Bridging the Week by Gary DeWaal

In an inaugural-type speech last week, Jay Clayton, newly appointed Chairman of the Securities and Exchange Commission, advocated for kumbaya with other regulators, particularly with the Commodity Futures Trading Commission. Mr. Clayton singled out working with the CFTC in order to achieve greater harmonization of rules required under Dodd-Frank, as well as to reduce unwarranted complexity and costs to both market participants and the two agencies. Separately, the Financial Industry Regulatory Authority settled more disciplinary actions for the alleged failure of  broker-dealers to fully comply with the SEC’s current recordkeeping requirements related to electronic brokerage records. The requirements are the same obligations that the CFTC is eliminating effective August 28 for being antiquated and not accommodating new technologies. As a result, the following matters are covered in this week’s edition of Bridging the Week:

• New SEC Chairman Previews Governing Principles; Stresses Commitment to Working With CFTC (includes My View);
• CFTC’s Division of Market Oversight Initiates Review of Swap Reporting Rules;
• Two More Broker-Dealers Sanctioned by FINRA for Recordkeeping Violations (includes My View);
• Researching How SEC Detects Unusual Trading Does Not Help Alleged Insider Trader Avoid Criminal and Civil Government Prosecution (includes Legal Weeds and Hard to Believe); and more.

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Briefly:

• New SEC Chairman Previews Governing Principles; Stresses Commitment to Working With CFTC: Last week, Jay Clayton, newly appointed Chairman of the Securities and Exchange Commission, enumerated eight “guiding principles” that he says will govern his leadership. Among these are that regulatory actions cause change and can have long-term effects. Some may be positive, such as the US public company disclosure and trading system which, he said, “is an incredibly powerful, efficient, and reliable means of making investment opportunities available to the general public.” However, he questioned whether this system is also causing a decline in the total number of US listed public companies in the last decade. He noted that, during this period, “the median word-count for SEC filings has more than doubled, yet readability of those documents is at an all-time low.” Mr. Clayton also said that coordination with other regulators is paramount. The SEC’s new chairman committed to working with the Commodity Futures Trading Commission to find ways where the agencies can harmonize rules enacted under the Dodd-Frank Wall Street Reform and Consumer Protection Act related to over-the-counter swaps, and to “reduce unnecessary complexity as well as costs to both regulators and market participants.” Other key principles articulated by Mr. Clayton include (1) that each part of the SEC’s three-part mission – to protect investors, to maintain fair, orderly and efficient capital markets, and to facilitate capital markets – is critical; (2) the SEC must protect the long-term interests of Main Street investors; (3) the SEC’s historic approach to regulation “is sound;” and (4) as markets evolve so must rules and operations of the SEC. Mr. Clayton enumerated his principles in an inaugural-type speech before the Economic Club of New York on July 12.

My View: Just as in 1981 when the SEC and CFTC voluntarily proposed a rationalization of the then contentious regulation of options and futures on securities – known as the “Johnson-Shad Accord” (click here for background) – that was subsequently enacted into law, there is opportunity now for the SEC and CFTC to rationalize the regulation of security-based swaps and investment management regulation.  In general, deference should be given to the CFTC in connection with all trading rules related to transactions in derivatives of any kind, including security-based swaps. This is because of the Commission’s expertise and long-time experience in protecting the public and market participants from fraud, manipulation and abusive practices related to derivatives on all commodities (except onions and motion picture box office receipts), including financial instruments. Contrariwise, deference should be given to the SEC when it comes to the registration of commodity pool operators of private commodity pools for CPOs that are registered as investment advisers with the SEC or affiliated with SEC-registered IAs. Prior to 2012, the CFTC maintained a rule that was then rescinded that exempted such CPOs from CFTC registration. (Click here for background on former CFTC Rule 4.13(a)(4) in the February 14, 2012 advisory entitled “CFTC Adopts Significant Changes to CPO and CTA Registration and Compliance Requirements” by Katten Muchin Rosenman LLP.) No compelling rationale was provided at the time for such action. Accordingly, that rule rescindment should now be reversed. (Click here for advocacy of this position in a letter by the Managed Futures Association to CFTC Acting Chairman J. Christopher Giancarlo, dated June 6, 2017.) Of course, I still wonder about the efficacy of maintaining multiple regulatory agencies to oversee US markets' regulation in the first place. (Click here to access the section My View to the article “US Department of Treasury Recommends Modifications to Volcker and Bank Capital Rules, and Rationalization of Financial Regulation” in the June 18, 2017 edition of Bridging the Week.)

Correction: An earlier version of Bridging the Week incorrectly noted that the Johnson-Shad Accord was proposed in 2000; it was 1981 (the proposal was enacted into law in 1982). In 2000 revisions to the Johnson-Shad accord were proposed by then CFTC and SEC charimen, William Rainer and Arthur Levitt, respectively (click here for details).

• CFTC’s Division of Market Oversight Initiates Review of Swap Reporting Rules: The Division of Market Oversight of the Commodity Futures Trading Commission announced a “comprehensive review” of its swap data reporting requirements. DMO’s review will be conducted in two parts. First, the Division will examine swap data repositories’ operations, with emphasis on how SDRs validate incoming data and counterparties confirm data at SDRs. Secondly, the Division will review workflows generally, with a focus to standardize data fields, to reduce the amount of messages that are required to be reported regarding a single swap, and to evaluate when extending reporting timelines will enhance reporting quality. Among other things, the Division will explore possible alignment of CFTC reporting deadlines with those of the Securities and Exchange Commission and the European Securities and Markets Authority, and the harmonization of data fields with foreign regulators. The Division aims to present the Commission with recommendations related to SDR operations by the fourth quarter this year, and regarding overall workflows, by late first quarter or early second quarter in 2018. The CFTC will accept comments on its proposed roadmap through August 21.
   
• Two More Broker-Dealers Sanctioned by FINRA for Recordkeeping Violations: Two more broker-dealers – State Street Global Markets, LLC and Acorns Securities, LLC – agreed to settle disciplinary actions filed by the Financial Industry Regulatory Authority charging them with violations of recordkeeping rules of the Securities and Exchange Commission. In the action naming State Street, the firm agreed to pay a fine of US $1.5 million to resolve FINRA’s claim that, from November 4, 2011, through April 21, 2017, the firm failed to keep approximately 131.5 million electronic brokerage records of orders placed by certain of its institutional customers in a non-erasable and non-rewritable format known as “WORM” as required by SEC rule. According to FINRA, most of these records were of unexecuted orders. In addition, charged FINRA, State Street failed to store separately from the original duplicate copies over 245 million records of orders and up to approximately 52 million electronic communications, and to have an audit system to monitor the inputting of new records and changes to old record, also as required by SEC rule. (Click here to access the SEC’s requirement regarding acceptable electronic storage media at 17 CFR 240.17a-4(f).) Similarly, Acorns Securities, which acts as an introducing broker-dealer, consented to remit a fine of US $175,000 for likewise failing to retain electronic records in WORM format and not implementing a required audit system, as well as not advising their examining authority of their intent to use such media at least 90 days in advance, as currently required.

My View: Just two weeks ago, HSBC Securities (USA), Inc. agreed to pay a fine of US $1.5 million to settle FINRA charges that, from May 2003 through the present, it did not maintain order records related to approximately 12.36 million transactions in required WORM format, as well as for related recordkeeping violations. This followed FINRA’s assessment of a total of US $14.4 million in fines against 12 other firms for “significant deficiencies” in their retention of required books and records on electronic storage media at the end of 2016. These actions, which are based on an existing SEC requirement grounded in outdated technology, may be justified as a matter of law, but seem unwarranted as a matter of policy. Recently, the Commodity Futures Trading Commission approved a revised records retention rule that eliminated many of its existing antiquated recordkeeping requirements and aims to be “technology neutral” in order to accommodate future advances in recordkeeping technology. Among other things, the revised rule eliminates the CFTC requirement that electronic records be kept in WORM format. Instead, the CFTC’s revised rule is more principles-based and 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 new recordkeeping requirement is effective August 28. The SEC should quickly consider amending its current recordkeeping requirements to conform to the CFTC’s new amended rule.

• Researching How SEC Detects Unusual Trading Does Not Help Alleged Insider Trader Avoid Criminal and Civil Government Prosecution: Fei Yan, a post-doctoral associate at a major research university, was arrested on July 12 and charged with insider trading in connection with transactions in options on the stock of Stillwater Mining Company during November and December 2016, when he allegedly knew through misappropriated, nonpublic information that the firm was subject to takeover negotiations by Sibanye Gold Limited. He acquired this non-public information, according to a complaint approved by the US Attorneys’ Office located in New York City, through conversations with his spouse who, at the time, was an associate at a law firm that had been retained by Stillwater to handle relevant legal matters. Shortly after conversations with his wife, who worked on the Stillwater potential takeover for her employer, Mr. Yan purchased relevant options, which he sold after the announcement of Stillwater’s acquisition on December 9. Moreover, many of Mr. Yan’s purchases of Stillwater options followed his scrupulous research on the Internet regarding how the Securities and Exchange Commission detects unusual trades and his review of related articles, including “U.S. Insider Trading Enforcement Goes Global” and “Want to Commit Insider Trading? Here’s How Not to Do It.” The complaint alleged that Mr. Yan purportedly traded the relevant options in an account in the name of his mother – who lived in China. In connection with this matter, Mr. Yan was charged with two counts of securities fraud and one count of wire fraud. If convicted, Mr. Yan could be subject to substantial imprisonment and fines. Mr. Yan was also named in an SEC civil complaint related to the identical matter, as well as to transactions in options in Mattress Firm Holding Corp. The SEC charged that Mr. Yan purchased options on Mattress Firm stock based on misappropriated information also obtained through his spouse as a result of work at her law firm regarding’s Mattress’s Firm’s potential acquisition by Steinhoff International Holdings N.V. in 2016.

Legal Weeds: Two recent enforcement actions by the Commodity Futures Trading Commission also charged persons with insider trading for misappropriating trading information. In the first action brought in 2015, the CFTC alleged that Arya Motazedi, a gasoline trader for an unnamed large, publicly traded corporation, misappropriated trading information of his employer for his own benefit. In the second action, CFTC brought and settled charges against Jon Ruggles, a former trader for Delta Airlines, for trading accounts in his wife’s name based on his knowledge of trades he anticipated placing for his employer. Both actions were grounded in a provision of law under the Dodd-Frank Wall Street Reform and Consumer Protection Act and a CFTC rule that prohibit use of a manipulative or deceptive device or contrivance in connection with futures or swaps trading. (Click here to access Commodity Exchange Act Section 6(c)(1), US Code § 9(1), and here to access CFTC Rule 180.1. Click here for background on these CFTC enforcement actions in the article “Ex-Airline Employee Sued by CFTC for Insider Trading of Futures Based on Misappropriated Information” in the October 2, 2016 edition of Bridging the Week.)

Hard to Believe: If the allegations in these cases are proven true, it will demonstrate that studying too hard may sometimes not be such a great thing!

More briefly:

• FINRA Issues FAQs for Broker-Dealers to Comply with New Fixed Income Disclosure Requirements to Retail Clients: The Financial Industry Regulatory Authority issued guidance in the form of Frequently Asked Questions regarding its recently adopted enhanced confirmation disclosure requirements for corporate and agency debt securities sold to retail clients. Beginning on May 14, 2018, members must disclose, in connection with retail transactions, the amount of mark-ups or mark-downs if the member transacts an offsetting principal trade in the same security on the same day; the time of execution; and, if the confirmation statement is electronic, a hyperlink to certain trading data on a FINRA-hosted web page. (Click here for background on FINRA’s initial proposal regarding this matter in the article “FINRA Proposes to Require Brokers to Disclose Mark-Ups and Mark-Downs to Retail Clients on Fixed-Income Securities” in the February 28, 2017 edition of Bridging the Week.)
   
• President Nominates Rostin Behnam as CFTC Commissioner and Intends to Have Kevin McIntyre Serve As Chairman of FERC: The White House nominated Rostin Behnam as Commissioner of the Commodity Futures Trading Commission, for a term expiring June 19, 2021, and indicated its intent to have Kevin J. McIntyre serve as Chairman of the Federal Energy Regulatory Commission through June 30, 2023. Mr. Behnam currently serves as senior counsel to Debbie Stabenow, Ranking Member of the US Senate Committee on Agriculture, Nutrition & Forestry. Mr. McIntyre is currently co-head of the global energy practice at the law firm Jones Day.
   
• Industry Generally Supports CFTC’s Proposed CCO Amended Obligations; Some Argue Proposal Does Not Go Far Enough, While Another Says It Strays Too Far: In letters submitted to the Commodity Futures Trading Commission, industry organizations were generally supportive of the Commission’s recently proposed changes to the enumerated duties of chief compliance officers of futures commission merchants and swap dealers. Among other things, the CFTC’s amendments, if adopted, would eliminate the current requirement that annual reports identify each specific law provision and CFTC rule that pertains to an FCM and SD and specifically tie each such provision to the precise firm policies and procedures that are reasonably designed to ensure compliance. In a joint response letter, the Futures Industry Association and the Securities Industry and Financial Markets Association commended the CFTC for seeking to promote consistency with parallel requirements adopted by other regulators while reducing regulatory burdens and enhancing regulatory oversight. However, the industry organizations identified other measures the Commission should take to enhance alignment of its CCO rules with those of the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Among other things, the two groups urged the Commission to define what specific responsibilities a CCO must fulfill to “administer” a registrant’s compliance policies and procedures as required under the proposed amended Commission rule. Likewise, the National Futures Association urged the Commission to more clearly define the CCO’s role to be that of an independent advisor and not a supervisor. Contrariwise, Better Markets argued that the CFTC’s proposed amended rule “strays from the CFTC’s overarching duty to put public interest above concerns about regulatory costs and burdens, efficiencies, and regulatory harmony.” (Click here for background on the CFTC’s CCO proposal in the article “CFTC Recommends Amendments to CCO Obligations and Annual Reports” in the May 7, 2017 edition of Bridging the Week.)

For further information:

CFTC’s Division of Market Oversight Initiates Review of Swap Reporting Rules:
http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-33.pdf
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmo_swapdataplan071017.pdf

FINRA Issues FAQs for Broker-Dealers to Comply With New Fixed Income Disclosure Requirements to Retail Clients:
http://www.finra.org/industry/faq-fixed-income-confirmation-disclosure-frequently-asked-questions-faq

Industry Generally Supports CFTC’s Proposed CCO Amended Obligations; Some Argue Proposal Does Not Go Far Enough, While Another Says It Strays Too Far:
https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1811&ctl00_ctl00_cphContentMain_MainContent_gvCommentListChangePage=1

New SEC Chairman Previews Governing Principles; Stresses Commitment to Working With CFTC:
https://www.sec.gov/news/speech/remarks-economic-club-new-york

President Nominates Rostin Behnam as CFTC Commissioner and Intends to Have Kevin McIntyre Serve As Chairman of FERC:

• https://www.whitehouse.gov/the-press-office/2017/07/13/ten-nominations-sent-senate-today
• https://www.whitehouse.gov/the-press-office/2017/07/13/president-donald-j-trump-announces-key-additions-his-administration

Researching How SEC Detects Unusual Trading Does Not Help Alleged Insider Trader Avoid Criminal and Civil Government Prosecution:

• Criminal Complaint:
  https://www.justice.gov/usao-sdny/press-release/file/980156/download
• SEC Complaint:
  https://www.sec.gov/litigation/complaints/2017/comp-pr2017-125.pdf

Two More Broker-Dealers Sanctioned by FINRA for Recordkeeping Violations:

Acorns Securities:
/ckfinder/userfiles/files/Acorns%20FINRA%20WORM.pdf
State Street Global Markets:
/ckfinder/userfiles/files/State%20Street%20FINRA%20WORM.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 15, 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.