Happy New Year and welcome to 2016! Last year ended quietly at financial service industry regulators worldwide. In the United States, counsel for Jon Corzine and the Division of Enforcement of the Commodity Futures Trading Commission traded very different views over Mr. Corzine’s responsibility for the collapse of MF Global in 2011. Meanwhile, the Financial Industry Regulatory Authority sanctioned one broker-dealer US $2.95 million for allegedly submitting inaccurate blue sheets, and another, US $7.3 million for purportedly selling unregistered microcap stocks and anti-money laundering offenses in the face of red flags. I also reflect on the film The Big Short. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- Former MF Global CEO Claims CFTC Charges Against Him Are Meritless (includes My View);
- Broker-Dealer to Pay FINRA Almost US $7.3 Million to Resolve Claims It Sold Unregistered Microcap Shares and Committed AML Violations;
- Broker-Dealer Agrees to FINRA Sanction of US $2.95 Million for Alleged Blue Sheet Failures; Another to Pay Almost US $13 Million for Mutual Fund Suitability Violations (includes Compliance Weeds);
- IOSCO Recommends Best Practices for Financial Markets and Intermediaries for Business Continuity;
- Non-Member Trading Firm Settles Disciplinary Action With CME Group for Allegedly Self-Matching Orders and Not Using Unique Tag 50 IDs (includes Compliance Weeds); and more.
Former MF Global CEO Claims CFTC Charges Against Him Are Meritless.
Jon Corzine, former chief executive officer of MF Global Inc. (MFG), objected to a proposed motion for summary judgment to be filed by the Division of Enforcement of the Commodity Futures Trading Commission in its lawsuit against him and Edith O’Brien related to their alleged role in the collapse of MFG in October 2011, claiming that the CFTC “grossly mischaracterizes the evidence.”
The CFTC filed a civil lawsuit against Mr. Corzine and Ms. O’Brien—the assistant treasurer of MFG at the time of the firm’s collapse—as well as against MFG itself and its parent company, MF Global Holdings Ltd. (MFGH), in June 2013 in a federal court in New York. The firm—a CFTC-registered futures commission merchant prior to its collapse—filed for bankruptcy protection in October 2011 after using nearly one billion US dollars of customer-segregated funds to support its own proprietary positions.
The CFTC charged all four defendants with failing to segregate customer funds as required by law and for misusing customer funds. MFGH and Mr. Corzine were charged as controlling persons of MFG; Ms. O’Brien was charged with aiding and abetting MFG’s wrongful conduct; and MFG and Mr. Corzine were also charged with failure to supervise. MFG and MFGH subsequently settled the CFTC actions. (Click here to access the CFTC’s complaint.)
In a letter to the court dated December 16, 2015, informing it of its intent to file a motion for summary judgment, the CFTC’s Division of Enforcement claimed that there were “[u]ndisputed facts [that] reveal that Corzine failed to act in good faith to prevent [MFG’s] segregation violations and, further knowingly induced the violations.” Among other things, the CFTC alleged that “Corzine knew that one policy—one that was specifically designed to protect customer funds—was ignored and/or violated on multiple occasions.”
Responding in a letter to the court dated December 22, 2015, Mr. Corzine argued that he “never directed, authorized, or countenanced any violations of [relevant law or CFTC rules] by MF Global or any of its employees.” Moreover, he claimed he delegated responsibility for matters related to customer funds protection “to experienced and competent personnel in the finance, treasury, compliance and legal departments.”
No date was set for a hearing on this matter.
All customers of MFG were repaid all balances the FCM owed them. (Click here for details of this distribution in the article, “MF Global Inc. Trustee Announces Final 100% Distribution to Customers” in the April 7, 2014 edition of Bridging the Week.)
My View: Time will tell whether the CFTC possesses sufficient evidence to prove its case against Mr. Corzine, or whether, beforehand, the relevant judge will grant a Commission motion for summary judgment. However, more than four years after the collapse of MFG one thing is clear: in the face of potential material issues, regulators expect senior officers to do more than simply take a verbal or even a written assurance from subordinates that “all is well—don’t worry,” or, even worse, a vague response. Where there is a potential material breach of law, regulators expect the senior officers to take some purposeful or affirmative action to ensure themselves that representations by staff can be reasonably relied on. As David Meister, the then Director of the CFTC’s Division of Enforcement, said at the time of the filing of the agency’s enforcement action against MFG and Mr. Corzine, “ [t]urning a profit is not the only job of the person at the top of a CFTC-regulated firm. Particularly in times of crisis, the person in control, like the CEO here, must do what’s necessary to prevent unlawful uses of customer money, so that customers’ money is still there if and when the music stops.”
- Broker-Dealer to Pay FINRA Almost US $7.3 Million to Resolve Claims It Sold Unregistered Microcap Shares and Committed AML Violations: The Financial Industry Regulatory Authority fined Cantor Fitzgerald & Co. US $6 million and required disgorgement of almost $1.3 million in commissions and interest in connection with the firm’s selling of more than 73.6 million shares of microcap securities, allegedly without conducting adequate due diligence, from March 2011 through at least September 2012. According to FINRA, during the relevant time, Joseph Ludovico, the broker who handled these transactions for the firm, effectuated the relevant transactions without considering “red flags” that suggested the transactions might be “illegal, unregistered distributions.” Among other things, after depositing microcap securities in their accounts, customers immediately liquidated the securities and wired the proceeds away from the firm. In fact, a portion of the relevant sales involved shares that were neither registered with the Securities and Exchange Commission nor lawfully exempt from registration. FINRA also alleged that Cantor Fitzgerald failed adequately to supervise the relevant transactions and did not have an anti-money laundering program that adequately identified and reported suspicious transactions. FINRA claimed that, despite servicing mostly institutional clients, the firm, began in March 2011, to service a small number of customers who liquidated large volumes of microcap securities without ensuring that the firm’s existing supervisory structure would comply with applicable securities laws. FINRA said that Jarred Kessler, Executive Managing Director of Equity Capital Markets for Cantor Fitzgerald, sought to expand this business in December 2011 knowing "that it posed unique challenges" given the firm's existing business mix. Cantor Fitzgerald consented to the sanctions to resolve this matter. In addition, to resolve charges against them, Mr. Kessler agreed to pay a fine of US $35,000 and be suspended as a supervisor for three months, while Mr. Ludovico agreed to pay a fine of US $25,000 and be suspended in all capacities for two months.
- Broker-Dealer Agrees to FINRA Sanction of US $2.95 Million for Alleged Blue Sheet Failures; Another to Pay Almost US $13 Million for Mutual Fund Suitability Violations: Macquarie Capital (USA) Inc. agreed to pay a fine of US $2.95 million to the Financial Industry Regulatory Authority to resolve charges that, between 2012 and 2015, it produced to the Securities and Exchange Commission and FINRA a substantial number of so-called “blue sheets” that were inaccurate and did not have an adequate audit system to ensure the reliability of its blue sheet submissions. (Blue sheets refer to trade data produced on an automated basis by member firms to the SEC or FINRA, upon their request. Regulators use this data for their investigations, including those related to suspicious and insider trading.) According to FINRA, Macquarie’s issues began in January 2012 after it developed a new system to generate blue sheet submissions following the commencement of clearing activities for its cash trading business. FINRA determined that, during the relevant time, because of its trade reporting problems, Macquarie submitted to it at least 600 blue sheets that misreported approximately 160,971 transactions and to the SEC at least 1,143 blue sheets that misreported approximately 178,318 transactions. Errors included reversing buy/sell codes on allocations of certain customer trades; miscalculating the net amount of allocations on certain customer trades; and failing to provide any or complete customer information on certain transactions. According to FINRA, Macquarie self-reported its infraction. Separately, Barclays Capital, Inc. agreed to pay more than US $10 million in restitution to customers and a fine of US $3.75 million to resolve FINRA charges that it failed to comply with its suitability obligations in connection with sales of mutual funds to retail clients from January 1, 2010, through June 30, 2015. Among other things, FINRA claimed that Barclays failed to provide adequate supervisory guidance to ensure the suitability of its mutual fund transactions; failed to identify unsuitable mutual fund switches; failed to notify customers of the costs of switches; and failed to have a system to aggregate mutual fund purchases to ensure customers received appropriate discounts, among other issues.
Compliance Weeds: Maintaining accurate books and records and producing accurate information to regulators is required both in the regulated securities and futures industries. Both the Securities and Exchange Commission’s and the Financial Industry Regulatory Authority’s rules require broker-dealers to provide trade data upon request. The SEC requires broker-dealers to submit “legible, true, complete and current” blue sheet data (click here and here to access SEC Rules 17a-4(j) and 17a-25, respectively), while FINRA has a similar obligation (click here and here to access FINRA Rules 8211 and 8213, respectively). The Commodity Futures Trading Commission has similar recordkeeping and production requirements for future commission merchants as well as other industry participants. (Click here and here to access CFTC rules 1.35 and 1.31, respectively.)
- Non-Member Trading Firm Settles Disciplinary Action with CME Group for Allegedly Self-Matching Orders and Not Using Unique Tag 50 IDs: Haitong International Futures Limited agreed to pay a fine of US $90,000 to the CME Group to resolve charges that, on multiple dates between December 2012 and June 2014, the firm executed numerous transactions for a client in the E-mini Dow calendar spread that purposely self-matched. According to the findings of the relevant Chicago Board of Trade business conduct committee, “[t]he matching buy and sell orders were entered with the knowledge and intent that the orders would match opposite one another. The purpose of these transactions was to roll positions from one contract month to the next.” Haitong, a CME Group non-member firm, was also charged with not assigning unique user IDs—known as “Tag 50s”—in connection with its electronic trading. Separately, Abengoa Bioenergy Operations, LLC, another CME Group non-member, agreed to pay a fine of US $35,000 to resolve CBOT charges that, on five days in 2013, it engaged in exchange for related position transactions where the firm owned and controlled both accounts involved in the relevant transaction; did not transfer a relation position in connection with an exchange for physical transaction; or did not have sufficient documentation of the corresponding cash position in an EFP transaction. Also, four CME Group members—Frank Catalano, Kevin Loftus, Christopher McGrath and Patrick Weber—agreed to pay fines between US $15,000 and US $35,000 and/or to CME Group trading suspensions to resolve allegations related to impermissible non-competitive open-outcry trades, while five persons—including both members and non-members—Aaron Benn, Drew Heynen, David Taylor, Robert Wharton and Ryan Zee—settled CME Group allegations related to various trade practice offenses by payment of fines between US $10,000 and US $30,000 and/or a CME Group trading suspension. Finally, ABN AMRO Clearing Chicago, LLC agreed to pay a fine of US $25,000 for misreporting open interest in the July 2013 Lumber Futures contract on June 28, 2013, and submitting a correction 16 minutes late on July 1, 2013.
Compliance Weeds: The Haitong disciplinary action should remind non-member traders that they have express obligations when they access CME Group markets electronically, and could be held liable if they fail to fulfill their obligations. Among other things, each person entering orders manually or automatically into CME Globex must ensure that the order is accompanied by an operator identification known as a “Tag 50 ID.” This identification must be unique to the individual entering the order or, in the case of an automated trading system, the team of persons on the same shift responsible for the ATS’s operation. All Tag 50s must also be unique at the level of the clearing member firm. Only certain Tag 50s must be affirmatively registered with CME Group—those associated parties receiving preferential fees or those requested by Market Regulation or the Globex Control Center (typically when the participant generates significant messaging volume). Individuals and team members may not permit their unique Tag 50s to be used by other persons. (Click here for a CME Group summary of Tag 50 requirements, and here for access to relevant CME Group rules 576 and 536B2.) Other exchanges have equivalent requirements (e.g., ICE Futures U.S.; click here to access IFUS Rule 27.12(f)).
- IOSCO Recommends Best Practices for Financial Markets and Intermediaries for Business Continuity: The International Organization of Securities Commissions published two reports that address how financial markets and intermediaries manage risks, deal with catastrophic events, including cyber attacks, and quickly restore their functionality. Both reports provide recommendations to regulators and “sound practices” to trading venues and market intermediaries, respectively. Among other things, IOSCO recommended that trading venues have “communication protocols” to ensure the sharing of information regarding the introduction of new systems or changes to critical systems. This is important, said IOSCO, to ensure “Trading Venue participants are given sufficient time to make the requisite system changes or adjustments.” For market intermediaries, IOSCO recommended that firms “[e]stablish an appropriate governance structure” that can implement its business continuity plan successfully in case of a major operational disruption. Earlier in December, the Commodity Futures Trading Commission proposed rules to enhance cybersecurity at market infrastructures it oversees. (Click here to access the article, “CFTC Proposes Enhanced Cybersecurity Rules for Exchanges, Clearing Houses and Data Repositories” in the December 20, 2015 edition of Bridging the Week.)
- CFTC Chairman Blasts Congress and President for No Budget Increase: Commodity Futures Trading Commission Chairman Timothy Massad blasted Congress and the White House for not increasing the agency’s budget from 2015 in the recently approved fiscal year 2016 budget for the US government. According to Mr. Massad, “[t]he CFTC’s appropriation simply doesn’t match our vast responsibilities, especially as the markets we oversee have grown enormously in size, importance and technological complexity.” The CFTC had requested a budget of $322 million for 2016, which represented an increase of $72 million over its 2015 enacted level (click here to access a copy of the CFTC’s proposed 2016 budget).
- HK OTC Clearinghouse Granted DCO Registration Exemption: OTC Clearing Hong Kong Limited has been exempted from registering as a derivatives clearing organization by the Commodity Futures Trading Commission in connection with its swaps clearing activities. The CFTC granted this relief to OTC Clear because it found the clearinghouse is subject to “comparable, comprehensive supervision and regulation” by its home regulator, the HK Securities and Futures Commission. Under the CFTC’s exemption, OTC Clear may now clear proprietary interest rate swap positions of US persons that are OTC Clear clearing members or affiliates of clearing members.
- SEFs Granted No-Action Relief by CFTC Staff From Post-Trade Recordkeeping Requirements for Allocations: Staff of the Commodity Futures Trading Commission’s Division of Market Oversight granted no-action relief to swap execution facilities from a requirement that they capture and maintain certain post-trade allocation information in their audit trail data. SEFs had argued that such information is currently not captured by SEFs because trade allocations are typically made post-trade away from a SEF and occur between a clearing firm or a customer and the relevant clearinghouse. The no-action relief will expire November 15, 2017.
- CFTC Seeks Comments on Technical Elements for Swap Reporting: The Commodity Futures Trading Commission is seeking comments on its proposed technical specifications for data in connection with mandatory swaps data reporting. The proposed specifications address data currently required to be reporting and elements “that are currently not reportable under the Commission’s regulations, but which have been identified by Staff as data elements that—when reported in a consistent and clear manner—may assist the Commission in fulfilling its regulatory mandates.” Comments will be accepted through February 22, 2016.
- Totally Irrelevant (But Is It?): A Review of the Film The Big Short: I admit (maybe with a bit of guilt), I wholeheartedly enjoyed the recently released film The Big Short, starring Christian Bale, Steve Carell, Ryan Gosling and Brad Pitt, and co-written and directed by Adam McKay, based on the book of the same name written by Michael Lewis. For folks in the financial services industry, the plot is well known and easy to follow. However, for those not in the financial services industry, the movie ingeniously and entertainingly explains the intricate workings of mortgage-backed securities, the housing market, collateralized debt obligations and credit default swaps so that arcane financial terms and structures are not a hindrance to enjoyment of the movie (think: bubble baths and fine dining). Basically, the film tells the story of how one hedge fund manager, Michael Burry (played by Mr. Bale), postulated in 2005 that the value of MBSs would begin to substantially collapse during 2007 because of weaknesses in the US housing market. He convinced a number of investment banks to issue him CDSs to take advantage of his calculations. Other investors and traders including Jared Vennett (Mr. Gosling), Mark Baum (Mr. Carell) and Ben Rickert (Mr. Pitt) directly or indirectly learned of Mr. Burry’s investments and took similar market positions when they too reflected upon the tenuous condition of MBSs and CDOs supported by the housing market. After the CDSs initially failed to generate the expected results when the housing market began tanking in 2007, the instruments ultimately behaved as Mr. Burry predicted, and the four investors all achieved fantastic returns. At the same time, many investment banks ended up failing, were merged out of existence and/or were supported by a massive US government and taxpayer bail-out. The film clearly intends not to present a flattering portrayal of Wall Street. However, I left the theater wondering why, if some in the private sector through hard work or otherwise could so readily see the housing bubble and the impending collapse of MBSs and CDOs beginning in 2007, why could not the Board of Governors of the Federal Reserve System and other financial regulators responsible for safeguarding our markets and overseeing the financial services industry forecast the same impending storm? Moreover, afterwards, why were concerns regarding the lack of transparency in over-the-counter markets and too many so-called “too big to fail” investment banks addressed not only by the adoption of measures to increase market transparency and to enhance the financial resiliency of such firms, but by mandating the concentration of derivatives risk in fewer (but different) private entities (i.e., clearinghouses) ultimately backed by the same investment banks? To me this seemed, and still does seem, counterintuitive. But I guess that will be addressed in The Big Short’s sequel—can’t wait to see it! But until then, go see The Big Short and enjoy.
For more information, see:
Broker-Dealer Agrees to FINRA Sanction of US $2.95 Million for Alleged Blue Sheet Failures; Another to Pay Almost US $13 Million for Mutual Fund Suitability Violations:
Broker-Dealer to Pay FINRA Almost US $7.3 Million to Resolve Claims It Sold Unregistered Microcap Shares and Committed AML Violations:
CFTC Chairman Blasts Congress and President for No Budget Increase:
CFTC Seeks Comments on Technical Elements for Swap Reporting:
Former MF Global CEO Claims CFTC Charges Against Him Are Meritless:
HK OTC Clearinghouse Granted DCO Registration Exemption:
IOSCO Recommends Best Practices for Financial Markets and Intermediaries for Business Continuity:
Non-Member Trading Firm Settles Disciplinary Action With CME Group for Allegedly Self-Matching Orders and Not Using Unique Tag 50 IDs:
SEFs Granted No-Action Relief by CFTC Staff From Post-Trade Recordkeeping Requirements for Allocations:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of December 31, 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.
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