Criminal actions naming individuals dominated news regarding the US financial services industry the past two weeks. Last Friday, a former junior bank trader pleaded guilty to criminal charges for spoofing, manipulation and attempted manipulation of gold and silver futures from December 2009 through February 2012, while earlier last week a former proprietary trader who admitted stealing his former employer’s trading system’s source code was sentenced to one year and one day imprisonment. Two weeks ago, a health care consultant, a former colleague at a federal agency, and three partners of an investment adviser were criminally charged with engaging in a scheme to obtain confidential proprietary information from the federal agency and trade on it for profit. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:
David Liew, a former junior trader that many media sources have indicated was based in Singapore and associated with Deutsche Bank, pleaded guilty in a federal court in Chicago on June 1 to engaging in spoofing, manipulation, and attempted manipulation of gold and silver futures on the Commodity Exchange, Inc. from December 2009 through February 2012.
On June 2, Mr. Liew also settled charges brought by the Commodity Futures Trading Commission related to the same matter by agreeing never to trade commodity interest contracts under the CFTC’s jurisdiction and never to associate with any CFTC registrant as a principal, officer or employee, among other penalties. However, as part of his CFTC settlement, Mr. Liew was not assessed a fine. The CFTC said that Mr. Liew received "meaningful cooperation credit" because he entered into a formal cooperation agreement with it, provided the Commission with substantial assistance to date, and promised to continue to cooperate with the Commission and other government agencies.
According to the CFTC and the plea agreement entered by Mr. Liew, during the relevant time, Mr. Liew entered into “hundreds of bids and offers” with the intent to cancel the orders before execution. He did this either to facilitate the execution of an order he placed on the opposite side of the market, or that other unnamed persons associated with his employer placed. Typically, after the desired order was filled, the spoofing orders that were previously placed to move the market were cancelled.
Mr. Liew acknowledged that all the orders subject to his two settlements were spoofing orders although, in some cases, the spoofing orders did not work as anticipated to drive the market up or down, and in some other cases, all or part of the spoofing orders were executed. Mr. Liew placed his orders manually by clicking a computer mouse or using his keyboard.
In addition, both the CFTC and the plea agreement referenced that, on occasion, Mr. Liew coordinated with an unnamed trader at “another [non-specified] major global bank” to engage in manipulation or attempted manipulation in order to move the gold and silver futures market to activate resting stop orders. After the stop orders were elected, Mr. Liew would liquidate his position by buying or selling back positions to profit.
According to Mr. Liew’s plea agreement, Mr. Liew “was taught to spoof by other metals traders, including other metals traders” at his employer.
In his criminal matter, Mr. Liew was formally charged with one count of conspiracy to commit wire fraud affecting a financial institution and spoofing. For this, he faces potential imprisonment from 24 to 30 months according to applicable sentencing guidelines. However, the Department of Justice indicated that it would recommend a lower sentence if Mr. Liew continued to provide “full and truthful cooperation.”
In connection with his CFTC Charges, Mr. Liew was charged with attempted manipulation and manipulation for his conduct prior to August 15, 2011. He was also charged with spoofing and using or attempting to use a manipulative device for this conduct on and after August 15, 2011 – express prohibitions of law that first became effective during July 2011 (one year after the enactment of the Dodd Frank Wall Street Reform and Consumer Protection Act).
Mr. Liew had only just begun working as a metals trader in December 2009 when he initiated his spoofing conduct, following completion of his employer’s global analyst program in approximately July 2009, according to Mr. Liew’s criminal plea.
Legal Weeds: The criminal action against Mr. Liew marks the third criminal action brought against an individual for spoofing.
In the first action, Michael Coscia was criminally charged with spoofing in October 2014 after settling civil actions related to the same conduct with the CFTC, the UK Financial Conduct Authority and the CME Group in July 2013. He was convicted of this offense in November 2015 and is currently serving a three-year prison term. (Click here for details of Mr. Coscia’s civil charges and settlements in the article, “CFTC, UK FCA and CME File Charges and Settle with Proprietary Trading Company and Principal for Spoofing” in the July 22, 2013 edition of Between Bridges. Click here for details of Mr. Coscia's criminal conviction and sentencing in the article, "Michael Coscia Sentenced to Three Years Imprisonment for Spoofing and Commodity Fraud” in the July 17, 2016 edition of Bridging the Week.)
Mr. Coscia’s conviction is currently being considered by a federal appeal court based in Chicago. Mr. Coscia had argued, among other things, that the provision of law prohibiting spoofing under which Mr. Coscia was prosecuted had not given him adequate notice of what trading activity was precisely prohibited. (Click here for background in the article, “Federal District Court Approves Flash Crasher’s US $38 Million Settlement; Federal Appeals Court Appears Sympathetic to Michael Coscia’s Claim That Spoofing Prohibition Is Too Vague” in the November 20, 2016 edition of Bridging the Week.)
In the second action, Navinder Sarao was criminally charged during April 2015 with engaging in manipulative conduct, including spoofing, involving E-mini S&P future contracts traded on the Chicago Mercantile Exchange between April 2010 and April 2015 including specific conduct that contributed to the May 6, 2010 flash crash. He pleaded guilty to his charges in November 2016 and awaits sentencing. For his offenses, Mr. Sarao was also charged by the CFTC. He settled with the Commission by agreeing to pay over $38.6 million in penalties and other sanctions. (Click here for background regarding Mr. Sarao’s criminal plea and CFTC settlement in the article, “Alleged Flash Crash Spoofer Pleads Guilty to Criminal Charges and Agrees to Resolve CFTC Civil Complaint by Paying Over US $38.6 Million in Penalties” in the November 13, 2016 edition of Bridging the Week.)
Just a few weeks ago, the CFTC resolved charges against Stephen Gola and Jonathan Brims, former associated persons of a futures commission merchant that recently settled its own CFTC charges, for engaging in spoofing activities from July 16, 2011, through December 31, 2012. According to the CFTC, the individuals engaged in spoofing conduct on more than 1,000 occasions by placing bids or offers for US Treasury futures products with an intent to cancel the orders before execution. (Click here for background in the article, “Former FCM Traders Settle CFTC Charges They Engaged in Spoofing More than 1,000 Times” in the April 2, 2017 edition of Bridging the Week.)
Given Mr. Liew’s cooperation agreement and language in both Mr. Liew’s plea agreement and the CFTC settlement order, more legal actions related to the conduct underlying Mr. Liew’s charges appear highly likely.
The Commodity Futures Trading Commission amended its recordkeeping requirements to eliminate many existing antiquated requirements and to be “technology neutral” in order to accommodate future advances in recordkeeping technology.
Among other things, the amended rule eliminates the existing requirement that,
Instead, the amended rule solely requires that all “regulatory records” be maintained in a way that “ensures the authenticity and reliability of such regulatory record” in accordance with applicable law and CFTC regulations.
The CFTC’s amended rule apples to all records that applicable law or CFTC regulations generally requires any person (including a legal entity, such as a corporation) to keep – whether a CFTC registrant or not (such records are termed "regulatory records" while such a person is referenced as a "records entity"). A regulatory record includes all books and records required to be kept, as well as any correction or amendment, and for electronic records,
(i) any data necessary to access, search or display any such books and records; and
(ii) all data produced and stored electronically describing how and when such books and records were created, formatted and modified.
However, to the extent other existing rules today relax certain recordkeeping obligations for certain persons, those rules will continue to trump the new amended recordkeeping rule. (e.g., recordkeeping obligations for trade option counterparties who are not swap dealers or major swap participants, or of unregistered members of exchanges regarding text messages and maintaining required records in a particular way; click here to access CFTC Rule 1.35(a)).
All records entities maintaining required books and records electronically must “establish appropriate systems and controls that ensure the authenticity and reliability of electronic regulatory records” However, the Commission determined not to require records entities to adopt specific policies and procedures reasonably designed to ensure the person’s compliance with the new recordkeeping requirements, as originally proposed. The Commission determined that, given the specificity of record keepers obligations under the amended rule, the proposed requirement for written policies and procedures was unnecessary. (Click here for background on the CFTC’s entire initial proposal in the article, “New Records Retention Regime for 21st Century Proposed by CFTC” in the January 16, 2017 edition of Bridging the Week.)
The CFTC determined not to change the duration of recordkeeping requirements in its amended rule with one exception. The CFTC agreed with two commentators’ request that the retention duration for electronic pre-execution communications that are required to be kept by swap dealers and major swap participants should be reduced to five years from the date of creation of the required record, not for five years from after the termination of the swap as currently is the obligation. (Click here for background regarding this requirement in CFTC Rule 23.202(a)(1).)
Because the amended rule was not intended to change what constitutes required records, the CFTC said that it would not provide guidance regarding requests for algorithmic trading systems’ source code, in response to a request from one commentator. The CFTC’s proposed amended rule does not impact record-keeping requirements of the Securities and Exchange Commission.
The CFTC’s amended recordkeeping rule will go into effect 90 days after it is published in the Federal Register.
Compliance Weeds: Although the new amended CFTC recordkeeping rules eliminates the anachronistic formal requirements that electronic books and records be maintained in WORM format and the need for an electronic records keeper to engage a third-party technical consultant, the new requirements are still very strict, albeit principles-based, with an eye towards accommodating evolving technologies.
As the Commission noted in issuing its amended rule,
[T]he obligation to satisfy the [new amended requirements] is one that a records entity ignores at its peril. It is ultimately the duty and responsibility of records entities to ensure accurate and reliable records.
Moreover, the new amended rule, does not require record entities to draft new policies and procedures.
That being said, persons impacted by the new amended rule, particularly non-registrants who may be required to maintain required records, should carefully review the new requirements to ensure their retention system comports with the Commission’s new expectations. For most firms, the amended rule will prove beneficial as it provides flexibility. But for others that may have overlooked compliance previously, now’s the time to get it right!
My View: Kudos to the Commission and staff for processing this helpful amended rule in only 64 days, from the close of the time period for public comments on March 20 to May 23.
My View: Just a few weeks ago, David Humphrey, a former branch chief in the SEC’s Division of Corporate Finance, pleaded guilty to criminal charges of making false statements in government filings in order to conceal his unauthorized trading of options and securities at various times while employed by the SEC from 1998 through 2014. On the same day, Mr. Humphrey also agreed to settle civil charges brought by the SEC related to the same matter. He consented to pay the SEC a fine of US $51,917 and disgorge profits of the same amount plus interest.
Under Regulation Automated Trading as initially proposed, the Commodity Futures Trading Commission would have been permitted to obtain proprietary source code of so-called “AT Persons” pursuant to its general inspection authority. Subsequently, the CFTC modified its proposal to limit such access to requests made pursuant to enhanced special call procedures, but did not restrict such access to requests through subpoena only.
The current pending criminal and civil action against Mr. Worrall, and the recent criminal prosecution and civil action against Mr. Humphrey, evidences one of the many potential concerns of critics fearful of turning over proprietary source code to staff of the CFTC or Department of Justice other than pursuant to lawful subpoena.
Although Mr. Worrall’s and Mr. Humphrey’s alleged wrongful conduct likely represents only the rarest of potential behavior by otherwise ordinarily and overwhelmingly very honest and ethical government employees, it illustrates how, over a relatively long period of time, a rogue government employee could disregard important safeguards to routinely and flagrantly engage in illicit activity right under the nose of his/her employer – including potentially misappropriating confidential information such as source code provided by a private entity.
Only in connection with the issuance of a lawful subpoena can a private entity have an effective opportunity to address in federal court concerns about confidentiality and attempt to tailor government access to proprietary source code subject to reasonable conditions.
(Click here for additional information regarding the criminal and civil charges against Mr. Humphrey in the article, “Ex-SEC Employee Pleads Guilty to Lying About Trading Securities” in the May 14, 2017 edition of Bridging the Week.)
Legal Weeds: All companies subject to the Commodity Exchange Act should review confidentiality provisions in their employment and severance agreements with employees to ensure that they do not expressly or implicitly prohibit an employee or ex-employee from taking advantage of CFTC rights and remedies under the Agency’s whistleblowing rules. Moreover, companies must be careful not to take action that could be deemed to impede an employee or employee from taking advantage of such provisions.
The CFTC adopted its current rules to more fully parallel equivalent rules previously enacted by the Securities and Exchange Commission. Using these rules, the SEC has actively pursued enforcement actions against many firms that utilized confidentiality agreements that the Agency believed discouraged employees from reporting potential violations of federal securities laws to it. (Click here for an overview of these enforcement actions in the article, “More Firms Sanctions for Whistleblower Offenses by SEC” in the January 29, 2017 edition of Bridging the Week.)
Compliance Weeds: Testing trading software or placing trades to sense market depth or latency in live markets risks the wrath of CME Group exchanges if the testing involves the placement of orders without the intent for execution. According to CME Group, “The entering of an order(s) in a non-test product without the intent to execute a bona fide transaction, including for the purpose of verifying connectivity or checking a data feed, is not permissible.” (Click here for further information in the CME Group MRAN RA1516-5 – Disruptive Practices Prohibited, Q/A 21.) Moreover, the CME Group does not consider the execution of an order, in whole or part, as necessarily dispositive of a bona fide intent to complete a trade. According to CME Group, “A variety of factors may lead to a violative order ultimately achieving an execution. Market Regulation will consider a multitude of factors in assessing whether [its Disruptive Trading rule] has been violated" (CME Group MRAN RA1516-5, Q/A 6).
My View: The CFTC is underfunded. Despite its hard-working staff, the agency is challenged to fulfill its regulatory mission, let alone timely assist industry participants to approve new products and initiatives. Those of us who interact with CFTC staff regularly can see first-hand how stretched they are and how urgently they require more resources, A solution to obtain more funding for the Agency must be found.
My View: It never appeared to be the intent of CME Group to extend strict liability obligations to clearing members for the failure of such firms’ direct access clients to enter accurately all mandatory audit trail fields. There is no way, realistically, a clearing member could ordinarily know of such issues. Once CME Group realized that a prior amendment had inadvertently accomplished this unintended result, staff rapidly re-amended the relevant rule to restore the status quo. Moreover, CME Group made clear that the potential liability of a clearing member for a direct access client’s incorrect input of mandatory audit trail information would be conditioned solely if the member knew or should have known of such violation. This is consistent, generally, with existing standards under a separate CME Group rule (click here to access CME Group Rule 574 – last paragraph). Not a perfect outcome and perhaps some tinkering of language is still required, but it’s better than where it was.
For further information:
Alleged Conduit to Hedge Fund for Confidential Non-Public Government Information Criminally Charged for Insider Trading Along with Three Fund Partners and Government Employee:
Central Banks and FX Market Participants Publish Global Principles of Good Practice:
CFTC Strengthens Protections for Whistle-Blowing While You Work:
CME Group Exchanges Charge One Trader With Impermissibly Entering Orders To Test Gold Market Latency and Another With Failure to Timely Complete Delivery:
Commissioner Bowen Votes to Process CFTC 2018 Budget Proposed by Acting Chairman Despite Disapproval:
Covfefe! NFA Reminds Swap Dealers of Upcoming Monthly Risk Reporting Requirements:
See also: Interpretive Notice Regarding Swap Valuation Disputes:
Dubai Regulator Offers Special License for FinTech Firms to Escape Ordinary Regulatory Requirements:
FCM Broad Strict Liability Globex Audit Trail Rule Amendment Revised to a Known or Should Have Known Standard by CME Group:
Former Newbie Bank Trader Pleads Guilty to Criminal Charges and Settles CFTC Civil Charges for No Fine for Spoofing, Attempted Manipulation and Manipulation of Gold and Silver Futures:
Principles-Based Rules Rule in CFTC Record Keeping Rule Amendment:
Proprietary Trader Who Admitted Stealing Employer’s Source Code Sentenced to One-Year Imprisonment:
See also: Plea Declaration:
Senior Brokerage Firm Officer Suspended by HK Regulator Six Months for Allegedly Failing to Stop Third Party Fund Transfers:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 3, 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.