Little news emanated from the Commodity Futures Trading Commission or the Securities and Exchange Commission last week. However, a few interesting matters came out of self-regulatory organizations that reminded me of some valuable compliance tips. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- Non-Member Sanctioned by NYMEX Business Conduct Committee for Non-Bona Fide EFRPs; Can’t Shift Blame to Broker or FCM Despite Try (includes Compliance Weeds);
- ICE Futures Europe Proposes Tough Prohibitions to Avoid Interaction With Sanctioned Countries or Persons;
- CTA and Principal Barred as NFA Members for Not Cooperating With NFA Examination (includes Compliance Weeds);
- Correspondent Broker Charged by FINRA With Failing to Monitor Customers’ Potential Spoofing Activity; and more.
- Non-Member Sanctioned by NYMEX Business Conduct Committee for Non-Bona Fide EFRPs; Can’t Shift Blame to Broker or FCM Despite Try: Bunkerbridge PTE Ltd, a non-member of the New York Mercantile Exchange, was fined US $30,000 by a NYMEX business conduct committee for engaging in a non-bona fide exchange for related position transaction on December 1, 2014, in violation of exchange rules. According to the BCC, Bunkerbridge’s EFRP was illegitimate because it failed to include the mandatory transfer of a related position. In its decision, the BCC suggested that Bunkerbridge had tried to shift the blame for its problem to a broker or futures commission merchant; however, the BCC rejected such attempted liability transfer. According to the BCC, “[i]n reaching its decision, the [BCC] Panel found that Bunkerbridge, as a party to the noted EFRP transaction, bore the responsibility to comply with Exchange Rules, including compliance with the terms of the contract and recordkeeping requirements, and such responsibility could not be deferred to a broker or [FCM].” Separately, SIG Energy LLP agreed to pay a fine of US $10,000 to resolve charges brought by ICE Futures U.S. that, one on instance, it violated spot month position limits intraday involving the Henry LD1 Fixed Price futures contract during the March 2016 expiration period.
Compliance Weeds: Both parties to an EFRP must ensure their transaction is bona fide. Most basically, one party to an EFRP must be the seller of the exchange contract and the purchaser of the related position (or long exposure associated with such position), while the other party must be the purchaser of the exchange contract and the seller of the related position (or short exposure associated with such position). Although generally there are no qualification requirements for parties to an EFRP, where the related position is a swap, each party to the EFRP must be a so-called “eligible contract participant” (click here to access Commodity Exchange Act § 1a(18) for a definition of ECP). Other requirements also apply to EFRPs. (Click here for background regarding EFRPs in the article “Alphabet Soup Under CFTC Scrutiny: CFTC Review of CME Handling of EFRPs (EFPs, EFRs, and EOOs) Suggests Tougher Times for Traders and FCMs; Time to be Pro-Active!” in the August 6, 2013 edition of Between Bridges.) Under CME guidance, brokers or FCMs that execute or clear EFRPs for customers “are responsible for ensuring” their customers who engage in EFRPs are “fully informed regarding Exchange EFRP requirements and should “exercise due diligence in identifying circumstances” where a customer’s EFRP may be non-bona fide. (Click here to access the relevant CME Group Market Regulation Advisory Notice regarding EFRPs – Q/A25.) ICE Futures U.S. has more prescriptive requirements for firms that execute or clear EFRPs for customers. On ICE Futures U.S. such firms are expected to “establish, document and execute controls that are reasonably designed to determine a customer’s suitability to engage in EFRP transactions and detect the execution of non-bona fide EFRPs.” (Click here to access ICE Futures U.S. FAQs – Q/A8.) Any party that facilitates the execution of an EFRP that it knows is non-bona fide and fails to take “appropriate action” could be held liable under the relevant CME rule (click here to access CME Group Rule 538C – last paragraph; see also, ICE Futures U.S. FAQs – Q/A8). Under CFTC rules, all FCMs, introducing brokers and members of designated contract markets or swap execution facilities must, upon a request by DCM, SEF, the CFTC or Department of Justice, “request from its customers, and, upon receipt,” provide to the requesting entity records supporting the related position to an EFRP. (Click here to access CFTC Rule 1.35(c)(1).) Clearing firms have equivalent obligations under exchanges’ rules regarding their customers’ documents supporting EFRPs, although exchanges may call on the customers directly to provide such documents.
- ICE Futures Europe Proposes Tough Prohibitions to Avoid Interaction With Sanctioned Countries or Persons: ICE Futures Europe proposed a host of changes to its rules to help ensure that neither its members nor their employees’ activities, or any delivery conducted under exchange auspices, implicate sanctions in effect under any law, rule or guidance of any government authority. Sanctions would include prohibitions against doing business with designated persons or countries. Under the exchange’s proposed amended rules, members would have to have policies and procedures “which are adequate to ensure compliance” with applicable sanctions laws. Comments to the proposed rule amendments will be accepted from members of ICE Futures Europe through March 23.
- CTA and Principal Barred as NFA Members for Not Cooperating With NFA Examination: NEX Capital Management LLC , a registered commodity trading advisor, and Jacob Wohl, an associated person and principal of Nex Capital, were permanently barred from being members of the National Futures Association or from acting as principals of an NFA member for failing to cooperate with an NFA examination. According to an NFA Hearing Committee panel, an NFA examination team attempted to visit Nex’s office – apparently in a residence – on two days in June 2016. However, on each occasion, no one from Nex responded to the team’s telephone calls or ringing of a buzzer outside the firm’s designated address. On one occasion, however, the NFA team said it observed two persons viewing them from the second floor of the residence. The NFA team also could not access Nex at other locations identified by the firm in its registration information or through email. The NFA, however, received emails from David Wohl who identified himself as an attorney, threatening NFA with criminal and civil court “action” for stalking and vandalism. NFA endeavored to commence its review of Nex after receipt of a customer complaint that suggested the firm had managed customer funds prior to the its registration as a CTA as well as from an individual who claimed he had received less money than he believed he had made through Nex. Nex withdrew as a CTA and NFA member, and Jacob Wohl was terminated as an AP and principal on July 25, 2016.
Compliance Weeds: Hide and seek is not a good game to play with regulators. However, determining when there is an event that requires an “immediate,” “same day” or “within 24 hours” mandatory notice filing to the Commodity Futures Trading Commission, the Securities and Exchange Commission or both by a futures commission merchant, futures-industry introducing broker or a broker-dealer often requires quick judgments under highly pressured circumstances. Unfortunately, material facts may sometimes be assessed incorrectly in the heat of a moment, and after some brief research, an apparent precipitous circumstance may turn out to be a false alarm. Accordingly, it is important that registrants are cognizant of all mandatory extraordinary reporting requirements, and when a possible reporting event occurs, first pause (calm the environment), second reflect (understand all available facts), and third, challenge (ensure that a perceived problem is truly a problem). Only after there is confirmation of a problem (or near certain confirmation), however, should a required report be made. By then, the full scope of the problem should be known and hopefully fixed -- at least on an interim basis; however, failure to assemble full information and/or implement an immediate fix will not excuse a delay in required reporting. If there is ongoing doubt one way or another about the occurrence of a potential reportable event, consider at least an interim, informal report to a relevant regulator to advise it of the potential of a reportable event. To the extent practical, a look-back to consider lessons learned and more permanent fixes to prevent a future occurrence should also occur as soon as possible. (Click here to access a handy chart published by the National Futures Association of Futures Commission Merchant Reporting Requirements, and here for Introducing Broker Reporting Requirements. Click here to access a summary chart of broker-dealer regulatory notification requirements by the Financial Industry Regulatory Authority.)
- Correspondent Broker Charged by FINRA With Failing to Monitor Customers’ Potential Spoofing Activity: The Financial Industry Regulatory Authority filed a disciplinary proceeding against Lightspeed Trading LLC, an introducing broker and member of FINRA, for allegedly failing to properly monitor and supervise the activities of its customers, as well as Richard Kenny, one of its own registered representatives, from July 2011 through November 2012. According to FINRA, the firm failed to “reasonably supervise” trading by two accounts – Fineline Trading Group LLC and Makino Capital LLC – each ultimately owned by a different brother – Behruz Afshar or Shahryar Afshar. FINRA claimed that the brothers placed one-lot orders on one side of NASDAQ PHLX LLC, an option markets, which were never intended to be executed, to alter the options series’ best bid or offer. After other traders joined the new best bid or offer, their trades would be executed against larger all or nothing (“AON”) orders the brothers had previously placed on the other side of the market. After execution of these AON orders, the brothers would usually cancel their prior one-lot orders. The brothers were able to carry out their scheme, in part, by designating one account as “customer” and the other as “professional” in order to take advantage of priority rules of the exchange (e.g., the brothers’ one-lot trades were typically placed as professional orders, thus getting lower priority for execution. This helped ensure their AON orders were not executed against their own one-lot orders). FINRA claimed that Lightspeed did not have “adequate supervisory systems” to monitor for the potentially manipulative activity and ignored various red flags that should have tipped it off to the potentially problematic activity. For example, FINRA alleged the firm did not detect that one brother’s account would enter option orders on one side of the market at the same time as the other brother’s account placed orders on the other side of the market and that one salesperson had a firm identification that permitted him to enter orders in the brothers’ accounts although his job function did not entail entering orders. Also, during the tenure of the brothers’ accounts, each account alternated designation as professional or customer, by quarter. FINRA seeks a fine and other sanctions against Lightspeed. Previously, Mr. Kenny was held liable by a FINRA hearing panel for not cooperating completely in a FINRA investigation related to this matter (click here to access decision). The Securities and Exchange Commission brought civil charges against Mr. Kenny and the two brothers and their companies related to this matter in 2014 that the individuals resolved last year by payment of aggregate sanctions of approximately US $1.9 million. (Click here to access background in the article “Spoofing Case Filed by SEC” in the December 6, 2015 edition of Bridging the Week; click here for terms of settlement.)
And more briefly:
- ICE Futures Canada Enacts Trader Identification FAQs Just Like ICE Futures U.S.: ICE Futures U.S. formally implemented a new Frequently Asked Questions regarding identification requirements for electronic traders. (Click here for details in the article “ICE Futures Issues Guidance Regarding Identification Requirements for Orders Placed Through Its Electronic Trading System” in the February 27, 2017 edition of Bridging the Week.) ICE Futures Canada adopted rules that impose similar identification requirements for automated trading systems accessing its electronic trading platform.
- NASDAQ Futures Modifies Self-Match Functionality: NASDAQ Futures modified its self-match prevention functionality to eliminate “skip internal functionality” as the only alternative. Under this functionality, an incoming order that would match an opposite order for the same user identification would skip the resting order and match with the next marketable order from a participant with a different user identification. Under the new functionality, a user of SMP can choose either to cancel a new order if it matches an opposite order with the same identification or cancel the resting order. It a participant currently using the skip internal functionality does not elect one of these two alternatives by noon March 17, the functionality will default to cancel resting order.
- IOSCO Issues Guidance on Unique Transaction Identifiers: The International Organization of Securities Commissions issued technical guidance to authorities to help them establish rules for assigning uniform global unique transaction identifiers for over-the-counter derivatives transactions. The guidance addresses the definition, format and usage of UTIs to assist in the aggregation of data across trade repositories to assist regulatory authorities to achieve better oversight of the OTC derivatives market and market activity worldwide.
For more information, see:
Correspondent Broker Charged by FINRA With Failing to Monitor Customers’ Potential Spoofing Activity:
CTA and Principal Barred as NFA Members for Not Cooperating With NFA Examination:
ICE Futures Canada Enacts Trader Identification FAQs Just Like ICE Futures U.S.:
ICE Futures Europe Proposes Tough Prohibitions to Avoid Interaction With Sanctioned Countries or Persons:
IOSCO Issues Guidance on Unique Transaction Identifiers:
NASDAQ Futures Modifies Self-Match Functionality:
Non-Member Sanctioned by NYMEX Business Conduct Committee for Non-Bona Fide EFRPs; Can’t Shift Blame to Broker or FCM Despite Try:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of March 4, 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.
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