Bridging the Week by Gary DeWaal: October 21 to November 1, and November 4, 2019, (CFTC Settlement Undone; Aiding and Abetting Liability Potentially Broader; Spoofing = Wire Fraud)

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Published Date: November 03, 2019

Two weeks ago, a federal court of appeals sided with the Commodity Futures Trading Commission ruling that a district court could not require the testimony of three commissioners and various staff to assess whether the agency committed civil contempt in connection with its handling of an enforcement settlement with two food giants. In response, the district court confirmed it would solely evaluate the existing record to determine whether to grant the defendants’ motion for a contempt finding against the Commission and sanctions; however, it also set aside the settlement consent order and instructed the parties to propose a trial date – although they could also propose new resolution terms. Last week, a law firm filed its own lawsuit against the CFTC for the agency’s non-provision of documents related to the settlement in response to a request under the Freedom of Information Act. Unrelatedly, the House Committee on Agriculture proposed to reauthorize the CFTC for another five years and to expand the reach of potential aiding and abetting liability to reckless acts in addition to purposeful acts. As a result, the following matters are covered in this week’s edition of Bridging the Week:

The next regularly scheduled edition of Bridging the Week will be November 18, 2019.

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The Hon. John Blakey revoked the settlement order following a decision by a federal court of appeals to grant, in part, relief requested by the CFTC in a mandamus petition precluding him from requiring the Chairman of the CFTC, two commissioners, and various employees of the Commission to provide testimony in a contempt proceeding against the CFTC and the individuals. Previously, the defendants requested that the CFTC and the individuals be held in contempt because they claimed the CFTC and the individuals had violated terms of a mutual gag agreement contained in the consent order when the Commission and two commissioners issued statements contemporaneously with publication of the order. The defendants also sought sanctions against the CFTC.

Under the agreement, defendants agreed to remit a fine of US $16 million and not to violate various provisions of law relating to manipulation, wash sales, and speculative limits. The consent order made clear, however, that nothing in the order reflected an agreement or determination that the defendants violated any provision of applicable law. (Click here for details regarding this dispute in the article “Contempt and Sanctions Hearing Against the CFTC Arising From Manipulation Complaint Settlement Delayed to October 2” in the September 2, 2019 edition of Between Bridges.)

The US Court of Appeals for the Seventh Circuit held that only the CFTC could potentially be held in contempt for violating the gag order and not any individuals, and that the determination of whether the CFTC was in contempt should be made by Judge Blakey solely on the basis of the existing record without any consideration of collateral evidence, including the testimony of any CFTC commissioners or employees.

In response, Judge Blakey issued a docket entry noting that he would resolve defendants’ motion for contempt, sanctions and other relief relying solely on the existing record. He also set aside the consent order on the grounds that the “factual record” does not support a proposition that the parties agreed to settle their dispute with an understanding that the settlement terms were binding on the Commission but not on agents of the Commission, including commissioners and staff. Additionally, Judge Blakey requested that the CFTC and defendants renew their motions for summary judgment and propose a trial date during a hearing on November 20. Judge Blakey indicated that the parties may still try to settle this matter, however.

Separately, the New York-based law firm of Kobre & Kim sued the CFTC in a federal court in NY, claiming that the Commission failed to produce documents related to the CFTC-Kraft/Mondelez settlement that it requested under the Freedom of Information Act. The law firm claims that it requested the documents because the original settlement failed to contain any findings of fact or conclusions of law, and thus the CFTC has left “the public in the dark” regarding its current theory of manipulation. According to the law firm, “[i]n effect, the CFTC negotiated a private resolution that left the industry without any intelligible guidance and with a potential misimpression that the legal theories asserted against [Kraft/Mondelez] had a sound legal basis.” (Click here to access a copy of Kobre & Kim’s Complaint.)

Legal Weeds: In its petition for mandamus, the CFTC also requested that the civil contempt proceeding against it be ended. However, the Court of Appeals rejected this request, claiming that if a decision ultimately is rendered adverse to the CFTC, the Commission can appeal that outcome in the ordinary course. The Court of Appeals also declined to transfer the contempt proceeding to a different judge as asked by the CFTC, saying that Judge Blakey was in the “best position to decide as an initial matter” if a contempt determination was warranted.

Following the Court of Appeals’ decision, Judge Blakey indicated that not only would he be considering the CFTC’s possible violation of the consent order, but also possible violations of the court’s prior orders, “including this Court’s orders making the settlement conference discussions private in conformity with traditional trial court practice.”

Judge Blakey previously had suggested that the Commission as well as individual commissioners and staff might be subject to criminal contempt determinations. However he withdrew this threat on September 19. (Click here to access the relevant docket entry at 336.)

Judge Blakey’s pronouncement on the wide scope of his contempt determination coupled with Kobre & Kim’s FOIA lawsuit against the CFTC on Halloween serve to underscore how the Commission’s initial handling of its settlement with Kraft and Mondelez will continue to haunt the agency for some time.

Additionally, the proposed reauthorization bill would (1) amend core principles for contract markets and swap execution facilities to require the CFTC to adopt rules detailing trader data and other information such trading venues must be able to access from cash markets and other data sources related to contracts referencing digital commodities and (2) expand the reach of the CFTC’s enforcement authority outside the United States to circumstances where certain prohibited activities (e.g., fraud and manipulation) “have or would have a reasonably foreseeable substantial effect within the United States.” 

As proposed, the CFTC would also be required to adopt policies to safeguard proprietary information it receives whether through investigations or otherwise proportionate to the “level of sensibility of the information” and limit access to the information to “appropriate” Commission staff.

My View: In light of the CFTC’s relentless prosecution of Jitesh Thakkar for developing software used by Flash Crash Spoofer Navinder Sarao despite the dropping of parallel criminal charges by the Department of Justice, the proposed expansion of potential aiding and abetting liability for non-registrants is a significant red flag. Potentially holding programmers of futures trading, advisory or surveillance systems liable for the non-intentional development of software that might be used for illicit purposes could have a material chilling effect on software development for legitimate purposes and inhibit US leadership in creating new fintech innovations for the derivatives industry. (Click here for background regarding the CFTC’s pursuit of Mr. Thakkar in the article “Department of Justice Declines to Retry Alleged Programmer for Flash Crash Spoofer” in the April 28, 2019, edition of Bridging the Week.)

​The defendants had argued that they could not be convicted of wire fraud because a violation under the relevant statute requires the making of affirmative misrepresentations and spoofing trading does not entail false statements. According to defendants, their orders – even if spoofing orders – entailed no representations beyond their stated terms and solely communicated an implied commitment that if their orders were accepted before cancelled, they would be filled according to their terms.

The Hon. John Tharp, Jr., the presiding judge in this matter, disagreed with defendants’ arguments. He wrote that omitting or concealing material information, even absent a duty to disclose, constitutes a violation of wire fraud prohibitions “if the omission was intended to induce a false belief and action to the advantage of the schemer and the disadvantage of the victim.” Judge Tharp claimed that when orders are placed with an intent to cancel them before execution in connection with spoofing, the intent is to create a “false belief about the supply or demand for a commodity” so that a market moves in a direction to execute resting orders of the spoofer on one side of the market to the detriment of other traders on the other side of the market who are not knowledgeable of the spoofer’s trading intent.

The court also rejected defendants’ argument that the wire fraud statute is unconstitutionally vague. Judge Tharp wrote that spoofing is similar to pump and dump schemes that have frequently been prosecuted under wire fraud prohibitions.

The Dodd Frank Wall Street Reform and Consumer Protection Act that contained an express spoofing prohibition was not signed into law until July 21, 2010, and the anti-spoofing provision was not effective until July 16, 2011. Thus, the DOJ could not prosecute defendants utilizing the prohibition for the overwhelming majority of their purportedly illicit spoofing transactions. (Click here for background regarding the effective date of the anti-spoofing prohibition and other provisions of Dodd-Frank.)

Policy and Politics: In February 2019, the Futures Industry Association filed a friend of the court brief in this matter arguing that prosecuting defendants for wire fraud (and not spoofing) raised issues of concern to the business community because such action implied that orders entered without an intent of execution for any reason constituted fraudulent statements to the marketplace. However, observed FIA, such a view would challenge “the vitality of the established legal precept” that market participants have no obligation to disclose any information in connection with open orders including their intentions regarding such orders. According to FIA, criminalization of “a market participant’s failure to disclose trading intentions opens the door for arbitrary prosecutions and vexatious private claims.” (Click here to access a copy of the FIA filing.) The US Chamber of Commerce, the Bank Policy Institute and the Securities Industry and Financial Markets Association made similar arguments in a friend of the court brief they also filed in this matter.

More Briefly:

Separately, Joshua Sterling, Director of the CFTC’s Division of Swap Dealer and Intermediary Oversight, indicated that his Division staff would soon commence targeted thematic reviews of swap dealers and commodity pool operators. In a speech before the Alternative Investment Management Association, Mr. Sterling said the purpose of the review would be “both to mitigate the potential for blind spots in our oversight and enhance our engagement with registrants.” According to Mr. Sterling, firms subject to reviews are those likely “to have a significant impact” on derivatives markets and each review would be completed onsite within five business days. The objective of the reviews is not to refer matters to the Division of Enforcement, he said, but to provide general guidance to the industry and determine potential rulemakings.

The CFTC alleged that, from March 2016 through July 2017, FGC solicited and allowed US persons to trade futures on the Chicago Mercantile Exchange’s Globex platform without being registered as a futures commission merchant. The SEC charged that from 2014 through 2019, the firm offered and sold instruments based on US and internationally listed stocks to US persons that did not meet certain minimum financial standards by qualifying as “eligible contract participants” under applicable law (Click here to access a definition of an ECP at 7 U.S.C. §1a(18)). However, as these instruments constituted security-based swaps, they could only be sold to nonqualified US persons if the instruments were subject to an effective registration statement and were traded on a national securities exchange. FGC met neither of these requirements, alleged the SEC.

FGC settled with the CFTC and SEC by agreeing to pay each a US $100,000 fine. FGC additionally agreed to remit to the SEC US $32,952 as disgorgement and interest.

Unrelatedly, Upstream Energy Services LLC, a Texas-based crude oil and natural gas advisory firm, was also charged by the CFTC with operating as an FCM without registration. The CFTC claimed that between April 2017 and September 2018, the firm accepted orders for futures and options on behalf of two clients owned by the same person, and entered the orders and carried the resulting trades in its own trading accounts. Upstream extended credit to the clients for margin but was subsequently reimbursed by the clients for Upstream’s costs; Upstream also received fees from the clients for its trading services. Upstream agreed to pay the CFTC a US $75,000 fine to resolve its purported violation.

In other legal and regulatory developments involving Fintech:

Unrelatedly, Ze Qian, a nonmember, resolved an unrelated disciplinary action by NYMEX that claimed he prearranged the execution of transactions involving steel futures between an account he traded for his employer and an account owned and controlled by another person to enable Mr. Qian’s employer to receive trade credits from a market-maker incentive program administered by the exchange. To resolve this matter, Mr. Qian agreed to pay a fine of US $5,000 and serve a two-year all CME Group exchanges’ access ban. 

Additionally, three nonmembers were all fined either US $40,ooo or US $50,000 by the Commodity Exchange, Inc. or NYMEX and permanently barred from accessing CME Group exchanges for trading for engaging in spoofing trading. The three persons are Shiv Agarwal, Krishna Lakani and In-Ho Hwang. Finally, Boston Metal Co., Ltd was also sanctioned US $40,000 for failing to supervise one of its employees who allegedly engaged in spoofing trading and for not ensuring that each of its traders used a unique Tag 50 identification when placing electronic orders.

For further information

CFTC Chair Says Position Limits Proposal Coming Soon; Head of DSIO Says Thematic Reviews Coming Soon Too:

CFTC Chair Stresses Need for Principles-Based Regulation to Accommodate Fintech and Announces Elevation of LabCFTC to Operating Office:

District Court Judge Calls for Do Over in Settlement of CFTC Enforcement Action Against Food Giants After Court of Appeals Mostly Grants Commission’s Mandamus Request:

Court of Appeals:

District Court:

DOJ Relies on Bitcoin Block Chain Analysis for Indictment of Leader and Users of Darknet Child Pornography Website:

US and Non-US Companies Charged by CFTC for Acting as Unregistered FCMs:

House Ag Committee Proposes CFTC Reauthorization That Includes Aiding and Abetting Expansion:

No Action Granted by SEC to NY Digital Trust Company to Settle Equities Transactions Without Clearing Agency Registration:

OCC Loses Effort to Have Scope of DFS Judgment Limiting National Fintech Charters Narrowed:

Purported Faulty Block Trade Reporting, Pre-arranged Trading to Obtain Exchange Incentive Fees and Failure to Supervise Result in NYMEX Disciplinary Action Settlements:

Spoofing Can Violate of Wire Fraud Statute Rules Federal Judge:

Trader Accused by SEC of Making Misstatements Regarding Bond Pricing Asks for Summary Judgement Claiming Practices Were Industry Norm:

Two Affiliated Broker-Dealers Agree to US $15 Million Sanction for Purported AML Program and Supervisory Deficiencies:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of November 2, 2019. 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. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or employees.

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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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