Staff of the Commodity Futures Trading Commission issued formal no–action relief, some other regulators referenced exercising discretion, while some additional regulators and regulatory organizations discussed forbearance – albeit not general forbearance. However, overall, during the past two weeks, regulators worldwide recognized the difficulty swap dealers are having in complying with the March 1 deadline to implement certain variation margin requirements for uncleared swaps, and indicated or at least implied they would likely not be taking enforcement action against non-compliers, subject to such entities’ good faith efforts to comply with their obligations expeditiously. Separately, US futures exchanges brought a host of disciplinary actions alleging non-bona fide exchange for related position transactions, wash sales, position limits violations and disruptive practices. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:
- CFTC Postpones Swap Dealer Compliance Date for OTC Swaps Variation Margin Requirements; Other Regulators Likely to Exercise Forbearance;
- Futures Traders Resolve SROs’ Disciplinary Actions Related to Alleged Non-Bona Fide EFRPs, Wash Sales, Position Limits Violations and Disruptive Practices (includes Compliance Weeds);
- ICE Futures Issues Guidance Regarding Identification Requirements for Orders Placed Through Its Electronic Trading System (includes Compliance Weeds and My View);
- NYS Requires State-Regulated Financial Services Institutions to Maintain Cybersecurity Program (includes Compliance Weeds);
- Australian Regulator Sanctions Broker for Engaging in Pre-Negotiated Futures Transactions With Client Without Requisite Time Delay (includes Compliance Weeds);
- Broker-Dealer Settles SEC Charges Related to Alleged Compliance and Trading Surveillance Breakdowns (includes Compliance Weeds);
- Continuing to Make Regulations Great Again: White House Implements More Steps to Reduce Regulatory Burdens; and more.
- CFTC Postpones Swap Dealer Compliance Date for OTC Swaps Variation Margin Requirements; Other Regulators Likely to Exercise Forbearance: On February 13, the Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight said it would not recommend enforcement action to be taken against a swap dealer (“SD”) if it failed to comply with variation margin requirements for uncleared swaps effective March 1 (“March 1 VM Requirements”). DSIO said its no-action relief would apply through September 1 where an SD (1) did not comply with the March 1 VM Requirements solely because it failed to complete necessary credit support documentation or, acting in good faith, required more time to resolve operational issues; (2) made best efforts to comply with its March 1 VM Requirements “as soon as possible” after March 1; (3) continued to post and collect variation margin with counterparties when there were pre-existing variation margin requirements until such time it could comply with the March 1 VM Requirements; and (4) by no later than September 1, complied with the March 1 VM Requirements for all swaps for which the requirements were applicable on or after March 1. Subsequently, a number of other regulators and regulatory organizations worldwide indicated that they were also cognizant of the difficulty SDs were having in complying with the March 1 VM Requirements and said or implied they would (or that regulators under their purview should) likely exercise some forbearance on a case-by-case basis for some additional time, provided the SDs acted diligently to meet their obligations. Relevant regulators or regulatory organizations included the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency in the US, the International Organization of Securities Commissions, the European Supervisory Authorities (including the European Securities and Markets Authority) and the Financial Conduct Authority in Europe. Under international rules, SDs with the largest outstanding notional amounts of uncleared swaps began complying with initial and variation margin requirements on September 1, 2016. As of March 1, 2017, SDs are required to comply with variation margin requirements with all relevant counterparties not included in the first phase. (Click here for some background on the current deadline dates for margin requirements for uncleared swaps in the article “BIS/IOSCO Delays Rollout of Margin Requirements for Uncleared Swaps” in the March 22, 2015 edition of Bridging the Week.) Separately, the CFTC’s DSIO indicated it would not recommend an enforcement action against an SD that failed to comply with minimum transfer amount requirements under its rules in connection with one or more uncleared swaps with any legal entity that owned more than one separately managed account, subject to certain conditions. (Click here to access CFTC Rule 23.152(b)(3) and here for CFTC Rule 23.153(c).)
- Futures Traders Resolve SROs’ Disciplinary Actions Related to Alleged Non-Bona Fide ERPs, Wash Sales, Position Limits Violations and Disruptive Practices: Four companies settled disciplinary actions brought by the Chicago Board of Trade and ICE Futures U.S. alleging that they engaged in wash sales. In each action, the relevant exchange alleged that the respondent engaged in transactions solely for the purpose of transferring positions between two related accounts. Bank of America Corporation agreed to pay a fine of US $30,000 to the Chicago Board of Trade to resolve charges that on June 2, 2015, it engaged in two exchange for related position transactions between accounts of two of the firms’ wholly owned subsidiaries solely to transfer Federal Funds Futures positions between them. Similarly, Gold-Eagle Corporation consented to a sanction of US $25,000 by the CBOT to settle charges that it engaged in one EFRP transaction on January 4, 2016, to transfer corn futures between two accounts it owned and controlled. CBOT also alleged that both BOA and Gold-Eagle engaged in the problematic EFRPs without the exchange of a related cash position, making the EFRPs non-bona fide. Similarly, Sucres et Denrees S.A. and Sucden Geneva S.A. each were ordered to pay a fine of US $25,000 to ICE Futures U.S. when a business conduct committee determined that, on 16 instances on two days in February 2015, the affiliated firms traded opposite each other to transfer positions in Sugar No 11. futures. Separately, Sierentz Fund LP agreed to pay a fine of US $10,000 and disgorge profits of US $78,847.50 to ICE Futures U.S. to settle charges that it “inadvertently” held an intraday position in the Henry LD1 Fixed Price Future higher than the applicable spot month position limit during the July 2016 settlement period, while PetroChina International (America), Inc. consented to a sanction of US $50,465 by ICE Futures U.S., including disgorgement of profits of US $2,965, for alleged multiple violations of spot month position limits. Finally, Daniel Pires, a non-member, agreed to remit US $20,000 to CBOT to resolve charges that, between March and June 2015, he entered multiple user-defined 10-Year U.S. T-Note covered option spread orders that allegedly were intended to obtain more favorable prices for his options instruments than were available in the outright market. CBOT alleged that this practice constituted disruptive trading.
Compliance Weeds: There are two important takeaways from these series of exchanges’ regulatory actions. First, position limits are 24/7 (Click here to access ICE Futures US Rule 6.20(b), for example.) Both enforcement actions by ICE Futures U.S. alleging violations of position limits related to purported intraday violations. Trading firms should monitor their position limit compliance not just at the end of each trading day but intraday too. This can be particularly challenging when multiple accounts of different affiliates or even trading desks within a single entity must be aggregated to assess overall positions, but it is important. Second, entering a user-defined spread for the purpose of disadvantaging other market participants can be a violation of general prohibitions against market disruption. (Click here to access CME Group Rule 575D; click here to access the CME Group MRAN regarding disruptive practices, Q/A 22.) In the CBOT disciplinary action against Mr. Pires, the exchange claimed that the respondent entered a user-defined covered option spread with the intent to avoid allocation of futures contracts that should have been tied to the covered options instruments. He did this, said CBOT, in order to obtain more favorable prices for the options instruments than were available in the marketplace. Even though CME Group’s Globex System utilizes reasonability checks aimed to prevent this conduct from occurring, its system is not infallible
- ICE Futures Issues Guidance Regarding Identification Requirements for Orders Placed Through Its Electronic Trading System: ICE Futures U.S. issued guidance in the form of Frequently Asked Questions regarding its trader identification requirements for electronic traders. Under ICE Futures rules, all persons who access ICE Futures’s trading system, whether manually or automatically, must utilize a unique identification. Traders using ICE Futures’s WebICE system must have a WebICE User ID, while traders accessing the market through a FIX connection must have a FIX User ID (Tag 9139) and an Authorized Trader ID ("ATID"; Tag 116 Right). WebICE User IDs are assigned by the ICE User Administration either directly by or through firms with direct access. FIX User IDs – which identify a FIX login – are also generated by the ICE User Administration upon request by a direct access company, while ATIDs – which identify the specific trader – are self-generated. ATIDs must be unique for each trader or for each automated trading system. The ATID for an ATS should reflect the individual that operates, administers and/or monitors the ATS, or all individuals in a group that perform these functions. ATIDs may not be shared among individuals except for multiple individuals that operate an ATS. Manual orders entered by an ATS operator must have a separate ATID, distinct from the ATS’s ATID. Certain traders must register their ATIDs with ICE Futures (or other ICE exchanges), such as individual ICE Futures members or employees of individual members or certain firms who participate in special exchange-administered fee discount programs. ICE Futures U.S.’s new FAQs will be effective March 1, absent objection by the Commodity Futures Trading Commission.
Compliance Weeds: Requirements regarding the use of trader identifications and related matters for electronic orders vary from exchange to exchange and the devil is in the details. For example, CME Group rules make explicitly clear that team tags – representing a group of persons who simultaneously administer, operate and monitor an automated trading system – would be expected to change for different shifts. (Click here to access CME Group MRAN regarding Tag 50 ID Requirements Q/A 11.) The new proposed guidelines of ICE Futures U.S. have no similar express requirement regarding team tags and the obligations around shifts. (Click here to access new ICE Futures US proposed FAQ Q/A9.) Also, exchanges impose express responsibilities on clearing members that sponsor persons who directly place electronic orders with exchanges. Among other things, a clearing member:
- must for each person it authorizes for direct access, “take any and all actions requested or required” by an exchange, including requiring such person to produce documents, provide information and answer questions in connection with any investigation. (Click here to access ICE Futures U.S. Rule 27.04(c)(i) and here for CME Group Rule 574 – 3d paragraph.); and
- should take “appropriate action” if the clearing member has actual or constructive notice of a violation of an exchange rule; otherwise it may be found to itself have engaged in conduct detrimental to the exchange. (Click here to access ICE Futures U.S. Rule 27.04(d) and here for CME Group Rule 574 – last paragraph.)
Clearing member sponsors must be aware of these responsibilities and should implement and maintain policies and procedures reasonably designed to help them comply with their obligations
My View: Whenever I write about exchange requirements regarding electronic orders and direct access persons, I wonder about the value add of proposed Regulation Automated Trading by the Commodity Futures Trading Commission. (Click here for background regarding the CFTC’s supplemental proposal in the article “Proposed Regulation AT Amended by CFTC; Attempts to Reduce Universe of Most Affected to No More Than 120 Persons” in the November 6, 2016 edition of Bridging the Week.) As I have suggested previously, it appears that the CFTC could accomplish most of its objectives by better leveraging existing exchange requirements and plugging what it perceives to be gaps through amendments to core principles for designated contract markets. It is not clear what more prescriptive regulation at the federal level functionally adds, other than substantial costs and ambiguity.
- NYS Requires State-Regulated Financial Services Institutions to Maintain Cybersecurity Program: New York State adopted what it claimed was the “first-in-the-nation” regulation that requires commercial banks, insurance companies and other financial services entities regulated by the NY Department of Financial Services to implement and maintain a cybersecurity program designed to protect consumers’ private information and the entities’ own information technology systems (click here for a list of institutions regulated by the NYDFS). Among other things, each covered entity’s cybersecurity program should be based on its own risk assessment and be designed to (1) identify and evaluate internal and external cybersecurity threats that might threaten to compromise nonpublic information stored on the entity’s information system; (2) protect the entity’s information system and nonpublic data from unauthorized access through the use of “defensive infrastructure”; (3) detect cybersecurity breaches; (4) respond to cybersecurity breaches to minimize any adverse impact; (5) recover from cybersecurity attacks and resume normal operations; and (6) satisfy all regulatory reporting requirements. Covered entities are also required to appoint a chief information security officer; conduct continuous monitoring or periodic penetration testing and vulnerability assessments; and provide regular cybersecurity training to staff, among other obligations. Covered entities must submit a certification to the NYDFS Superintendent by February 15 of each year that they are in compliance with all requirements of New York’s cybersecurity regulation. Smaller entities may be exempt from certain of the state’s requirements. The new regulation will be effective March 1, 2017; however, the compliance dates for certain provisions are delayed for up to two years.
Compliance Weeds: All members of the National Futures Association have been required to implement and enforce written policies regarding cybersecurity since March 1, 2016. These policies must be “reasonably designed to diligently supervise the risks of unauthorized access to or attack of their information technology systems, and to respond appropriately should unauthorized access or attack occur.” The requirements do not impose one-size-fits-all obligations on members, but instead permit members to adopt procedures relevant to the type, size and complexity of their business. (Click here for details regarding the NFA’s requirements in the article “NFA Proposes Cybersecurity Guidance” in the November 13, 2015 edition of Bridging the Week.)
- Australian Regulator Sanctions Broker for Engaging in Pre-Negotiated Futures Transactions With Client Without Requisite Time Delay: The Australian Securities & Investment Commission fined BGC Partners (Australia) Pty Limited Aus $90,000 (approximately US $69,000) for failure to exercise pre-negotiated trades on behalf of a client in accordance with regulatory requirements. In Australia, when a market participant seeks to engage in a pre-negotiated trade on behalf of a client, it must have the client’s general or specific authority in writing, and it must make an enquiry through an electronic message for one side of the trade, wait 3o seconds, and then enter a matching order reflecting the pre-negotiated agreement. According to ASIC, on at least six occasions in 2016, BGC did not place only one side of a negotiated trade into the market place and then wait 30 seconds before placing the other side and/or failed to obtain a client’s authorization prior to engaging in a pre-negotiated transaction on its behalf.
Compliance Weeds: This enforcement action may have taken place on a continent far far away; however, on this continent noncompetitive trades are prohibited by Commodity Futures Trading Commission rule, unless executed in accordance with exchange rules it has approved. (Click here to access CFTC Rule 1.38.) Exchanges generally have rules permitting the simultaneous placement of opposite orders for different beneficial owners by a party with discretion over both accounts as well as by different parties that my engage in pre-execution communications. (Click here to access CME Group Rules 533 and 539.) These rules can be quite complex, however, and are not one-size-fits-all. Traders should ensure they understand the nuances of these provisions.
- Broker-Dealer Settles SEC Charges Related to Alleged Compliance and Trading Surveillance Breakdowns: Sidoti & Company LLC, a Securities and Exchange Commission-registered broker-dealer, agreed to pay a fine of US $100,ooo to resolve charges that, on multiple occasions from November 2014 through July 2015, it failed to have written policies and procedures to prevent the improper use of material nonpublic information by the firm and its associated persons by an affiliated hedge fund. Moreover, written policies and procedures the firm implemented in July 2015 were not “reasonably designed” to avoid such improper use, alleged the SEC. According to the SEC, from November 2014 through July 2015, Sidoti had written policies and procedures to prevent the misuse of material nonpublic information by its own investment and research department. However, the policies did not preclude its chief executive officer or associated persons from using such information to make investment decisions for an affiliated fund. As a result, charged the SEC, during this time the affiliated fund traded stock that was on Sidoti’s daily-restricted list on 126 instances. After written policies and procedures were finally adopted in July 2015 that prohibited the affiliated fund from trading in securities on the restricted list and imposed certain physical barriers, there were no procedures to enforce such barriers. Sidoti settled this SEC enforcement action without admitting or denying any findings.
Compliance Weeds: When President Ronald Reagan adopted the Russian proverb “trust, but verify” as his own when negotiating with President Mikhail Gorbachev of the Soviet Union in 1986, he could also have been articulating the essential elements of an effective compliance program. As this SEC action against Sidoti & Company evidences, it is not sufficient for a financial services registrant solely to roll out policies and procedures reasonably designed in theory to ensure compliance with applicable laws and rules and trust that they will be followed. The registrant should endeavor to ensure that the policies and procedures are routinely followed, and that they are working as designed. Otherwise they should be amended.
And more briefly:
- SEC Division of Investment Management Issues Guidance Regarding Robo-Advisors: The Securities and Exchange Commission’s Division of Investment Management issued guidance regarding best practices investment advisers should follow when utilizing automated systems to provide discretionary asset management services through online algorithmic-based programs, sometimes called “robo-advisors.” DIM alerted such advisers to ensure (1) their disclosure to customers is sufficiently specific so that a client could comprehend the adviser’s business practices and potential conflicts of interest; (2) that questionnaires used to collect client information to base the automated investment advice obtain sufficient information to enable the robo-adviser to provide suitable and appropriate advice; and (3) their compliance program adequately reflects the unique nature of their business model. Among other things, this program should address the development, testing and back testing of algorithmic code and the oversight of third parties that develop, own or manage code used by the robo-advisor.
- NFA Proposes Amendment to Filing Deadline for Forex Dealer Member CCO Annual Report: The National Futures Association proposed to permit Forex Dealer Members to submit their required compliance annual report to it within 90 days of the company’s fiscal year-end, as opposed to 60 days as now required. This would conform this requirement to similar requirements of futures commission merchants and swap dealers. The amendment will be effective March 4, absent objection from the Commodity Futures Trading Commission.
- CPOs Reminded by NFA of CFTC Amended Requirements Regarding Financial Reporting Obligations: The National Futures Association provided guidance to commodity pool operators on how they can file notices with it to take advantage of recently amended regulations by the Commodity Futures Trading Commission that permit them to satisfy their financial reporting obligations using alternatives to generally accepted accounting principles for non-US pools. The guidance also covers how CPOs can file notices to permit the use of CFTC-granted audit requirement relief under limited circumstances (e.g., small first year period of operation or pool has insiders only). (Click here for background on the CFTC’s amended rules in the article “CFTC Codifies Prior Exemptive Relief Into Final Rules Regarding CPO Financial Reports” in the December 4, 2016 edition of Bridging the Week.)
- SEC Approves FINRA Proposed Mark-Up/Mark-Down Disclosure Requirement on Retail Investors’ Corporate and Agency Bonds’ Confirmations: The Securities and Exchange Commission approved amendments to a rule of the Financial Industry Regulatory Authority that will require member firms to disclose certain new transaction-related information to retail customers for certain of their fixed income trades (click here to access current FINRA Rule 2232). This information would include the amount of mark-up or mark-down if the member engages in an offsetting trade in the same security on the same day; a link to a FINRA-sponsored web page that includes trading data on the relevant security; and the execution time of the transaction. The amendments become effective May 14, 2018.
- ESMA Raises Concerns to EC Regarding Systematic Internalizers Operating Broker-Crossing Networks: The European Securities and Markets Authority wrote a letter to the European Commission to note its concern that certain investment firms currently operating broker-crossing networks may be seeking to circumvent requirements under the Markets in Financial Instruments Directive II that if they operate an internal matching system and execute client orders on a multilateral basis, such system needs to be authorized as a trading venue. ESMA says some investment firms may be trying to exploit an apparent loophole in regulatory requirements by setting up networks of interconnected systematic internalizers to cross third-party buying and selling interests through principal trading, or other back-to-back trading. ESMA says it is monitoring this activity and may issue questions and answers in the future to clarify the permitted activities of systematic internalizers.
- Canadian Securities Regulators Join the Sandbox Movement: The Canadian Securities Administrators joined a growing international movement by launching a regulatory sandbox – namely a regulatory initiative to support businesses offering innovative products in the financial services industry. After identifying their proposal to a local provincial securities regulator, the business may be required to test its technology in a live environment, submit a business plan and demonstrate potential investor benefits in order to participate in the sandbox. Innovative products that might be approved include online platforms such as crowdfunding portals and online lenders; business models using artificial intelligence for trades or recommendations; and cryptocurrency or distributed ledger-based ventures.
- Continuing to Make Regulations Great Again: White House Implements More Steps to Reduce Regulatory Burdens: The White House issued another executive order aimed to “lower regulatory burdens on the American people” by requiring each head of a federal agency to appoint within 60 days a specific person as its “Regulatory Reform Officer.” In addition, each federal agency is required to establish a Regulatory Reform Task Force consisting of the RRO and other enumerated personnel. These task forces are charged with identifying regulations that “eliminate jobs, or inhibit job creation”; are not effective; or impose costs that are greater than the benefits, among other matters. The task forces must prepare a first report by May 25 that, among other things, identifies regulations for “repeal, replacement or modification.” Previously, the White House implemented an executive order requiring that, for the remainder of fiscal year 2017, all federal agencies identify at least two existing regulations for repeal whenever they propose or promulgate a new regulation, and that the sum of the incremental costs of any new regulations and repealed regulations not exceed zero. (Click here for background in the article “Making Regulation Great Again: President Trump Requires Loss of Two Regulations for Every New One and Orders Review of All Financial Services Laws and Rules” in the February 5, 2017 edition of Bridging the Week.) Independent agencies, like the Commodity Futures Trading Commission and the Securities and Exchange Commission, do not appear formally covered by the White House’s new executive order, but may nonetheless voluntarily apply its mandates.
For more information, see:
Australian Regulator Sanctions Broker for Engaging in Pre-Negotiated Futures Transactions With Client Without Requisite Time Delay:
Broker-Dealer Settles SEC Charges Related to Alleged Compliance and Trading Surveillance Breakdowns:
Canadian Securities Regulators Join the Sandbox Movement:
CFTC Postpones Swap Dealer Compliance Date for OTC Swaps Variation Margin Requirements; Other Regulators Likely to Exercise Forbearance:
Continuing to Make Regulations Great Again: White House Implements More Steps to Reduce Regulatory Burdens:
CPOs Reminded by NFA of CFTC Amended Requirements Regarding Financial Reporting Obligations:
ESMA Raises Concerns to EC Regarding Systematic Internalizers Operating Broker-Crossing Networks:
Futures Traders Resolve SROs’ Disciplinary Actions Related to Alleged Non-Bona Fide EFRPs, Wash Sales, Position Limits Violations and Disruptive Practices:
ICE Futures Issues Guidance Regarding Identification Requirements for Orders Placed Through Its Electronic Trading System:
NFA Proposes Amendment to Filing Deadline for Forex Dealer Member CCO Annual Report:
NYS Requires State-Regulated Financial Services Institutions to Maintain Cybersecurity Program:
SEC Approves FINRA Proposed Mark-Up/Mark-Down Disclosure Requirement on Retail Investors’ Corporate and Agency Bonds’ Confirmations:
SEC Division of Investment Management Issues Guidance Regarding Robo-Advisers:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of February 25, 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.
© 2019 Katten Muchin Rosenman and Gary DeWaal. All Rights Reserved.