Bridging the Week by Gary DeWaal: February 9 to 13 and 16, 2015 (Hat in Hand for Budget; OCR; Overcharges; Swaps Clearing and Execution)

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Published Date: February 15, 2015

Last week, the week ending in Valentine’s Day, Chairman Timothy Massad went hat in hand before committees of the House of Representatives where he was shown little love while seeking an increased budget for the Commodity Futures Trading Commission. Also last week, the CFTC postponed the roll-out of certain new requirements for large reportable traders, while two non-US regulators continued to consider potential new rules related to swaps clearing and execution. As a result, the following matters are covered in this week’s Bridging the Week:

• CFTC Chairman Calls for Increased Funding and Discusses Priorities During Congressional Testimony (includes My View);
• CFTC Postpones OCR Roll-out; CME Group and ICE Futures U.S. Adopt Conforming Amendments (includes Compliance Weeds);
• FINRA Sanctions Registered Broker-Dealer for Helping Unregistered Brokers; Tacks on AML Violations;
• Former Broker-Dealer CEO Agrees to Settle SEC Charges Related to Non-Disclosed Overcharges to Customers;
• Adviser Sanctioned for Placing Regulated Customer Funds With Brokers, Not Custodial Bank;
• Canadian Securities Regulators Seek Comment on Mandatory Swaps Clearing; Monetary Authority of Singapore Declines to Impose Swaps Trading Regime; and more.

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CFTC Chairman Calls for Increased Funding and Discusses Priorities During Congressional Testimony

Timothy Massad, Chairman of the Commodity Futures Trading Commission, appeared before members of the House of Representatives last week and advocated for a 28% increase in funding levels for the agency from fiscal year 2015 to 2016.

Chairman Massad requested an overall funding level of US $322 million, up from US $250 million for fiscal year 2015, that would fund, among other things, an increase in authorized staffing from 746 persons currently to 895 full-time equivalents next year.

He claimed the increase was necessary in order for the CFTC to fulfill both its traditional responsibilities in connection with the oversight of futures and options trading, but also its increased obligations imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act. According to Chairman Massad regarding the CFTC’s historical obligations,

the markets the Commission has traditionally overseen have grown in scale, technological sophistication, and complexity. The number of actively traded futures and options contracts has doubled since 2010 and increased 6 times over the last ten years. Trading is increasingly conducted in an automated, electronic fashion, and cybersecurity has become a major new threat to the integrity and smooth functioning of the critical market infrastructure that the Commission regulates. While these developments, among others, have brought new responsibilities and challenges to the Commission, its capabilities have not kept pace. Our resources continue to be stretched far too thinly over many important responsibilities.

Chairman Massad told the House members that of the requested US $72 million increase, US $28 million would be allocated to technology, while the remainder would be spent on personnel in “critical areas” such as enforcement, surveillance, examinations, registration and compliance.

Chairman Massad requested additional resources before the US House Appropriations Committee, Subcommittee on Agriculture, Rural Development, Food and Drug Administration and Related Agencies on February 11. Public reports reflect that the Chairman of the Committee, Rep. Robert Aderholt (R-Ala), was less than enthusiastic in responding to Chairman Massad’s requests. (Click here for sample article, “Republican: Obama ‘caving to political extremes’ with budget request” in the February 11, 2015 edition of The Hill.)

The following day, February 12, Chairman Massad was more explicit in telling members of the House Committee on Agriculture what the CFTC would be limited in doing if it did not obtain more resources. Among other matters, he claimed the CFTC would be unable to (1) review and approve in a timely manner new registration applications from new swap dealers and swap execution facilities, in addition to new clearinghouses, domestic exchanges, foreign boards of trade and other market participants; (2) thoroughly exam “critical infrastructures” such as clearinghouses and exchanges; (3) “engage proactively” in addressing new risks such as cybersecurity; (4) respond timely to requests for industry registration for clarification of interpretation of CFTC requirements; or (5) engage in the “necessary level” of risk oversight of market activities or the financial integrity of participants in the clearing process.

In addressing the risk of cybersecurity specifically, Mr. Massad said,

[c]ybersecurity is perhaps the single most important new risk to market integrity and financial stability. The need to protect our financial markets against cyber attacks is clear. These attacks threaten privacy, information security, and business continuity, all vital elements of a well-working market. … there is much more we would like to do in this area. However, our capacity to carry out more frequent examinations and to address cybersecurity more broadly is significantly constrained by our current budget. Some of our major financial institutions are reportedly spending more on cybersecurity each year than our agency’s entire budget.

During his testimony before the House Committee on Agriculture, Chairman Massad also expressed concern about the Basel III leverage ratio and the disincentive it may impose on banks to clear trades through clearinghouses. According to a quote attributable to the chairman included in a summary provided by the Managed Futures Association to its members, “[i]t becomes more expensive for firms to engage in clearing. The concern is that it would require firms that wish to clear derivatives to hold more capital in respect of money that they can’t really use anyway to leverage up their business.” (Click here for details regarding this issue in the article, “Industry Organizations Request Basel Committee Reconsider Proposed Treatment of Segregated Customer Margin” in the November 17 to 21 and 24, 2014 edition of Bridging the Week.)

My View: Chairman Massad provided strong advocacy for a CFTC budget increase last week, but it may have been for naught because of the simple political reality that the party that passed Dodd-Frank is no longer the party that controls Congress. However, Congress should listen to the exhortation of the Managed Futures Association in response to the chairman’s testimony: “[t]he Commission is tasked with overseeing market activity and participants, mitigating future systemic risks, and protecting the sensitive data it collects. It must also safeguard against regulations that could stifle the ability of companies to use derivatives to manage their risks and create jobs. To fulfill that mandate, the CFTC needs the appropriate funding to hire expert personnel and employ cutting-edge technology. Congress has an important responsibility to exercise vigorous, ongoing oversight of the agency while ensuring the necessary resources are available.” What is the proper amount of these resources is open to debate. But it seems likely that the amount is more than what is allocated to the CFTC currently. Credit to MFA for speaking out on this important topic.

And briefly:

• CFTC Postpones OCR Roll-out; CME Group and ICE Futures U.S. Adopt Conforming Amendments: The Commodity Futures Trading Commission further delayed the roll-out of new large trader reporting requirements that initially were adopted during November 2013—the so-called “OCR Final Rule.” Under the OCR Final Rule, the CFTC expanded upon its prior large trader reporting regime, and required the electronic submission of certain large traders’ and position holders’ data on updated forms: new Form 102A to identify holders of large positions, new Form 102B to identify traders that exceed a stated volume of transactions (50 contracts/day on a notional value basis; “volume threshold accounts”) during a single trading day (regardless of end-of-day positions), new Form 102S to identify holders of certain swaps positions, new Form 40/40S to collect information from reporting traders and new Form 71 to collect information on omnibus volume threshold accounts. The OCR Final Rule also obligated certain categories of persons required to submit data to the CFTC to generate and retain certain records on an ongoing basis. Originally, compliance with the OCR Final Rule was required by August 14, 2014, but this date was delayed for all but the recordkeeping elements. Because of the slow development of necessary technology, the CFTC has further delayed the implementation date for requiring the electronic transmission of certain new forms, subject to conditions, as follows: Form 102A, 102B (regarding trading on designated contract markets) and 102S until September 30, 2015; Form 102B (regarding trading on swap execution facilities) until February 13, 2017; and Forms 40/40S and 71 until February 11, 2016. Legacy non-automated reporting requirements and the OCR Final Rule’s recordkeeping requirements are still in effect. Both CME Group and ICE Futures U.S. amended their rules to conform to the OCR Final Rule’s revised implementation dates. The relevant CME Group Rule (561) regarding Form 102A anticipates a three-month phase-in period after the OCR Final Rule becomes mostly effective with a need to subsequently refresh filings using the new Form 102A if the old Form 102 was used during the phase-in time. (Click here for additional information in the article “CFTC Extends Relief From Certain OCR Requirements” in the February 13, 2015 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

Compliance Weeds: Sometimes lost in the debate over the Commission’s new proposed position limit rules and rules on aggregation is the fact that a comprehensive scheme involving large trader position reporting, position limits and accountability levels is already in effect under applicable law, CFTC and exchange rules. Moreover, violators of these requirements may be penalized by the CFTC and exchanges. It is important for both brokers and traders to review their policies and procedures to ensure compliance with the many subtle elements of these requirements. (Click here for an overview of the Commission’s proposed new position limit and aggregation rules in the article “CFTC Proposes New Position Limit Rules: Addresses Absolute Limits of 28 Core Futures Products, Aggregation, and Bona Fide Hedging” in the November 5, 2013 edition of what is now known as Between Bridges.)

• FINRA Sanctions Registered Broker-Dealer for Helping Unregistered Brokers; Tacks on AML Violations: The Financial Industry Regulatory Authority fined Lightspeed Trading LLC US—a registered broker-dealer—US $250,000 for helping three unregistered brokers conduct business from June 1, 2008, through June 30, 2012. FINRA claimed that, during this time, the three entities solicited customers to trade through accounts at Lightspeed, and Lightspeed paid these brokers transaction-compensation while the entities were unregistered. In addition, FINRA alleged that one of the unregistered entities engaged in trading activity that appeared to be spoofing or layering. However, Lightspeed never investigated the trading, claimed FINRA, “for the purpose of determining whether or not it constituted suspicious activity that should properly be reported.” Accordingly, FINRA also charged Lightspeed with failure to maintain and follow adequate anti-money laundering procedures and failed to follow its own procedures related to the investigation of potentially suspicious activity and the filing of suspicious activity reports.
   
• Former Broker-Dealer CEO Agrees to Settle SEC Charges Related to Non-Disclosed Overcharges to Customers: Craig Lax, the former chief executive officer of G-Trade Services LLC, a US-registered broker-dealer, agreed to pay disgorgement of US $783,000 for his role in the firm’s overcharging of customers in connection with certain of their equity transactions. According to a complaint filed by the SEC against Lax in a federal court in New Jersey, from at least January 2008 to August 2011, G-Trade engaged in a “fraudulent scheme to conceal from customers a practice of charging hidden mark-ups and mark-downs on securities trades.” This was arranged, claimed the SEC. by G-Trade routing customer securities trades for execution through a subsidiary, ConvergEx Global Markets Limited (CGM), a Bermuda broker-dealer. On occasion, customers of G-Trade ultimately paid both an agreed commission and a hidden mark-up or mark-down assessed by CGM if the traders at CGM “believed they could add a [trading profit] without detection by the customer.” The SEC claimed that Mr. Lax would suspend the taking of trading profits when a customer requested certain detailed information about trading. In addition to paying disgorgement, Mr. Lax agreed to be suspended from the securities industry for at least five years and to cooperate with the SEC going forward; he may be subject to payment of a fine too. Both G-Trade and ConvergEx are wholly-owned subsidiaries of ConvergEx Group, NY-based firm. (Click here for further information on an earlier SEC lawsuit against three ConvergEx Group subsidiaries and two ex-employees related to this matter in the article, "SEC Charges ConvergEx Subsidiaries and Former Employees with Fraud for Excessive Charges on Customer Transactions” in the December 16 to 20 and 23, 2013 edition of Bridging the Week.)
   
• Adviser Sanctioned for Placing Regulated Customer Funds With Brokers, Not Custodial Bank: Water Island Capital LLC, an investment adviser registered with the Securities and Exchange Commission, agreed to pay a fine of US $50,000 for holding certain customer funds with broker-dealers and not with a custodial bank, among other violations of law. According to the SEC, Water Island currently manages approximately US $3.5 billion in assets for several mutual funds, including mutual funds commonly known as “alternative mutual funds” (these are mutual funds for which Water Island trades equities and derivatives, including swaps, as part of a merger arbitrage). Under law, if a mutual fund maintains securities and similar investments in the custody of a qualified bank, the cash proceeds from the sale of such securities and investments, as well as other cash assets must likewise be held in the custody of such bank. Although Water Island’s compliance procedures incorporated this requirement in 2012, the SEC claimed that the firm did not maintain certain customer assets with such a bank, as required, from January to September 2012. These assets included approximately $247 million in cash collateral that were held instead with broker-dealers, according to the SEC. In accepting Water Island’s settlement, the SEC “considered remedial acts promptly undertaken by Respondent and cooperation afforded the Commission staff.”
   
• Canadian Securities Regulators Seek Comment on Mandatory Swaps Clearing; Monetary Authority of Singapore Declines to Impose Swaps Trading Regime: The Canadian Securities Administrators is seeking comment on a proposed rule and policy related to the mandatory clearing of derivatives. In general, CSA proposes that, in connection with an over-the-counter derivative subject to mandatory clearing, a local (Canadian) counterparty must submit the transaction to a regulated clearing agency. However, substituted compliance may apply to transactions involving a local counterparty where transactions are submitted to clearing subject to the laws of a Canadian jurisdiction other than the jurisdiction of the local counterparty or certain foreign jurisdictions. Exemptions from mandatory clearing requirements are contemplated where one of the counterparties is not a financial institution and engages in hedging or risk mitigation, as well as for intragroup transactions. In addition, CSA proposes to make all final determinations regarding what specific derivatives or class of derivatives should be cleared. It will do so, considering, among other factors, “the standardization of a derivative or class of derivatives, its risk profile, and the liquidity and characteristics of its market.” CSA’s objective is “to harmonize, to the greatest extent appropriate, the determination of mandatory clearable derivatives or classes of derivatives across Canada and with international standards.” Comments are due by May 13. Separately, the Monetary Authority of Singapore determined not to impose a mandatory trading regime for OTC derivatives at the present time. According to the regulator, “MAS will continue to monitor developments, consult the industry closely, and conduct detailed analysis to determine the conditions that might make a trading mandate necessary.”

And even more briefly:

• Shanghai Stock Exchange Launches Options Trading: The week before Chinese New Year, the Shanghai Stock Exchange launched trading of its first stock options—options on an exchange-traded fund comprising the 50 largest companies traded on the SSE (the so-called “SSE 50 ETF”). There currently are no exchange-traded options on futures in China. (Click here to access the related article “China Regulator to Permit Designated Domestic Futures Contracts to be Traded by Foreigners” by Katten Muchin Rosenman LLP.)
   
• NFA Institutes Changes for CPO Financial Statement Filing: The National Futures Association has slightly modified requirements related to annual filing of financial statements by commodity pool operators through its EasyFile system. These new requirements include preparation of a cover page and inclusion of an additional balance (redemptions receivable from other funds) in the Pool Financial Business section. (Click here for additional information in the article, “NFA Modifies EasyFile for Pool Annual Financial Statements” in the February 13, 2015 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)
   
• ICE Futures Europe Publishes Guidance on Block Trades: ICE Futures Europe has revised its guidance regarding block trades to include new eligible contracts and thresholds. In the guidance, the exchange reminds members that they may not disclose the identity of a party to a block trade to potential counterparties unless granted permission to do so. And they may “not share specific, material and non-public information with other [m]arket participants, except in the normal course of business.” In connection with block trades, members are prohibited from front-running or pre-positioning.

For more information, see:

Adviser Sanctioned for Placing Regulated Customer Funds With Brokers, Not Custodial Bank:
http://www.sec.gov/litigation/admin/2015/ic-31455.pdf

Canadian Securities Regulators Seek Comment on Mandatory Swaps Clearing; Monetary Authority of Singapore Declines to Impose Swaps Trading Regime:

Canada:
http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20150212_92-101_roc-derivatives.htm
Singapore:
http://www.mas.gov.sg/News-and-Publications/Media-Releases/2015/MAS-Proposes-Legislative-Amendments.aspx

CFTC Chairman Calls for Increased Funding and Discusses Priorities During Congressional Testimony:
http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-10
http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-11

See also:
CFTC 2016 Budget Request:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcbudget2016.pdf
MFA Statement on CFTC Budget Hearing:
http://www.managedfunds.org/wp-content/uploads/2015/02/02.11.15-CFTC-Budget-Hearing-Ag-Approps1.

CFTC Postpones OCR Roll-out; CME Group and ICE Futures U.S. Adopt Conforming Amendments

CFTC:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/15-03.pdf
CME Group:
http://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/RA1502-5RR.pdf
ICE Futures U.S.:
https://www.theice.com/publicdocs/futures_us/exchange_notices/Notice_OCR_Reporting_Update_%202015-02-10.pdf

FINRA Sanctions Registered Broker-Dealer for Helping Unregistered Brokers; Tacks on AML Violations:
http://disciplinaryactions.finra.org/viewdocument.aspx?DocNB=38687

Former Broker-Dealer CEO Agrees to Settle SEC Charges Related to Non-Disclosed Overcharges to Customers

Complaint:
http://www.sec.gov/litigation/complaints/2015/comp-pr2015-27.pdf
Announcement of Settlement:
http://www.sec.gov/news/pressrelease/2015-27.html#.VN1iZylvl_i

ICE Futures Europe Publishes Guidance on Block Trades:
https://www.theice.com/publicdocs/circulars/15025_attach.pdf

NFA Institutes Changes for CPO Financial Statement Filing:
http://www.nfa.futures.org/news/documents/easyfile-changes_I-15-09.pdf

Shanghai Stock Exchange Launches Options Trading:
http://english.sse.com.cn/aboutsse/news/c/c_20150209_3880004.shtml

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of February 14, 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.

Recent Commentaries

• Between Bridges Gary DeWaal: May 4, 2020 (Block Trades; EFRPs, Wash Trades; GSCs; CBDCs; Privacy Violations; Misrepresentations by IAs)
• Between Bridges Gary DeWaal: April 13, 2020 (Morphing Futures Contract; Transforming Digital Assets; Blue Sheets)
• Between Bridges by Gary DeWaal: March 30, 2020 (Unregistered Digital Securities Offering; Risk Management Breakdown; COVID-19)

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