC Form 304 reports detailing all its call cotton purchases and sales as of the close of business on the relevant Friday, as required, and on two occasions – one in October 2015 and one in January 2016 – filed late reports. (Call cotton refers to physical cotton contracted to be purchased or sold or actually bought and sold for a later-to-be-determined price based upon a specified futures contract’s price.) Under CFTC rules, cotton merchants or dealers that hold or control 100 cotton futures positions are required to prepare Part III of CFTC Form 304 reports as of the close of each Friday, and to submit such reports to the CFTC within two business days. According to the Commission, after staff alerted CNCGC of its obligations on July 28, 2015, it fully complied with its requirements regarding the CFTC Form 304 except for two subsequent occasions. CNCGC agreed to pay a fine of US $150,000 to resolve this matter.

Compliance Weeds and My View: Part III of CFTC Form 304 (Unfixed Price Cotton “On-Call”) must be filed by any cotton merchant or dealer that holds a so-called reportable position in cotton (i.e., pursuant to large trader reportable levels; this is currently 100 contracts) regardless of whether or not it constitutes a bona fide hedge. Form 304 (Part III) must be prepared as of the close of business on Friday every week, and received by the CFTC in New York by no later than the second business day following the date of the report. CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bona fide hedging position under CFTC rules. These documents must be prepared as of the close of business on the last Friday of each relevant month. Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Parts I and II Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report. In announcing its settlement with CNCGC, the CFTC summarized its prior recent actions involving cotton call reporting violations since 2013 – all of which involved foreign entities (click here to access). However, despite CFTC staff issuing an advisory in 2013 regarding Part III of its Form 304 – which currently is buried on a page of assorted CFTC advisories on various topics (click here to access the CFTC Advisory; click here to access the page on which the CFTC advisory is located) – it is not really clear why or how a non-US cotton merchant or dealer would ordinarily be aware of its obligations to the CFTC. It would be a better use of CFTC resources to more effectively educate non-US market participants regarding their obligations, than to prosecute them. The CFTC recently proposed changes to its Form 204s and 304s as part of its re-proposed regulations establishing position limits for 25 core physical commodity futures contracts and their economically equivalent futures, options and swaps. (Click here for details in the December 19, 2016 Advisory, “CFTC Finalizes Aggregation Rules and Re-Proposes Positions Limits Rules” by Katten Muchin Rosenman LLP.)

  • SEC Files Charges Against Broker-Dealer and Chief AML Officer for Failure to File Suspicious Activity Reports: The Securities and Exchange Commission filed an administrative proceeding against Windsor Street Capital, L.P., a registered broker-dealer (formerly known as Meyers Associates, L.P.) for allegedly facilitating the unregistered sales of “hundreds of millions” of penny stock shares and failing to file with the Financial Crimes Enforcement Network so-called “suspicious activity reports” related to these transactions that involved at least US $24.8 million in proceeds. The SEC also named John Telfer, the firm’s former chief compliance officer and anti-money laundering officer, in its complaint for purportedly aiding and abetting Meyers Associates’ failure to file the required SARs. According to the SEC, from at least June 2013 through the present, Meyers Associates sold large quantities of shares of four penny stocks for two customers: Raymond Barton and William Goode. In connection with each stock, the two individuals allegedly represented that the stocks were lawfully exempt from SEC registration when they were not; however, Meyers Associates “accepted all of Barton and Goode’s representation at face value, without further inquiry,” said the SEC. The SEC claimed that Meyers Associates and Mr. Telfer failed to file SARs despite numerous red flags of suspicious activity including deposits of large blocks of stocks, liquidation of the stocks during periods of substantial favorable publicity regarding the securities, and transfer of the proceeds away from Meyers Associates. Some of the red flags were brought directly to Mr. Telfer’s attention by Meyers Associates’ clearing firm, claimed the SEC. The SEC seeks a cease and desist order and fines from Meyers Associates and Mr. Telfer, and disgorgement from the firm.

Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers, and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions or patterns of transactions involving at least US $5,000, which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. According to a recent FinCEN advisory, SARs may also be required to be filed for certain cyber events (click here for details). In 2014, the Financial Industry Regulatory Authority also fined Brown Brothers Harriman & Co. US $8 million for failing to file SARs in connection with similar activity involving penny stocks as alleged to be at issue in the Meyers Associates administrative proceeding. In Brown Brothers, FINRA also fined and suspended the firm’s global anti-money laundering compliance officer for his alleged role in the firm’s alleged misconduct. (Click here for details in the article “FINRA Says Brown Brothers Harriman Had an Unsatisfactory Anti-Money Laundering Program; Sanctions Firm and Former Global AML Compliance Officer,” in the February 10, 2014 edition of Bridging the Week.) More recently, Albert Fried & Company, LLC, an SEC-registered broker-dealer, agreed to pay a fine of US $300,000 to resolve charges by the SEC that, from August 2010 through October 2015, it failed to file SARs. According to the SEC, during this time on multiple occasions, Albert Fried received large-volume deposits of penny stocks from a number of customers. Afterwards, the customers sold the stocks in transactions that often constituted a “substantial portion” of the daily volume in the thinly traded securities. These liquidations, alleged the SEC, were often accompanied by other suspicious indicators. (Click here for further details in the article “Broker-Dealer Sanctioned by SEC for Anti-Money Laundering Breakdowns” in the June 5, 2016 edition of Bridging the Week.) Covered entities should continually monitor transactions they effectuate and ensure they maintain written procedures they follow to identify and evaluate red flags of suspicious activities and file required SARs with FinCEN when appropriate.

  • Affiliated FCMs Settle CFTC Enforcement Action Related to Alleged Non-Preservation of Customer Orders Audit Trail Records: E*Trade Securities LLC and E*Trade Clearing LLC, Commodity Futures Trading Commission-registered future commission merchants, agreed to settle CFTC charges that they failed to keep electronic audit trail logs reflecting certain of their customers’ orders between October 2009 and January 25, 2014. According to the CFTC, during this time, the respondents used a third-party vendor to provide its front-end order routing system for its customers. The respondents, said the CFTC, mistakenly believed that the vendor retained electronic audit trail logs of all orders that they could access at any time; however, the vendor destroyed all records after 10 days, according to the CFTC. The vendor, charged the CFTC, had previously advised the respondents that they were responsible for downloading and retaining all electronic audit trail logs. The E*Trade entities voluntarily reported their error to the CFTC and began correctly retaining the records beginning January 26, 2014. The two E*Trade entities agreed to jointly and severally pay a fine to the CFTC of US $280,000 to resolve this matter.

Compliance Weeds: CME Group Rule 536B.2 (click here to access) requires clearing members guaranteeing a client that has direct market access to maintain or cause to be maintained an electronic audit trail for such client that includes certain minimum information. These audit trails must be kept for at least five years. However, the same rule authorizes a clearing member not to keep the electronic audit trail of its direct access clients that are other clearing members or equity member firms. To take advantage of this option, a clearing member must notify its clearing member or equity member client that it is their obligation to maintain the electronic audit trail — thus excusing the guarantor clearing member from maintaining the record itself. However, as a result of a December 2015 amendment to this rule, this authority does not relieve a guarantor clearing member “from compliance with the applicable recordkeeping provisions of CFTC Regulations, including Regulation 1.31 or 1.35.” As I wrote in December 2014 when this rule was amended, “[t]he odd wording of this new sentence seems to imply the CFTC may believe that clearing member FCMs have an obligation to retain electronic audit trails they otherwise are not required to keep under the applicable CME Group rule—a trick even the great Harry Houdini likely could not master!” (Click here to access CFTC Rule 1.31 and here for CFTC Rule 1.35.) Earlier this month, the CFTC proposed overhauling its records retention rule to eliminate many existing antiquated requirements and to be “technology neutral” in order to accommodate future advances in recordkeeping technology. (Click here for detail in the article “New Records Retention Regime for 21st Century Proposed by CFTC” in the January 16, 2017 edition of Bridging the Week.)

  • Cooperate and Maybe Benefit Says CFTC Division of Enforcement: The Commodity Futures Trading Commission’s Division of Enforcement updated a 2007 advisory (click here to access) to clarify the type of cooperation it would consider to warrant a recommendation of reduced charges or sanctions against a company or an individual in connection with an enforcement investigation or action. It did this in separate advisories for companies and individuals. In general, the Division said it looks “for more than ordinary cooperation or mere compliance with the requirements of law.” In evaluating this, the Division noted three factors it will consider: (1) whether the cooperation resulted in “material assistance” to the Commission’s investigation and enforcement action, including its success, considering the timeliness, nature and quality of the cooperation; (2) whether the cooperation encouraged “high quality” assistance from other persons considering the significance and harm of the relevant type of misconduct and CFTC resources conserved as a result of the help; and (3) the subject’s culpability, and in the case of a company, its culture and other relevant factors. Uncooperative conduct could limit the credit a subject might otherwise receive, said the Division. Uncooperative conduct would include failing to respond timely and completely to requests for documents and testimony and misrepresentations, among other conduct. Although the Division expressly stated in its advisory for companies that its advice on cooperation was not intended to erode the attorney-client privilege or work product protections, it did not articulate a similar statement in its advisory for individuals. However in its advisory for companies, the Division noted that “[t]hese rights are no less important for an organizational entity than for an individual.”

And more briefly:

  • CFTC Staff Authorizes Withdrawal of Certain Excess Residual Interest Amounts Prior to Next Day Formal Segregation Computation Subject to Strict Conditions: The Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight issued a no-action letter authorizing futures commission merchants to withdraw excess residual interest from cleared swaps customer accounts prior to a formal next day segregation calculation, as currently required under one of its regulations (click here to access CFTC Rule 22.17(b)), to the extent the withdrawal is in response to margin deposits provided by cleared swaps customers to reduce their undermargined amounts since the firm’s last formal segregation computation – subject to strict conditions. (Prior to a time of clearing settlement with a derivatives clearing organization, an FCM must maintain a residual interest that at least equals the amount by which each cleared swaps customer is undermargined.) Among the conditions is that a withdrawal may not cause the FCM to hold less than 110 percent of its current targeted residual interest balance in cleared swaps customer accounts. DSIO also provided certain reporting relief regarding such withdrawals in the same no-action letter.
  • CBOT BCC Fines Former Corn Futures Floor Broker US $35,000 for Noncompetitive Trading With Other Locals: A Business Conduct Committee of the Chicago Board of Trade fined Kelly King, a member, US $35,000, for engaging in certain noncompetitive trades on multiple occasions between April 2009 and May 2010. During this time, claimed the BCC, Ms. King engaged in certain transactions that were reported and cleared as having been executed between Ms. King and locals in the corn futures pit, but the trades were not “competitively executed via open outcry.” Ms. Kelly was also banned from all CME Group trading for six months following the date when her fine is paid in full.
  • FINRA Seeks Comments on Implications of Distributed Ledger Technology: The Financial Industry Regulatory Authority issued a report regarding the implications of distributed ledger technology for the securities industry and solicited comments on the potential use and implications regarding the use of DLT. Among other matters, FINRA seeks comments regarding the governance of DLT networks; network security; anti-money laundering; customer data privacy; and compliance with reporting requirements. FINRA will accept comments on its DLT report through March 31. Previously, the European Securities and Markets Authority also published a discussion paper on distributed ledger technology and sought comments. (Click here for background in the article “ESMA Seeks Comment on Distributed Ledger Technology” in the June 5, 2016 edition of Bridging the Week.)
  • Investment Adviser Settles Charges Related to Overcharging Clients and Misplacing Client Contracts: Citigroup Global Markets, Inc., a registered broker-dealer and investment adviser, agreed to pay total sanctions of US $18.3 million as well as implement certain undertakings to resolve charges brought by the Securities and Exchange Commission that it overcharged advisory client accounts approximately US $18 million from 2000 to 2015. Among other reasons, some clients allegedly negotiated advisory fee rates that were lower than default rates, but these lower rates were not entered into CGMI’s computer systems, and some clients rates were purportedly increased “without any authorization or notification” when they were switched between branches. The SEC acknowledged, however, that all affected clients have been reimbursed. The SEC also charged that CGMI failed to comply with its books and records requirements when it could not find approximately 83,000 advisory contracts and failed to have written policies and procedures “reasonably designed” to ensure that clients were always charged correct fees. Citigroup Global Markets is an affiliated company of Citigroup, Inc.
  • Australia Regulator Proposes to Consolidate Market Integrity Rules: The Australian Securities & Investments Commission proposed to consolidate its various rules and clarify existing obligations regarding management requirements and responsible executives; principal dealing; block trades (and for futures, exchange for physical transactions); and recordkeeping, among other matters. Comments are due by March 7.

For more information, see:

Affiliated FCMs Settle CFTC Enforcement Action Related to Alleged Non-Preservation of Customer Orders Audit Trail Records:

Alleged Failure of HK Trading Firm to File Reports Regarding Physical Cotton Results in Enforcement Action by CFTC:

Australia Regulator Proposes to Consolidate Market Integrity Rules:

CBOT BCC Fines Former Corn Futures Floor Broker US $35,000 for Noncompetitive Trading With Other Locals:

CFTC Staff Authorizes Withdrawal of Certain Excess Residual Interest Amounts Prior to Next Day Formal Segregation Computation Subject to Strict Conditions:

Cooperate and Maybe Benefit Says CFTC Division of Enforcement:

FINRA Seeks Comments on Implications of Distributed Ledger Technology:

Investment Adviser Settles Charges Related to Overcharging Clients and Misplacing Client Contracts:

More Firms Sanctioned For  Whistleblower Offenses by SEC:

New Acting CFTC Chairman Provides Insight Into Priorities:

SEC Files Charges Against Broker-Dealer and Chief AML Officer for Failure to File Suspicious Activity Reports:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 28, 2017. 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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