Bridging the Week by Gary DeWaal: October 13 to 17 and 20, 2014 (Marking the Close; CPO Delegation; Clearinghouse Recovery; To Tweet or Not to Tweet)

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Published Date: October 19, 2014

What should happen when clearinghouses and systemically important global financial institutions have to deal with financial abyss scenarios was the subject of a number of reports and a commentary this past week. Modern technology was also in the news relevant to the financial services industry as an algorithmic trading firm was fined by the Securities and Exchange Commission for marking the close, while a research analyst was penalized by the Financial Industry Regulatory Authority for not being fully transparent in connection with certain of his Twitter posts.

As a result, the following matters are covered in this week’s Bridging the Week:

Video Version:

Article Version:

High-Frequency Trading Firm Pays US $1 Million for Serving Too Much “Gravy” on the Close From June to December 2009

Athena Capital Research, LLC, a New York City-based high-frequency trading firm, settled charges brought by the Securities and Exchange Commission for allegedly engaging in manipulative trading activities from June through December 2009 known as “marking the close.”

According to the SEC, Athena designed and employed computer algorithms—internally known as “Gravy”—that enabled it to make large purchases or sales of NASDAQ-listed stocks just prior to the exchange’s 4 p.m. close. These orders were placed each day after the exchange first publicized the net order imbalance in each stock 10 minutes prior to the end of trading. This indicator advised the market whether there were more buy orders than sell orders or more sell orders than buy orders for each stock and by how many shares.

Ordinarily the market price would be expected to move in the direction of the imbalance. For example, if the imbalance showed substantially more buy orders than sell orders, the market price would be expected to rise prior to the close, or fall, if there were more sell orders than buy orders.

The SEC claimed that, after learning of the imbalance, Athena would place a large imbalance-only-on-close order that was meant to take advantage of the perceived market conditions (for example, placing an order to sell securities when the imbalance reflected a predominance of buy orders). Athena then would execute orders in the opposite direction of its close order in the few seconds prior to the close (so-called “accumulation orders”), to improve its potential close order execution price, according to the Commission.

The majority of Athena’s accumulation orders were placed in the final two seconds of each trading each day, said the SEC, and the firm’s trades overall exceeded 70 percent of the total NASDAQ trading volume of relevant stocks just prior to the close.

Athena’s objective, charged the SEC, was for the price of its imbalance-only-on-close order fill to be superior to the average price of its accumulation orders executions and to be flat in each stock by the end of the day. According to an email by an Athena manager included by the SEC in its complaint,

[w]e have a desired accumulation pattern which includes grabbing stock at the beginning, a period of ‘average price’ accumulation, and a crescendo at the end.

Athena also modified its algorithm over time, claimed the SEC, to enhance its priority over other orders that might be placed on the close by other traders.

To settle the SEC’s complaint, without admitting or denying any of the Commissions findings, Athena agreed to pay a fine of US $1 million. The firm also agreed to be censured and committed not to violate the relevant provision of law and SEC regulation in the future. There were no requirements of disgorgement or any other trading prohibitions.

CFTC Makes Self-Executing and Expands Certain Relief Related to Delegating CPOs

The Commodity Futures Trading Commission made self-executing and somewhat expanded previously granted relief from registration requirements to commodity pool operators who delegate certain activities in connection with private investment funds.

In May 2014, the CFTC provided a streamlined process for CPOs to request registration relief when they delegated all of their management authority to another registered CPO (the so-called designated CPO) related to a commodity pool. However, where the delegating CPO was a natural person of the designated CPO—for example, a director—the individual had to agree to joint and several liability with the designated CPO. Also, among other limitations, the delegating CPO could not engage in sales activities for the fund that he/she served as a director. (Click here for the article regarding this process in “CFTC Implements Streamlined Way for Certain CPOs to Apply for Registration Relief” in the May 13, 2014 edition of Between Bridges.)

Under the new requirements set forth by the Commission's Division of Swap Dealer and Intermediary Oversight, registration relief does not need to be requested if all enumerated conditions are met. Among these conditions are that:

  1. through a legally binding document, the delegating CPO delegated its investment management authority regarding the relevant commodity pool to the designated CPO (although the delegating or designated CPO may also appoint certain third parties to serve as investment managers of the pool—either registered commodity trading advisors or persons lawfully exempt from CTA registration);
  2. the delegating CPO is not involved in the solicitation of participants for the relevant commodity pool (although he/she may engage in solicitation activities solely in his/her role as an associated person of the designated CPO provided he/she is registered as an AP of the designated CPO or lawfully exempt from AP registration);
  3. the delegating CPO is not involved in the management of any property of the relevant pool (although he/she may have management responsibilities over pool property under limited, enumerated circumstances where he/she is a principal or employee of the designated CPO or of a CTA of the relevant pool);
  4. the designated CPO is a registered CPO;
  5. the delegating CPO is not subject to any statutory disqualification;
  6. there is a “business purpose” for the designated CPO to be a separate entity from the delegating CPO other than for the delegating CPO to avoid registration;
  7. the designated CPO maintains the books and records of the delegating CPO; and
  8. if the delegating CPO is a natural person and affiliated with the commodity pool, the delegating and designated CPO have signed a legally binding agreement to be jointly and severally liable for violations under applicable law or regulations by the other in connection with the operation of the pool.

In articulating its new requirements, Commission staff acknowledged that “there may be other CPO delegation situations involving circumstances in which CPO registration no-action relief may be warranted.” Staff indicated it would continue to evaluate such circumstances in response to requests submitted to it.

(Click here for more details on the CFTC’s new requirements in the article “CFTC Provides Additional Relief to Certain Delegating CPOs” in the October 17 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

My View: The CFTC’s new requirements related to the delegation of management authority by directors of private commodity funds to avoid registration requirements are a good first practical step to address a CFTC view that where a fund is structured as a limited partnership and has many general partners, each general partner may be a CPO and obligated to register as such, and where a fund is structured as a corporation, trust or limited liability company with a board of directors, each director may also be deemed a CPO and required to register accordingly too. The next step is to begin rule-making—as recommended in a July 30, 2014 letter from the Managed Futures Association to Chairman Timothy Massad (click here to access)—to make clear that such general partners and directors are not required to register as CPOs in the first instance, and if subject to conditions, that one is not exposing directors of private investment funds to potential liability for their ordinary conduct as directors when they have not engaged in any misconduct.

And briefly:

And even more briefly:

Compliance Weeds: Although it is easy to view a regulator’s report of its enforcement accomplishments with a bit of cynicism, such reports are very useful summaries of a regulator’s priorities and should be used as checklists to help registrants double check their policies and procedures to ensure they are adequately addressing a regulator’s principal concerns. Some regulators, like the SEC, also periodically publish enforcement priorities and examination guides. (Click here, for example, to see the article “SEC Begins Assessment of Broker Dealers’ Cyber Security Preparedness,” in the April 14 to 18 and 21 edition of Bridging the Week.) These documents too should be carefully perused to conduct gap analyses between a firm’s existing policies and practices, and the current expectations of the regulator.

For more information, see:

CFTC Extends to December 31 Date by Which FCMs Must Obtain Form Acknowledgement Letters From Certain Foreign Depositories When Fault Is CFTC’s:

CFTC Makes Self-Executing and Expands Certain Relief Related to Delegating CPOs:

See also, July 15 Letter by the Managed Futures Association to Gary Barnett of the CFTC related to CFTC Staff Letter 14-69:

CPMI/IOSCO Advises Clearinghouses How to Recover from Threats to Their Viability:

FSB Advises Regulators How to Oversee Resolution of Failed Financial Institutions:

See also: Consultative Guidance on Cooperation and Information Sharing with Host Authorities of Jurisdictions Not Represented on CMGs where a G-SIFI has a Systemic Presence:

High-Frequency Trading Firm Pays US $1 Million for Serving Too Much “Gravy” on the Close From June to December 2009:

Investment Advisor Compliance Officer Charged by SEC for Altering Document Related to Insider Trading Probe:

See also:
In the Matter of Wells Fargo Advisors, LLC:
SEC v. Waldyr da Silva Prado Neto:
SEC Summary of Order against Mr. Prado:
In the Matter of Waldyr Da Silva Prado Neto:

LME to Be Gold Standard for Platinum and Palladium Price Fixing:

PIMCO Offers Views on the Protection of Client Funds at Clearinghouses:

Priorities Emerge in SEC Enforcement’s Look Back at 2014 Activities:

Research Analyst Tweeter Is Fined by FINRA for Not Tweeting About Personal Stock Holdings:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of October 18, 2014. 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 and/or Gary DeWaal 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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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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