Bridging the Week by Gary DeWaal


Bridging the Week by Gary DeWaal: June 26 to July 7 and July 10, 2017 (Wash Sales; Books, Records and WORM; Non-Prosecution Agreements)

Automated Trading Systems and Connectivity    Bitcoin Ecosystem    Books and Records    Bridging the Week    Cleared Swaps    Compliance Weeds    Exchanges and Clearing Houses    Legal Weeds    Managed Money    Position Limits    Supervision    Trade Practices (including Disruptive Trading)   
Published Date: July 09, 2017

During the prior two weeks, a trading firm agreed to pay a fine of US $5 million to the Commodity Futures Trading Commission to resolve charges that it engaged in wash trades in three ways. Separately, the CFTC entered into non-prosecution agreements with three traders for their cooperation in a CFTC enforcement action against their former employer – despite their own admitted spoofing activity. This marked the first time the CFTC entered into this type of agreement. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Trading Firm and Individual Trader Settle CFTC Allegations of Engaging in Wash Sales to Obtain Exchange Fee Rebates (includes Compliance Weeds);
  • Broker-Dealer Pays $1.5 Million to Settle FINRA Charges for Failing to Maintain Books and Records in WORM Format (includes Compliance Weeds);
  • CFTC Inks Non-Prosecution Agreements With Three Traders Who Admit to Spoofing (includes Legal Weeds); and more.

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Briefly:

  • Trading Firm and Individual Trader Settle CFTC Allegations of Engaging in Wash Sales to Obtain Exchange Fee Rebates: Rosenthal Collins Capital Markets LLC (now named DV Trading LLC), a proprietary trading firm, settled charges brought by the Commodity Futures Trading Commission that, from early 2013 through July 2015, it engaged in three trading strategies that constituted wash sales to generate fee rebates offered by the Chicago Mercantile Exchange for participation in its Eurodollar pack and bundle market maker program. (A Eurodollar pack or bundle involves the purchase or sale of a series of Eurodollar futures corresponding to a particular segment along the yield curve; click here for more background.) According to the CFTC, in one strategy, an RCCM trader determined a way to avoid the firm’s wash blocking efforts by entering orders on the opposite side of the market through two different servers. Although CME notified RCCM of the potential wash sale activity in early 2013, the Commission alleged that the firm did not institute measures to prevent the activity until later that year. In the second strategy, beginning in early 2014, two RCCM traders in different offices in different countries traded back and forth with each other, said the CFTC. This activity stopped in spring 2014, noted the Commission, after CME told RCCM that it would no longer count trades among traders at the same firm in its rebate calculation. Finally, in the third strategy, beginning in spring 2014, one RCCM trader, Brandon Elasser, placed Eurodollar pack trades known as “butterflies” on one side of the market, and similar but not identical pack spreads that contained the same component parts on the other side of the market. The CFTC claimed that Mr. Elasser entered transactions this way to take advantage of the CME Group’s matching engine that caused the component parts on each side of the market to trade opposite each other. RCCM agreed to pay a fine of US $5 million to resolve its CFTC charges. Mr. Elasser agreed to pay a fine of US $200,000 to settle separate charges filed by the Commission against him in connection with this matter.

Compliance Weeds: Under applicable law, it is prohibited for a person to enter into or offer to enter into transactions that are “commonly known” as wash sales. (Click here to access Commodity Exchange Act Sec. 4c(a)(2)(A)(i), 7 U.S.C. Sec. 6c(a)(2)(A)(i).) For the CFTC to show that a wash sale has occurred it must demonstrate that a wash result occurred (e.g., a purchase and sale of the same delivery month of the identical futures contract (or option strike price) at the same price), and that the wash result was intended. Intent can be demonstrated by specific prearrangement or inferred through conduct. CME Group arguably has a broader view of wash sales and wash trades. For CME Group, it is prohibited for a person to place or accept buy and sell orders for the same product and month (or option strike price) “where the person reasonably should know that the purpose of the orders is to avoid taking a market position exposed to market risk.” (Click here to access CME Group Rule 534 and here for the applicable CME Group Market Regulation Advisory Notice.) On CME Group exchanges, buy and sell orders for different accounts with common beneficial owners can be deemed wash sales. ICE Futures U.S. has equivalent prohibitions. (Click here to access the applicable IFUS guidance.) Firms with multiple traders that independently place orders through automated trading systems or manually may, on occasion, have offsetting trades inadvertently match. Provided such matching is de minimis, CME Group and IFUS typically will not consider such transactions as wash trades. However, firms are expected to have policies to minimize such matching. (See relevant CME Group MRAN, Q/A 13; IFUS Guidance Q/A 12.)

  • Broker-Dealer Pays $1.5 Million to Settle FINRA Charges for Failing to Maintain Books and Records in WORM Format: HSBC Securities (USA), Inc. agreed to pay a fine of US $1.5 million to settle charges brought by the Financial Industry Regulatory Authority that, from May 2003 through the present, it did not maintain order records related to approximately 12.36 million transactions in a non-erasable and non-rewritable format known as “WORM.” The transactions involved exchange traded funds, equities and fixed income products, alleged FINRA. Under applicable Securities and Exchange Commission rule, broker-dealers using electronic means to store records must preserve such records in WORM format. Moreover, broker-dealers using electronic storage media must advise their examining authority of their intent to use such media at least 90 days in advance; have an audit system to monitor the inputting of new records and changes to old records; and retain a third-party vendor to provide required electronic records to the SEC, FINRA and other regulatory authorities if the broker-dealer is unable to do so and to obtain an attestation from such vendor regarding its agreement. (Click here to access the SEC’s requirement regarding acceptable electronic storage media at 17 CFR 240.17a-4(f).) FINRA claimed that HSBC Securities violated these provisions too, and did not maintain adequate supervisory systems reasonably designed to achieve compliance with its recordkeeping obligations. At the end of 2016, FINRA assessed a total of US $14.4 million in fines against 12 other firms for “significant deficiencies” in their retention of required books and records on electronic storage media. (Click here for background in the article “FINRA Sanctions 12 Member Firms for Failure to Maintain Electronic Records in Required Format” in the January 8, 2017 edition of Bridging the Week.)

Compliance Weeds: In May 2017, the Commodity Futures Trading Commission approved a revised records retention rule that aims to eliminate many existing antiquated requirements and to be “technology neutral” in order to accommodate future advances in recordkeeping technology. Among other things, the revised rule will eliminate the existing requirement that electronic records be maintained in WORM format. Instead, the revised rule is more principles-based and solely requires that all “regulatory records” be maintained in a way that “ensures the authenticity and reliability of such regulatory record” in accordance with applicable law and CFTC regulations. (For background, click here to access the article “Principles-Based Rules Rule in CFTC Recordkeeping Rule Amendment “ in the June 4, 2017 edition of Bridging the Week.) The CFTC’s amended recordkeeping rule is effective August 28 (click here to access). As recommended by the Futures Industry Association, the SEC should also consider adopting equivalent modernized recordkeeping requirements for broker-dealers (click here to access the relevant FIA recommendation; see bottom of page 2).

  • CFTC Inks Non-Prosecution Agreements With Three Traders Who Admit to Spoofing: The Commodity Futures Trading Commission entered into non-prosecution agreements with three individual traders formerly associated with a futures commission merchant that recently agreed to pay a fine of US $25 million to resolve charges that it engaged in spoofing activities from July 16, 2011, through December 31, 2012. The three traders were: Jeremy Lao, Daniel Liao and Shlomo Salant. In each non-prosecution agreement, the relevant trader admitted that he engaged in spoofing activity on behalf of the FCM. The CFTC said that it entered into such agreements with the three persons because of their “substantial cooperation” with the investigation of their former employer; their “immediate willingness” to accept responsibility for their misconduct; and the material assistance they provided to the CFTC’s Division of Enforcement, including implicating their prior employer. In a press release announcing this matter, recently appointed CFTC Director of Enforcement James McDonald noted that these were the first non-prosecution agreements entered into by the Commission and that he expected such agreements would be “an important part of the of the Division’s cooperation program going forward.” In March 2017, two other traders of the same FCM – Stephen Gola and Jonathan Brims – settled charges brought against them for spoofing activities by agreeing to pay fines of US $350,000 and US $250,000, respectively, and each consenting not to trade on any CFTC-regulated markets until six months after they fully paid their fines. (Click here for details of this settlement in the article “Former FCM Traders Settle CFTC Charges They Engaged in Spoofing More Than 1,000 Times” in the April 2, 2017 edition of Bridging the Week.)

Legal Weeds: David Liew, a former junior trader who many media sources have indicated was based in Singapore and associated with Deutsche Bank, recently settled charges brought by the CFTC that he engaged in spoofing, manipulation, and attempted manipulation of gold and silver futures on the Commodity Exchange, Inc. from December 2009 through February 2012. To resolve this action, Mr. Liew consented never to trade commodity interest contracts under the CFTC’s jurisdiction and never to associate with any CFTC registrant as a principal, officer or employee. However, as part of his settlement, Mr. Liew was not assessed a fine by the Commission. The CFTC said that Mr. Liew received “meaningful cooperation credit” because he entered into a formal cooperation agreement with it, provided it with substantial assistance to date, and promised to continue to cooperate with the Commission and other government agencies going forward. (Click here for details regarding Mr. Liew’s CFTC action and criminal prosecution in the article “Former Newbie Bank Trader Pleads Guilty to Criminal Charges and Settles CFTC Civil Charges for No Fine for Spoofing, Attempted Manipulation and Manipulation of Gold and Silver Futures” in the June 4, 2017 edition of Bridging the Week.) Both the CFTC’s non-prosecution agreements with the three traders and its settlement terms against Mr. Liew suggest that the CFTC’s Division of Enforcement is willing to minimize sanctions against some wrongdoers in return for their meaningful assistance in building enforcement actions against other alleged wrongdoers whose conduct the Division considers more problematic.

More briefly:

  • LedgerX Approved as SEF by CFTC; Intends to List Bitcoin Options for Trading: LedgerX LLC received an order of registration as a swap execution facility from the Commodity Futures Trading Commission. LedgerX applied for registration as a SEF and a derivatives clearing organization in order to list and clear fully collateralized, physically settled options on Bitcoin – which the CFTC regards as swaps under its jurisdiction. LedgerX’s application for designation as a DCO, which was filed with the CFTC on January 25, 2017, is still pending. As part of its SEF order, LedgerX will not list any intended to be cleared swap until it has a clearing agreement with a registered DCO.
     
  • CFE Clarifies Requirements Related to Order Entry Operator IDs and Other Audit Trail Obligations: CBOE Futures Exchange issued amended guidance related to its electronic audit trail requirements for trading privilege holders (TPH), including a TPH’s obligations regarding the designation of one or more responsible traders, order entry operator IDs, audit trail and other books and records, and other compliance obligations. Among other things, every order and quote from a TPH must contain an Order Entry Operator ID. These IDs represent either the natural person ultimately responsible for directly or indirectly entering the order into the CFE matching system or an automated trading system that interfaces with the CFE (i.e., a system that automates the generation and routing of orders or quotes). An Order Entry Operator ID issued for one ATS may only be used for that ATS and may not be used for any natural person. Each clearing member must maintain or cause to be maintained front-end audit trail information for each TPH for which the clearing member is identified in the order or quote as responsible for the potential trade.
     
  • Global Regulator Coordinator Cites Significant Interdependence Among CCPs and Clearing Members: The Financial Stability Board reported that “considerable progress” has been made by world regulators and regulatory organizations since the 2007-2008 financial crisis to help ensure that the collapse of systematically important financial institutions can be resolved without wider disruption. However, the FSB also reported that approximately 10 global central counterparties (CCPs) control 88 percent of all financial resources (initial margin and default funds) provided to the 26 CCPs it collected data from, and that the top 20 clearing members (out of 307 included in the FSB’s study) account for 75 percent of all financial resources provided to the CCPs. As a result, “the default of a CCP’s top two clearing members could result in defaults of the same entity or affiliates in up to 23 other CCPs included in this analysis.” (The FSB endeavors to coordinate national financial sector authorities and international standard-setting bodies to promote effective regulation and supervision.)
     
  • ICE Futures U.S. Expands Definition of Agents to Include Automated Trading Systems, and Extends Obligation of Supervision to All Agents: ICE Futures U.S. proposed to amend one of its rules to make clear that every person trading on the exchange is responsible to supervise its employees and agents. Under IFUS’s proposed amended rule, an agent would include an automated trading system. Under the amended rule, persons would also be responsible for the acts and omissions of such agents. Currently, IFUS’s rules regarding supervision only pertain to employees although the exchange claims that its rule amendment solely formalizes its existing expectations. IFUS’s proposed rule amendment is equivalent to a current CME Group interpretation that “agents include any automated trading systems operated by any party.” (Click here for background on CME Group’s interpretation in the article “CME Group Settles With Trading Firm for Spoofing-Type Offenses, Holding It Strictly Liable for Acts of Agents; Orders Disgorgement of Profits” in the December 9, 2016 edition of Bridging the Week.) IFUS’s proposed rule amendment is scheduled to be effective July 26.
     
  • Two Designated Contract Markets Excused by CFTC Staff From Reporting Swap Transactions to Swap Data Repositories: The Division of Clearing and Risk and the Division of Market Oversight issued no-action relief to Cantor Futures Exchange, L.P. and the Cantor Clearinghouse L.P. as well as to the North American Derivatives Exchange, Inc. (which operates both as a designated contract market and a derivatives clearing organization) that will permit them in connection with certain swap transactions not to have to report such transactions to a swap data repository, as otherwise required. This relief is conditioned on the swaps being fully collateralized and the DCMs making available publicly, virtually in real time, certain time and sales data for all transactions, among other conditions.
     
  • ICE Europe Resolves Disciplinary Action Against Warehouse for Not Following Exchange-Mandated Grading and Warehousing Procedures: Durme Natie C.V.B.A., a warehousing company specializing in the handling of soft commodities in the port of Antwerp, agreed to pay a fine of GBP 33,333 (US $43,000) to resolve a disciplinary action brought by ICE Futures Europe that it failed to comply with certain aspects of the exchange’s grading and warehousing procedures regarding the exchange’s cocoa contracts. Among other things, ICE Europe claimed that the warehouse failed to record and maintain as required a method for the exchange or other third party to “readily” locate and identify relevant cocoa, and to comply by other technical requirements.
     
  • UK Regulator Proposes to Adopt Requirements on Fund Managers to Act in Investors’ Best Interest: The UK Financial Conduct Authority proposed new measures to ensure the safety of consumers’ invested funds with asset managers. The study found that there has been weak price competition in the asset management industry; that there has been no clear relationship between the prices charged to investors and the actual performance of retail funds; and that asset managers have not adequately been communicating with their clients regarding objectives. To remedy these issues, the FCA proposed that fund managers be required to act in investors’ best interests and utilize a standardized template of costs and charges to institutional investors.
     
  • LME Implements Accountability Levels and Position Limits for LMEprecious Contracts Beginning July 10: The London Metal Exchange announced new accountability levels and position limits for LMEprecious contracts. Effective with the launch of LMEprecious on July 10, the accountability level for any member or client account carrying gold or silver positions will be 4,000 lots net across all prompt dates, while the position limit will be 8,000 lots net across all prompt dates. Exceeding an accountability level does not impose any automatic obligation on a position holder to report directly to the LME or reduce or adjust the position. However, the LME member will be required to provide further information about the account or linked accounts upon request by the LME. When a position limit is violated, the LME will request further information regarding the position and the LME may give directions to the member regarding the account or the linked accounts. Members are obligated to ensure their clients comply with position limits and any directions the LME may issue. (Click here for an overview of the generally unique market structure and functioning of the LME, including the exchange’s unique trading and margin systems.)

For further information:

Broker-Dealer Pays $1.5 Million to Settle FINRA Charges for Failing to Maintain Books and Records in WORM Format:
/ckfinder/userfiles/files/HSBC%20FINRA%20WORM%20ENFORCEMENT.pdf

CFE Clarifies Requirements Related to Order Entry Operator IDs and Other Audit Trail Obligations:
http://cfe.cboe.com/publish/CFEregcirc/CFERG17-008.pdf

CFTC Inks Non-Prosecution Agreements With Three Traders Who Admit to Spoofing:

Global Regulator Coordinator Cites Significant Interdependence Among CCPs and Clearing Members:
http://www.fsb.org/wp-content/uploads/P050717-2.pdf

See also, FSB Analysis of Post-Crisis Resolution Reform:
http://www.fsb.org/wp-content/uploads/P060717-3.pdf

ICE Europe Resolves Disciplinary Action Against Warehouse for Not Following Exchange-Mandated Grading and Warehousing Procedures:
https://www.theice.com/publicdocs/circulars/17095.pdf

ICE Futures U.S. Expands Definition of Agents to Include Automated Trading Systems, and Extends Obligation of Supervision to All Agents:
http://www.cftc.gov/filings/orgrules/rule062617iceusdcm005.pdf

LedgerX Approved as SEF by CFTC; Intends to List Bitcoin Options for Trading:
http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/orgledgerxord170706.pdf

LME Implements Accountability Levels and Position Limits for LMEprecious Contracts Beginning July 10:
https://www.lme.com/~/media/files/notices/2017/06/17%20214%20introduction%20of%20accountability%20levels%20and%20position%20limits%20for%20lmeprecious%20contracts.pdf

Trading Firm and Individual Trader Settle CFTC Allegations of Engaging in Wash Sales to Obtain Exchange Fee Rebates:

Two Designated Contract Markets Excused by CFTC Staff From Reporting Swap Transactions to Swap Data Repositories:

UK Regulator Proposes to Adopt Requirements on Fund Managers to Act in Investors’ Best Interest:
https://www.fca.org.uk/publication/market-studies/ms15-2-3.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 8, 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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