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The Commodity Futures Trading Commission brought and settled an enforcement action against a Dubai-based brokerage company and trading firm for the purported spoofing-type trading by one of its employees. The Commodity Exchange, Inc. also brought an action against the same entity for spoofing, and additionally charged the firm with failure to supervise. Separately, J. Christopher Giancarlo, CFTC Chairman, told a Congressional committee that he would be recommending a one year delay in the implementation date of any new swap dealer de minimis threshold amount in order to determine who should be registered as a swap dealer; this amount currently is scheduled to decrease from US $8 billion to US $3 billion at the end of 2018. He said he would request the delay, among other reasons, out of deference to two new CFTC commissioners, in order to assess relevant data and "get the right result;" however, the two new commissioners did not seem to be in favor of a further delay. As a result, the following matters are covered in this week’s edition of Bridging the Week:
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According to the CFTC, from at least March through August 2016, a trader for AGC – a Dubai-based broker and trading firm – on multiple occasions placed orders involving COMEX-traded copper futures that involved the same pattern: placement of a small lot order on one side of the market typically one or two levels away from best bid or offer; placement of a series of larger orders on the other side of the market with an alleged intent to cancel; and cancellation of the larger orders following execution of the smaller order in whole or part. On occasion, said the CFTC, the trader used another AGC trader’s account to disguise his activity.
The CFTC claimed that AGC did not have an anti-spoofing policy; did not train its traders or managers regarding US prohibitions against spoofing; did not monitor for spoofing; and did not detect its trader’s purported spoofing. Moreover, charged the CFTC, even after AGC’s futures commission merchant alerted one branch of the firm to its suspicions regarding the trader’s conduct, there was no internal elevation of the issue to more senior managers within AGC. Only after CME Group indicated it was investigating the trader did AGC review the individual’s conduct and “promptly” terminate him, said the Commission.
To resolve this matter, AGC agreed to pay to the CFTC a fine of US $300,000. The CFTC acknowledged the firm’s assistance; early stage resolution; and remedial measures to deter similar conduct in the future in accepting AGC’s offer of settlement.
In addition to charging AGC with a violation of its prohibition against disruptive practices, COMEX also charged the firm with a violation of its duty to supervise. COMEX said that AGC’s failure to provide its traders with “sufficient training regarding Exchange rules,” as well as to monitor its employees’ trading for potential violations, was the basis for this charge. AGC agreed to pay an additional US $70,000 to resolve the COMEX disciplinary action.
The relevant individual was not charged by either the CFTC or COMEX. AGC is formally organized as a free zone company registered with the Dubai Multi Commodities Center and regulated by the Emirates Securities and Commodities Authority.
Legal Weeds: The obligation of persons to supervise their employees under CFTC rules only applies to registrants (click here to access CFTC Rule 166.3). The obligation to supervise employees and agents under COMEX rules applies to any person who trades on the exchange – whether they are members or not. AGC was a not a COMEX member. (click here to access New York Mercantile Exchange Rule 432.W).
Compliance Weeds: Although these two actions against AGC break no new ground regarding the CFTC’s or CME Group’s view regarding spoofing, they do provide clear articulation by the regulators of at least some elements of what they expect as the components of effective compliance program regarding disruptive trading: (1) a written policy prohibiting spoofing; (2) training; (3) monitoring tools and monitoring; and (4) follow-up on red-flags emanating from such monitoring or otherwise. Moreover, potential violations are expected to be elevated within a company and appropriate action taken.
Last year, CME Group exchanges brought and settled disciplinary actions against Geneva Trading USA, LLC and two of its employees – Krzysztof Marzec and Robert Kimmons – for engaging in alleged spoofing-type activities on the New York Mercantile Exchange, Inc. and the Commodity Exchange, Inc. from March 2013 through July 2013. To resolve the matter, Geneva Trading agreed to disgorge aggregated COMEX and NYMEX trading profits of US $91,241. For the actions of its two traders, Geneva Trading was charged by the CME Group exchanges with violating just and equitable principles of trades and related violations, but solely on a strict liability basis. The firm was not charged with failure to supervise, and it was not assessed a fine. The CME Group exchanges implied that no fine was assessed because the firm had and enforced robust policies and procedures regarding the purported wrongful conduct of its employees. (Click here for background in the article “CME Group Settles With Trading Firm for Spoofing-Type Offenses, Holding It Strictly Liable for Acts of Agents; Orders Disgorgement of Profits” in the October 9, 2016 edition of Bridging the Week.)
Mr. Giancarlo called for this extension during an appearance before the House of Representatives’ Committee on Agriculture on October 11, saying it was appropriate because of the recent turnover of commissioners and staff at the CFTC, and the Commission’s current vacancy of two commissioners. Mr. Giancarlo said he wanted all commissioners to have the benefit of any new data in order to assess what the correct amount of the threshold should be. The objective, Mr. Giancarlo said, “is to get the right result, not a rushed result.”
Under CFTC regulation, a person is not to be considered a swap dealer unless its swap dealing activities for the prior 12-month period exceeds a gross notional threshold amount of US $3 billion after a phase-in requirement of US $8 billion (click here to access CFTC Rule 1.3(ggg)(4)). The phase-in period was originally scheduled to expire on December 31, 2017, but was extended by the CFTC to the end of 2018, following issuance of an August 2016 final report by the Commission’s Division of Swap Dealer and Intermediary Oversight. (Click here for background in the article “Just in Time for Football Season, CFTC Chairman Decides to Punt Swap De Minimis Threshold for One Year” in the September 18, 2016 edition of Bridging the Week.)
Virtually contemporaneously with Mr. Giancarlo’s testimony, the two new CFTC commissioners issued press releases suggesting that no delay in finalizing the de minimis threshold amount should occur. According to one of the new commissioners, Brian Quintenz, “[w]hile we should always consider new data in the ongoing evaluation of public policy, it is well past time to address this issue head-on, finalize a rational and effective threshold, and provide the market with clarity.” Rostin Behnam, the other new commissioner, said “[a]dditional delays of the swap dealer de minimis threshold will only serve to prolong uncertainty for market participants and create market risk.”
Separately, in his testimony, Mr. Giancarlo reiterated his strong commitment to ensuring that “America’s derivatives markets operate free from fraud, manipulation, and other trading abuses,” and discussed the Division of Enforcement’s new self-reporting program to help the Commission “identify the individuals… most culpable for any wrongdoing.” (Click here for background on this reporting program in the article “New Math: Come Forward + Come Clean + Remediate = Substantial Settlement Benefits Says CFTC Enforcement Chief” in the October 1, 2017 edition of Bridging the Week.)
Additionally, Mr. Giancarlo provided an overview of the Commission’s LabCFTC and Project KISS initiatives, as well as his promotion of efforts to support cybersecurity at the CFTC and at derivatives markets. He also pointed to the need to amend current swaps trading rules, to enhance swaps data reporting, and to work with international regulators to promote cooperation and coordination. He cautioned European regulators not to unilaterally amend agreements regarding the oversight of systematically important cross-border clearinghouses in anticipation of Brexit as potentially contemplated. “If the EU must reconsider its approach to cross‑border supervision of systemically important CCPs, then we cannot have piecemeal and contradictory rule making,” said Mr. Giancarlo.
Mr. Giancarlo also indicated that he and Jay Clayton, Chairman of the Securities and Exchange Commission, had been regularly speaking since they both became chairman of their respective agencies, in order to help harmonize and simplify overlapping rules. According to Mr. Giancarlo, “[w]e hope to soon announce some interagency understandings that will result in real regulatory efficiencies,” perhaps as early as year-end.
My View: It is not clear that further delay in assessing an appropriate de minimis threshold amount will likely change the outcome of any CFTC vote. Although, in his testimony before the House Agriculture Committee, Mr. Giancarlo promised that he would make a recommendation in early 2018 on this matter, it seems a foregone conclusion – and the CFTC should save precious resources by formally proposing now to maintain the de minimis exception at US $8 billion, consistent with findings in DSIO’s 2016 final report.
Separately, Marex Financial, Limited, was charged with market disruption and failure to supervise in connection with the trading of an employee, Jake Wiltshire. Mr. Wiltshire was separately charged with market disruption.
According to IFUS, from May through October 2016, Mr. Wiltshire, trading for Marex and himself pursuant to a profit‑sharing arrangement, manually entered large orders on one side of the cocoa futures market to induce executions of smaller quantity orders on the other side. After the smaller orders were executed, Mr. Wiltshire cancelled the larger orders. Marex settled the IFUS disciplinary action by agreeing to pay a fine of US $25,000 and disgorging profits of more than US $9,000. Mr. Wiltshire settled his disciplinary action by agreeing to a 360‑day IFUS trading suspension.
In accepting Marex’s settlement, IFUS noted that after it alerted Marex regarding the employee’s conduct, the firm immediately terminated the employee and disciplined his supervisor. IFUS noted, however, that a monitoring tool used by Marex was not activated for cocoa markets during the relevant time.
Additionally, Peace River Citrus Products and R. William Becker agreed to pay a fine of US $7,500 to resolve charges by IFUS that they executed wash sales purportedly to move positions between firm accounts. Similarly, Chenwei Zhu, was ordered by a business conduct committee of the Chicago Mercantile Exchange to pay a fine of US $25,000, disgorge profits of over US $19,000, and serve a 35-business day suspension on all CME Group exchanges, related to trading to transfer equity between accounts. The BCC held that such trading was pre-arranged in violation of a CME rule prohibiting such conduct (click here to access CME Group Rule 432.G).
Compliance Weeds: Under the relevant IFUS rule (Rule 4.01), the duty of a person to “diligently supervise” its employees and agents applies to “every person” whether a member or not. Moreover, “agent” expressly includes “any Exchange-related activities associated with automated trading systems that generate, submit and/or cancel messages without human intervention.”
The parallel CME Group rule is not as explicit on its face. However, in a Market Regulation Advisory Notice entitled Supervisory Obligations for Employees, CME Group notes that, under its parallel rule, agents include not only natural persons, but “any automated trading systems … operated by any party.” (click here to access MRAN RA1517-5; click here to access CME Group Rule 432.W),
More briefly:
For further information:
CFTC Agrees to Transfer Enforcement Action Against Retail Metals Dealer to Venue Closer to Defendants:
/ckfinder/userfiles/files/CFTC%20Consent%20to%20Monex%20Venue%20Move%20Motion.pdf
CFTC Chairman Proposes to Again Postpone Final Action on Swap De Minimis Threshold; Suggests CFTC and SEC Already Working to Address Some Overlapping Rules:
http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-29
https://agriculture.house.gov/calendar/eventsingle.aspx?EventID=4064
CME Group Summarizes Summary Fines Process for Reporting Errors:
http://www.cmegroup.com/notices/market-regulation/2017/10/RA1714-5.pdf
European Commission and CFTC Reach Accord on Comparability of Margin Rules for Uncleared Swaps and a Common Approach to Trading Venues:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister101317.pdf
http://europa.eu/rapid/press-release_SPEECH-17-3949_en.htm
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmo_cacdtv101317.pdf
ICE Futures U.S. Sanctions Proprietary Trading Firm for Failure to Supervise for Malfunctioning Automated Trading System:
Model State Virtual Currency Law Finalized Finally:
http://uniformlaws.org/Act.aspx?title=Regulation%20of%20Virtual-Currency%20Businesses%20Act
Proprietary Trading Firm Charged by CFTC With Spoofing Based Solely on the Alleged Wrongful Trading of One Employee:
SEC Discloses Proposed Simplified Disclosure Obligations for Public Companies, Investment Companies and Investment Advisers:
https://www.sec.gov/rules/proposed/2017/33-10425.pdf
SEC Inspector General Says Ensuring Effective Cybersecurity Program Remains a Management Challenge for Agency:
https://www.oversight.gov/sites/default/files/oig-reports/Inspector-Generals-Statement-on-the-SECs-Mgt-and-Performance-Challenges-Oct-2017.pdf
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of October 14, 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.
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: October 9 – 13 and October 16, 2017 (Spoofing; Supervision; De Minimis Threshold; Automated Trading System Gone Bad)
Jump to: Automated Trading Systems and Connectivity