CME Group proposed a new clearing membership category to help customers avoid the risk of receiving a pro-rata allocation of losses from their carrying futures commission merchant in the circumstance of the FCM’s insolvency and its inability to satisfy its obligations to all its customers in full. In addition, the Financial Industry Regulatory Authority warned its members not to take advantage of recent federal appellate court decisions that it claimed were incorrect in permitting member firms to bar customers and associated persons from taking advantage of FINRA arbitration forums to resolve disputes. Finally, two former senior officers of a global investment bank responsible for certain of its foreign exchange trading were named in a criminal complaint filed in a federal court located in Brooklyn, NY, related to their purported front running of the foreign exchange trades of a customer. As a result, the following matters are covered in this week’s edition of Bridging the Week:
My View: In its rule proposal submission to the CFTC, CME Group acknowledged that some clearing members object that FCMs may potentially incur increased regulatory capital charges to serve as a DFP Guarantor. They argued that DFPs themselves should pay a minimum margin of 108 percent of requirements, as opposed to 104 percent, and there should be no additional capital requirements for a DFP Guarantor. CME Group rejected this argument, claiming that its proposal was more equitable and questioned “whether the DFP program does in fact create heightened capital requirements on the DFP Guarantor as compared to the capital requirements set out for FCM clearing members with respect to customers under Commission regulations.” (This is because under CFTC capital rules, FCMs potentially must set aside 8 percent of a customer’s margin requirements for positions carried with it. As a DFP Guarantor, an FCM would only potentially be required to set aside 4 percent of a DFP’s margin requirements.) This latter argument by CME Group clearly has merit. However, CME Group’s initiative is certainly more advantageous to FCMs with significant excess regulatory capital as opposed to FCMs will less excess regulatory capital. That being said, even if there is some fine tuning before these proposed rules are finalized, CME Group’s proposal would help customers that want to minimize their FCM risk and should be approved by the CFTC.
My View: It seems terribly inappropriate and unfair for FINRA to advise member firms that if they follow permissions given by a federal court that may be inconsistent with FINRA rules they “may be subject to disciplinary action.” FINRA certainly may express its disappointment regarding a court outcome and work with the Securities and Exchange Commission to design an appropriate response (including a legislative proposal to submit to Congress), but, in the interim, threatening to take disciplinary actions against members who fail to follow its rules, despite appellate courts’ views that such rules under certain circumstances do not have to be followed, seems to be a horrific precedent by a regulatory organization.
Legal Weeds: The criminal action against Mr. Johnson and Mr. Scott for fraud sounds like a securities action for insider trading based on a theory of misappropriation. A civil action was recently brought (and settled) by the Commodity Futures Trading Commission that also echoed the securities concept of insider trading, relying on the relatively new Dodd-Frank Wall Street Reform and Consumer Protection Act’s prohibition against employment of a manipulative or deceptive device in connection with futures trading. According to the CFTC, from September 3 through November 26, 2013, Arya Motazedi, a gasoline trader employed by an unnamed “large, publicly traded corporation” misappropriated “non-public, confidential and material information” of his employer to benefit his own trading of energy futures contracts listed on the New York Mercantile Exchange, Inc. Specifically, on 34 occasions Mr. Motazedi allegedly traded opposite his employer’s accounts to effectively and illicitly transfer funds from the firm to himself, and on 12 other occasions he traded in advance of orders he placed for the firm to generate “additional profits for himself to the detriment of the company.” The CFTC claimed that Mr. Motazedi owed a duty of confidentiality to his employer. This duty arose, said the Commission, because he and his employer “shared a relationship of trust and confidence,” and because his employer had express policies that prohibited him from engaging in personal transactions that “created an actual or potential conflict of interest.” The CFTC charged that Mr. Motazedi’s trading constituted fraud, as well as impermissible fictitious sales and noncompetitive trades. (Click here for details regarding this enforcement action in the article, “CFTC Brings First Insider Trading-Type Enforcement Action Based on New Anti-Manipulation Authority” in the October 6, 2015 edition of Bridging the Week.) A second insider trading-type case may be pending at the CFTC. (Click here for details in the article, “Trader Sanctioned Over US $3 Million by CME Group for Trading on Confidential Employer Information; Both He and Wife Barred From Exchange Trading” in the June 19, 2016 edition of Bridging the Week.)
Compliance Weeds: On CME Group, FCMs may only permit customers capable of making or taking delivery from carrying positions prior to a futures contract expiration that entails a delivery obligation. FCMs are affirmatively obligated to confirm that each customer can fulfill its delivery obligations (either making or taking delivery), and if not, are required to liquidate the customer’s position in an orderly manner prior to contract expiration. This concept of an orderly liquidation is also associated with the concept of bona fide hedging – although the obligation is that of the hedging entity, not an FCM. Under the definition of bona fide hedging transaction under applicable law, no positions may qualify as bona fide hedge positions (and thus potentially available for an exemption from position limits) unless the positions are maintained (1) to offset price risks derived from commercial cash or spot operations and (2) such positions “liquidated in an orderly manner in accordance with sound commercial practices” (Click here to access the relevant provision of the Commodity Exchange Act, Sec. 1.3(z)(1).)
And more briefly:
For more information, see:
CFTC Staff Suggest Measures by Clearinghouses to Enhance Recovery and Wind-Down Plans:
CME Group Proposes New Clearing Member Category to Help Customers Avoid Pro Rata Distribution Risk in Case of FCM Insolvency:
CME Group Sanctions Market Participants for Mishandling a Delivery, a Non-Bona Fide EFRP, a Transitory EFRP and Disruptive Trading:
JPMorgan Chase Bank:
ESMA Fines Rating Agency For Breakdowns in Internal Controls:
ESMA Issues Update on Extension of Funds' Marketing Passport to 12 Non-EU Countries:
FINRA to Federal Courts: Our Rules Trump Your Decisions:
Global Head of FX Cash-Trading Desk of Global Investment Bank Arrested for Front Running:
MF Global and Individual Defendants Finalize Settlement With Customers and Other Creditors:
SGX Acknowledges July 14 Exchange Shutdown Due to Hardware Failure:
SGX to Transfer Regulatory Functions to Separate Company:
UK FCA Recognizes Value of Dark Pools but Urges More Public Details Regarding Operations and Conflicts of Interest:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 23, 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.
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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Bridging the Week by Gary DeWaal: July 18 - 22 and July 25, 2016 (New Clearing Member Category; Above the Law; MF Global; FX Trading Front Running; Deliveries; EFRPs)Jump to: APAC Regulation (sans Capital and Liquidity) Block Trades and EFRPs Bridging the Week Compliance Weeds Dark Pools and Internalization EMEA Regulation (sans Capital and Liquidity and UK after March 1, 2019) Exchanges and Clearing Houses Forum Selection Insider Trading Legal Weeds Managed Money MF Global My View Systems and Controls Trade Practices (including Disruptive Trading)