COVID-19 fallout continued to dominate the financial services industry during the past few weeks, prompting ongoing adherence to business continuity and other contingency plans by market participants and new relief by regulators to enable markets to operate as efficiently as possible. The crashing of crude oil prices into deep negative territory on April 20 also caused consternation for many. Amidst all the extraordinary circumstances, a number of futures-industry exchanges published disciplinary actions related to alleged breaches of their rules concerning block trades and exchange for related position transactions as well as wash trades. Separately, the Financial Stability Board published 10 recommendations related to the supervision of global stablecoins. Curiously, the recommendations did not extend to central bank-issued digital currencies. As a result, the following matters are covered in this special edition of Between Bridges:
Block Trades, EFRPs
A non-US freight and commodity broker agreed to pay a fine of US $85,000 to NYMEX to resolve charges that, at various times from September 2018 through July 2019, it purportedly failed to report block trades executed for customers involving energy futures within required time periods following their execution as well as failed to report accurate trade information. The exchange’s business conduct committee also said that the firm failed to advise its employees of relevant exchange rules and market regulation advisory notices pertaining to block trades as well as failed to supervise them to ensure they complied with the exchange’s block trades reporting requirements.
Similarly, NYMEX also charged Eclipse International, Inc. with including inaccurate execution times on reports of multiple block trades and failing to report some block trades timely from April through July 2019. NYMEX additionally claimed that Eclipse failed to properly train its employees regarding the exchange’s block trades reporting requirements. The firm settled this action by agreeing to pay a fine of US $60,000.
On the other side of the Atlantic, Straits Financial Services Pte Ltd (SFS) agreed to pay a fine of £83,333.33 (approximately US $104,000) to resolve a disciplinary action by ICE Futures Europe for allegedly failing “to meet adequate standards of record-keeping” in connection with block trades and for not having “appropriate systems and controls in place to support monitoring of activity executed by brokers” at the firm. In its disciplinary notice, ICE Futures EU did not identify SFS’s conduct that gave rise to the disciplinary action or its duration, but cited its rule that requires all members to ensure that telephone lines for the receipt or giving of orders are tape recorded absent an undue burden on the firm. (Click here to access ICE Futures EU Trading Procedure 3.1.4.) The exchange acknowledged that it accorded SFS a material discount for an early settlement.
MNR Executions LLC consented to pay a fine of US $25,000 to resolve a disciplinary matter by the Cboe Futures Exchange LLC. CFE claimed that, on four occasions in October 2018, MNR failed to enter information related to exchange of contracts for related positions it executed against a counterparty within a required 30-minute window. On CFE, ECRPs are equivalent to exchange for related positions elsewhere.
Three unrelated entities and two individuals agreed to pay fines totaling US $125,000 to resolve allegations by the Chicago Board of Trade, Chicago Mercantile Exchange, and NYMEX related to wash trades.
A non-US affiliate of a major global insurance and asset management group consented to remit payment of US $35,000 to resolve charges by CME that, from March 1, 2018, through June 30, 2019, two of its employees entered buy and sell orders for futures spreads on Globex for accounts with common beneficial ownership. The exchange said the firm entered these transactions “when it reasonably should have known” that some of the futures trades would result in a “wash result.” CME said the purpose of these trades was to “manage an affiliate’s risk by rolling positions held in three separate accounts owned by the affiliate’s subsidiaries.” CME also claimed that the firm did not provide its employees with adequate training and did not diligently supervise them.
Eagle Seven LLC also agreed to pay a fine of US $35,000 to NYMEX because its automated trading system generated “numerous” trades between August 2 and 28, 2018, involving European Natural Gas futures contracts that self-matched. Although the exchange acknowledged that the firm did not intend its trades to execute against each other, Eagle “should have known” that new orders placed by the ATS on one side of the market might match against resting orders on the other side of the market previously generated by the ATS. NYMEX also claimed that the firm failed to train its employees adequately and failed to employ technology to minimize self-matching. In the notice of disciplinary action, NYMEX did not provide insight into the exact amount of self-matches by Eagle, or the percentage of self-matches compared to the overall amount of the firm’s or the exchange’s volume in the relevant contracts.
The purported coordinated placement of buy and sell orders on three occasions by a principal of L3 Gestora Recursos LTDA directly on one side of an options market and indirectly through another trader on the other side of the market for the identical account in a manner that resulted in the transactions matching, prompted charges by CME against the firm for wash trading. L3 Gestora settled this disciplinary action for a fine of US $30,000. In a related matter, Kaio Sartori consented to pay a fine of US $10,000 and to be banned from accessing any CME Group exchanges’ facility for five business days for his role in the three transactions as the relevant principal of L3.
Angelica Rodrigues also agreed to pay a fine of US $15,000 and to be banned from accessing any CME Group exchanges’ facility for five business days for entering buy and sell orders during Globex pre-open sessions between March 14 and April 17, 2019, in soybean futures for her employer’s accounts with common beneficial ownership. The CME BCC charged that Ms. Rodrigues should reasonably have known that the orders would match upon market open, and in fact, they did. The impermissibility of placing such orders in the pre-open state is highlighted in a CME Group MRAN. (Click here to access MRAN QRA 1903-5 Q/A 5.)
Spoofing, Position Limits
Yuan Ye consented to a two-month suspension from accessing all ICE Futures U.S. trading platforms for purportedly engaging in spoofing-type trading on December 30, 2016. According to IFUS, Mr. Ye placed large quantities on one side of a market not with the intent to trade, but rather “to create false depth, put pressure on the market, and mislead market participants” in order to move the market closer to his smaller lot orders resting on the other side of the market.
Legend Arb Trading LTD agreed to pay a fine of US $25,000 to the CBOT for violating the spot month speculative position limit of 540 contracts in soybean oil futures at the close of trading on November 27, 2019, the business day prior to Thanksgiving, by 144 lots. Legend liquidated its overage on November 29, 2019, the next business day, and did not profit from its activity, said the CBOT.
Compliance Weeds: Block trades are a type of noncompetitive transaction permissible under rules of the Commodity Futures Trading Commission if they are executed strictly in accordance with the applicable exchange’s rules. If they are not so executed, the transaction may be a violation of not only the applicable exchange’s rules, but of applicable law and CFTC rules. (Click here for background regarding block trades in the article “Block Trade Requirements Must Be Followed Strictly; No Chips Off the Old Block Trade Rules Permitted” in the January 10, 2016 edition of Bridging the Week.) According to CME Group, the prices of block trades must be fair and reasonable, considering (1) the size of the transaction; (2) the prices and sizes of other transactions in the same contract at the equivalent time; (3) the prices and sizes of transactions in other relevant markets; and (4) the circumstances of the markets or the parties to the block trade. (See CME Rule 526(D) contained in CME Group MRAN RA2002-5 (2020).)
In September 2016, the CFTC brought and settled an enforcement action against JSC VTB Bank (VTB), a Russia-based bank, and VTB Capital PLC (VTB Capital), a UK-based bank that was ultimately 94 percent owned by VTB, for engaging in block trades with each other contrary to CME Group rules, in that the prices of the block trades were not “fair and reasonable.” (Click here to access the relevant CFTC Order and Settlement.)
According to the CFTC, between December 2010 and June 2013, the two companies engaged in more than 100 block trades involving CME Group’s Russian Ruble/US Dollar futures contracts. The CFTC alleged that the companies engaged in these transactions to transfer certain Russian Ruble/US dollar risk from VTB to VTB Capital. However, in doing so, said the CFTC, the defendants chose a price for their block trades that “typically” reflected the midpoint between the prevailing bid-ask spread of the over-the-counter RUB/USD swap. The CFTC said that, because the VTB defendants did not seek other block trade prices from other counterparties, the prices chosen by the defendants for their block trades were not fair and reasonable prices, as required by CME Group rules. Thus the block trades were unlawful noncompetitive trades under the applicable CFTC rule. (Click here to access CFTC Rule 1.38(a).) To resolve the CFTC’s complaint, defendants agreed to pay a fine of US $5 million and to institute or enhance procedures to avoid noncompetitive transactions.
According to the CFTC’s complaint against the VTB defendants, the price of the allegedly problematic block trades was the midpoint of the bid-ask spread of the related swap instrument. Moreover, VTB claimed that, at the time of execution of the allegedly problematic block trades, the market in the RUB/USD futures contract was illiquid. Given these circumstances, it is hard to understand how the CFTC concluded that the prices of the relevant block trades were not fair and reasonable.
That being said, CME Group prohibits block trades between accounts with common beneficial ownership unless each party’s decision to trade was made independently. Given that VTB and VTB Capital appear to be under common beneficial ownership and acted in concert to effectuate a risk transfer from VTB to VTB Capital, it seems odd that the CFTC did not allege that this aspect of the relevant block trades was problematic, as opposed to the quality of the prices. Indeed, the CFTC noted in its Order that “[t]he block trades by design, did not create any market risk to the combined VTB entities because, ultimately, any financial gains and losses from these trades were consolidated on VTB’s books.” Ordinarily exchanges give wide latitude to the prices decided between parties to a block trade because such prices are reported to the public independently of trade prices in the ordinary market, are not included in the daily trading range and will not set off any conditional orders. (Click here to access CME Group’s MRAN regarding block trades in effect at the relevant time; see Section 5 entitled Time and Prices of Block Trades; click here to access similar current guidance by ICE Futures U.S., Q/A4.)
As a result of the CFTC’s enforcement action against the VTB defendants, it is unclear how parties can assuredly assess whether a block trade price is fair and reasonable absent contemporaneous liquid futures market conditions. This imposed unfair ambiguity in the face of relatively clear exchanges’ guidance.
Established in 2009, the FSB is an international organization comprising representatives of national authorities responsible for financial stability in material international financial centers that monitors and makes recommendations about the global financial system.
The FSB considered two types of GSCs: those that are asset-linked and seek to maintain a stable value by reference to real or financial assets or other cryptoassets, and those based on algorithms that seek to maintain a stable value through protocols that automatically adjust the supply of the stablecoin in response to changes in demand. The FSB affirmatively determined not to include central bank-issued digital currencies in its analysis of global stablecoins. (Click here for a discussion of a proposed issue of a CBDC by the Bank of England in the article “Bank of England Evaluates Central Bank-Issued Digital Currency” in the March 15, 2020 issue of Bridging the Week. Apparently the Peoples Bank of China began testing a national digital currency in a few cities during April; click here for background in Chinese.)
The FSB noted that GSCs typically involve three functions: (1) the issuance, redemption and stabilization of the value of the GSC; (2) the transfer of the GSC; and (3) interaction with other GSC users for storing and exchanging GSCs. The FSB concluded that in many ways these functions parallel functions of other payment systems or financial services or products and are subject to the same risks. However, they may also be subject to new risks depending on the design of the GSC. These risks include financial stability as well as market liquidity and credit risk, and operational and fraud risk, including being used for money-laundering purposes.
Other recommendations by the FSB for international authorities included ensuring GSCs:
Comments on the FSB’s proposals will be accepted through July 15, 2020.
In other legal and regulatory developments impacting crypto assets:
The Association’s goal is to create a “simple global payment system and financial infrastructure” to provide an alternative international payment system for unbanked persons as well as others. The Libra global stablecoin was initially proposed to be backed by a combination of cash, cash equivalents and short-term government securities and for its core blockchain to ultimately evolve to a decentralized system. This proposal has been revised so that some Libra stablecoins would solely be single currency denominated (e.g., US dollar, Great Britain pound) and the overall Libra reserve would constitute cash, cash equivalents and short-term government securities corresponding to the composition of outstanding single-currency stablecoins. The Libra global stablecoin would be tied to individual currency Libra stablecoins. The Libra Association has now proposed that the basket composition and weights of its reserve be overseen by a “group of regulators and central banks or an international organization (e.g., IMF) under the guidance of the Association’s main supervisory authority, the Swiss Financial Market Supervisory Authority.”
Additionally, the Libra Association proposed to forego any evolution of the Libra blockchain to a permissionless system to help ensure system security and a more robust compliance framework around its stablecoins as well as better protections for its reserves.
The Libra initiative was initially announced and backed in principal part by Facebook.
My View: There may be a race between privately developed global stablecoins and central bank-issued digital currencies. It is important that any requirements (or impediments) imposed on GSCs should also be applicable to CBDCs as there is little that would automatically make a CBDC safer than a privately issued alternative. If the principle “same risks, same regulations” means anything, it should mean that payment systems designed by governments should be subject to the same standards as any private payment systems. Governments should not be given an advance position at the starting gate solely because they are governments and are in a position to impede private innovation.
The FSB’s consultation expressly determined to place CBDCs outside the scope of its analysis and recommendations. This is a major oversight. CBDCs should be within the scope of the FSB’s final review and guidance.
Among the general principles codified in the proposed revised bankruptcy rules are that, in the case of an FCM bankruptcy, customer positions should be ported where possible and not liquidated; deliveries should be permitted to occur pursuant to the rules of relevant contract markets and clearinghouses but preferably outside the administration of the debtor’s estate; letters of credit may be drawn to their full value by a trustee when there is a shortfall in customer funds and a trustee may regard the full value of the letter of credit as having been provided to a customer (even if not drawn) when evaluating what might be otherwise owed the customer from the debtor’s estate; and the trustee should liquidate all of a customer’s open commodity positions if the account is in deficit and fails to meet a margin call within a reasonable time – with the time period being one hour or more “absent exigent circumstances,” when the time period may be less.
(Click here for a detailed analysis of the CFTC’s new proposed bankruptcy rules with a section-by-section comparison with existing requirements in the Katten Advisory dated April 29, 2020, entitled “More than a Refresh but Much Less Than A Substantial Overhaul: The CFTC Proposes Comprehensive Amendments to its Bankruptcy Rules.”)
According to FINRA, from November 2017 through February 2019, Kestra utilized the third-party vendor to help 68 registered representatives join it. Kestra worked with the vendor to develop a template spreadsheet to capture information regarding the salespersons’ customers, including their names, social security and driver license numbers, dates of birth and certain financial information. Kestra staff worked with recruited brokers to complete the spreadsheets.
FINRA alleged that Kestra’s actions in having recruited registered representatives take nonpublic personal customer information from their prior employer violated SEC Regulation S-P. (Click here for background) and constituted a violation of FINRA’s requirement that members and their associated persons exhibit high standards of commercial honor. (Click here to access FINRA rule 2010.)
On April 17, 2020, the Securities and Exchange Commission announced that Old Ironsides Energy, LLC agreed to pay a fine of US $1 million for including in marketing materials for a private fund – Old Ironsides Energy Fund LLP – legacy performance results by the adviser’s principals that included one prior private fund investment when the performance results were represented as a track record solely for early state direct drilling investments by the principals. The effect of this was to inflate the performance results for direct drilling investments. These marketing materials were used by Old Ironsides from spring 2014 through spring 2015. The SEC charged that this inclusion of the private fund investment was contrary to the adviser’s own procedures and the Investment Advisers Act and relevant SEC rule. (Click here to access 15 U.S.C. § 80b–6(4) and here for SEC Rule 206(4)-1(a)(5).)
On April 22, the SEC publicized that Monomoy Capital Management, L.P. agreed to pay penalties of almost US $2 million for failing to disclose in the operating documents of a private fund it managed – the Monomoy Capital Partners AIV II, L.P. – or otherwise from April 2012 through December 2016, that it charged back to the operating companies of the fund 100 percent of the adviser’s in-house operations group. According to the limited partnership agreement between the adviser and the fund, the adviser said that it solely charged the fund 2 percent of the limited partners’ committed capital for the first five years and 2 percent of their invested capital afterwards. The SEC claimed this undisclosed passing along of the in-house operation group’s costs constituted a fraud in violation of applicable law. (Click here to access 15 U.S.C. § 80b–6(2).) Monomoy Capital agreed to pay a fine of US $200,000 and disgorgement and interest of over $1.72 million to resolve the SEC’s charges.
Finally, on April 30, the SEC said that Monsoon Capital and Gautam Prakash, its founder, owner, managing director and chief compliance officer, agreed jointly and severally to pay a fine of US $100,000 as a result of certain actions of Mr. Prakash from 2015 through 2019. Specifically, the SEC charged that, during the relevant time, Mr. Prakash approximately twice each year flew back and forth to India, charging a private fund Monsoon advised – the Monsoon Infrastructure & Reality Co-Invest, L.P. (“MIRC”) – with the cost of a refundable business class fare while actually utilizing a much lower cost nonrefundable fare; he purportedly pocketed the difference. Additionally, Mr. Prakash borrowed US $1 million from MIRC in June 2017 for a few days in connection with a personal investment, despite being told by three Monsoon employees that the borrowing breached his fiduciary duty to MIRC. Mr. Prakash reimbursed MIRC both for his false travel expenses and the loan with interest. Notwithstanding, the SEC charged that his initial actions constituted a fraud on MIRC and other violations of law. (Click here to access 15 U.S.C. §§ 80b–6(1), (2) and (4).) Mr. Prakash agreed to be barred from association with any investment adviser and other SEC registrants as part of his settlement.
(Click here for a detailed analysis of the CFTC’s proposed new requirements in the Katten Advisory dated April 16, 2020, entitled “Revising Initial Expectations: CFTC Proposes Substantial Amendments to Form CPO-PQR and Related Requirements.")
(Katten’s Financial Markets and Regulation Group continues to provide regular updates to worldwide relief granted by principal financial services industry regulators in the United States, United Kingdom and elsewhere in response to the COVID-19 pandemic. Click here to access this dedicated site as well as to subscribe to the regular updates.)
Separately, the International Organization of Securities Commissions issued an overview of how regulators are currently supporting sustainable finance initiatives. According to IOSCO, 83 percent of 34 responding regulators note they facilitate sustainable investments by promoting transparency, while 43 percent noted they do so by prohibiting greenwashing. (Greenwashing is a form of marketing that overstates or deceptively promotes an organization's products, aims or policies as environmentally friendly when it is not the case.) Forty-one percent define ESG risks as financial risks that must be managed and disclosed while 14 percent affirmatively promote investments of capital in sustainable investments. Sixty-two percent of all responding regulators said their mandates do not include any explicit references to ESG. In a poll of market participants, a commonly expressed concern was the meaning of sustainable investments and sustainability risks and the absence or low quality of relevant data.
(ESG – which stands for environmental, social, and governance – references three principal factors related to the measurement and ethical impact of an investment in a business or enterprise.)
My View: It has been a pleasure to serve under Mr. Quintenz as a member of the TAC, to deal with him for clients on multiple issues, and to enjoy his many thoughtful writings.
For further information:
Ain’t No Regulator Called the “Canadian Office of Derivative Trading” Warns Canadian Securities Administrators:
Bitnomial Exchange Approved by CFTC as Contract Market for Margined Futures on Physically Deliverable Bitcoin Futures:
Block Trades Purported Rules Violations Prompt Disciplinary Actions by Exchanges on Both Sides of Atlantic:
Legend Arb Trading:
AXA Bank Belgium:
L3 Gestora de Recursos:
Eagle Seven, LLC:
Eclipse International Inc.:
Freight Investor Services Ltd.:
Brian Quintenz to Leave CFTC:
Broker-Dealer Fined by FINRA for Encouraging Registrants to Take Private Customer Information from Prior Employer:
CPOs Proposed to Have Option of Filing Parallel NFA Form to Satisfy Recommended Revised Quarterly Form CPO-PQR Requirements by CFTC:
CFTC Proposes Major Revamp of Its Bankruptcy Rule; Changes Mostly Codify Status Quo:
Financial Stability Board Proposes Recommendations for International Regulators Regarding Global Stablecoins:
Libra Revises Stablecoin Proposal:
Most Banking Regulators Consider Climate-Related Financial Risks in Scope of Existing Regulatory and Supervisory Frameworks:
SEC Sanctions Private Equity Firm and Investment Advisers for Purported Disclosure Failures:
US Regulators Authorize Paycheck Program Loans to Count as Good Capital and Extend CAT Deadlines:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 2, 2020. 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. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or employees.
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.
May 03, 2020
April 12, 2020
March 29, 2020
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Between Bridges Gary DeWaal: May 4, 2020 (Block Trades; EFRPs, Wash Trades; GSCs; CBDCs; Privacy Violations; Misrepresentations by IAs)Jump to: Bankruptcy Between Bridges Bitcoin Ecosystem Block Trades and EFRPs Central Bank Digital Currency Compliance Weeds COVID-19 Employers and Employees Environmental, Social and Governance Exchanges and Clearing Houses Fraud and Anti-Fraud Investment Advisers Managed Money My View Policy and Politics Position Limits Privacy Stablecoins Trade Practices (including Disruptive Trading)