Bridging the Week by Gary DeWaal: March 7 - 11, and 14, 2016 (Civil Rights Violation; Spoofing; Disorderly Liquidation; Risk Management; Disaggregation)

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Published Date: March 13, 2016

Last week, a federal court in New York permitted a lawsuit to proceed alleging that a United States Attorney and other government officials violated the civil rights of a former hedge fund operator. In addition, both ICE Futures U.S. and CME Group settled a number of disciplinary actions alleging possible spoofing and market disruption; liquidating positions in a disorderly fashion; and trading based on non-public customer information. Finally, IFUS proposed amending one of its rules to permit the possible disaggregation of certain positions among affiliated persons for position limits calculation purposes to parallel a rule proposed by the Commodity Futures Trading Commission that has not yet been adopted. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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My View: Sadly, the decision in this matter reads like an episode of Billions, the Showtime series based on the relentless and highly personal efforts of a fictional US Attorney to indict an equally make-believe hedge fund operator for insider trading. However, there can be no amusement in real life when activities of law enforcement personnel result in the demise of a real business and the suffering by real persons. This is particularly the case, as alleged by Mr. Ganek, where the warrant that authorized the highly publicized raid on the premises of his hedge fund that led to its demise may have been based on knowingly false information provided by government employees. Mr. Ganek’s claims are indeed, as the judge hearing this matter stated, “grave allegations.” (Click here to access my review of Billions in the article, “Billions: Ambiguity in Control” in the January 18, 2016 edition of Bridging the Week.)

Compliance Weeds: From perusing ICE Futures U.S.’s Disciplinary Notice related to Glencore Grain’s settlement it is hard to fully understand the facts underlying the firm’s alleged wrongdoing. However, the allegations of wrongdoing reminded me that there are actually two important elements of bona fide hedging transactions: First, the hedging transactions or positions ordinarily represent a substitute for transactions to be made or positions to be taken in the future and are economically appropriate for the risk in the conduct and management of a commercial enterprise. Second, hedge positions must be ”established and liquidated in an orderly manner “ consistent “with sound commercial practices.” Both legs must be met; it’s not either or. (Click here for details in the CFTC’s definition of bona fide hedging transactions in CFTC Regulation 1.3(z).)

Compliance Weeds: Although staff’s guidance is expressly limited to the application of its risk management program requirements to FCMs that handle customer funds, a similar requirement to maintain RMPs applies to swap dealers and major swap participants (click here to access the relevant CFTC Rule 23.600). Although staff indicated that similar guidance might be issued to SDs and MSPs later, this FCM guidance should be considered by SDs and MSPs, by analogy, to evaluate the adequacy of their own RMPs. Also, as staff commented in its guidance, an FCM must broadly evaluate its risks when designing its RMP. An FCM must consider risks posed by affiliates, all lines of the FCM’s business, all other FCM trading activity and “must describe in detail how the RMP has been integrated into risk management at the consolidated entity level.” (Click here for further CFTC guidance on RMPs in the Federal Register release adopting CFTC Rule 1.11 (pgs. 68517 – 68521).)

My View: Attempted compliance by introducing brokers handling swaps transactions with applicable CFTC requirements provides an unsavory path past Scylla and Charybdis that perhaps only Odysseus can safely navigate. One CFTC rule still provides that each IB must open each customer’s account with a carrying FCM, while another states that each FCM statement must reflect that the account was introduced by an IB and identify the name of the IB. (Click here to access CFTC Rule 1.57(a) and here to access CFTC Rule 1.33(f).) These rules make no sense in connection with IBs introducing over-the-counter swaps transactions to swap dealers and cannot possibly be adhered to. The CFTC should amend its introducing broker rules to conform to the evolution of the role of IBs to handle swaps transactions and not leave a Damoclean sword hanging over swaps IBs. In the interim, staff should issue appropriate interpretive guidance.

Compliance Weeds: CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bona fide hedging position under CFTC rules. These documents must be made as of the close of business on the last Friday of the relevant month. Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report. Part III of Form 304 (Unfixed Price Cotton “On-Call”) must be filed by any cotton merchant or dealer that holds a so-called reportable position in cotton (i.e., pursuant to large trader reportable levels; click here to access CFTC Rule 15.03) regardless of whether or not it constitutes a bona fide hedge. Form 304 (Part III) must be made as of the close of business on Friday every week and received by the CFTC in New York by no later than the second business day following the date of the report.

My View: There are many obligations under CFTC rules that apply to non-registrants. The obligation to file Forms 204 and 304 for certain traders of agricultural futures contracts who engage in hedging of corresponding physical positions is just one of many such requirements. The technical processes regarding Forms 204 and 304 are difficult to follow: sometimes a report is filed weekly not monthly. Sometimes the trigger for the filing is a reportable position; other times it is a position in excess of a speculative position limit. Sometimes a report is filed in New York; other times it is filed in Chicago. These are details that can often be lost in translation. As a result, it is not surprising that some recent enforcement actions regarding breaches in reporting requirements have involved non-US based firms (Click here for details regarding a CFTC fine against a Switzerland-based company in the article, “Non-US Cotton Merchant Fined US $480,000 for Not Filing Mandatory Weekly Reports of Physical Positions” in the May 17, 2015 edition of Bridging the Week. Click here for details regarding CFTC fines against two Brazilian-based companies in the article, “CFTC Fines Cotton Traders for Not Filing Weekly Reports Showing Their Physical Purchases and Sales” in the January 20, 2014 edition of Bridging the Week.) However, US-based non-registrants have also been subject to CFTC sanctions, as in the instant enforcement action Although the length of time of CHS’s and CHS Hedging’s violation was extensive, it is still questionable whether a fine of US $1 million is justified for an agricultural cooperative’s violation of a rule that is arcane at best and where there appears to have been no intentional wrongdoing.

Compliance Weeds: Both of these developments are significant. Traditionally, an exchange of futures for a related position must involve the purchase (or sale) of a futures position (or option under certain circumstances) and the simultaneous sale (or purchase) of a related position. There must be customary documentation to evidence the related position transaction that must be produced to an exchange upon request. In connection with the limited circumstances of delivery issues involving soft commodities, ICE Futures Europe will now permit the use of exchange for futures transactions to roll forward a futures contract. Effectively, the cash leg of such transaction will be the physical position that was not delivered. This is a highly exceptional circumstance and the principle cannot, for now, be applied to other exchanges or even other products on ICE Europe. Likewise, ICE Futures U.S.’s proposed amendment of its rules to potentially permit accounts of related entities or persons to be disaggregated for purposes of complying with exchange-position limits in advance of the adoption by the Commodity Futures Trading Commission of a similar rule is a practical response to situations where accounts within a corporate group are truly independently traded and one entity does not coordinate directly or indirectly with the other. The CFTC currently permits disaggregation for certain accounts of eligible entities (mainly certain commodity pool operators or commodity trading advisors) subject to independent control, but not to accounts of non-eligible entities. Again, this potential relief will not apply to positions subject to federal speculative position limits.

And more briefly:

For more information, see:

Another Non-Registrant Sanctioned by CFTC for Failure to File Accurate Monthly Reports of Cash Positions:

CFTC Staff Clarifies CPO-PQR FAQ:

CFTC Staff Issues Guidance on Elements of an Effective FCM Risk Management Program:

CME Group Says Once a Position Is Closed, It’s Always Closed:

CME Member Sanctioned for Trading on Non-Public Customer Information; FCM Fined for Netting Down and Not Closing Out Open Positions:

European Regulators Publish Draft Rules Regarding Margin Requirements for Uncleared Swaps:

FINRA Sanctions Broker-Dealer for Requiring Newly Hired Salespersons to Disclose Their Prior Firm’s Private Customer Information:

Guaranteed IBs Authorized by CFTC Staff to Introduce OTC Swaps to Swap Dealer and Cleared Swaps to FCM Other Than Guarantor:

IFUS to Adopt CFTC Proposed Aggregation Rule as Its Own in Advance of CFTC Adoption While ICE Futures Europe Permits Use of EFPs to Roll Forward Soft Commodities Futures Contracts Because of Delivery Issues:
ICE Europe:

IFUS Charges Trader With Possible Spoofing and Market Disruption While Another Entity Is Charged With Allegedly Liquidating Positions in a Disorderly Fashion to Avoid Speculative Limits Issues:
Cornerstone Global:

Inspector General Recommends Measures to Increase Productivity at CFTC Office of Chief Economist:

Federal Court Allows Former Hedge Fund Operator’s Lawsuit Alleging Civil Rights Violations to Proceed Against US Attorney and Other Government Officials:

NFA Will Review and Approve Uncleared Swaps Margin Models for SDs and MSPs:

Now You See It, Now You Don' CFTC EEMAC Withdraws Report Regarding Proposed Position Limits:

See also, withdrawn copy of CFTC EEMAC February 25, 2016 report:’s_2015_Review_and_Consideration_of_the_CFTC_’s_Proposed_Rule_on_Position_Limits,_February_2016

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of March 12, 2016. 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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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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