Gary DeWaal and Associates LLC

Today may be Cinco de Mayo and a cause for festive partying. However, last week the New York Stock Exchange and two affiliates were not celebrating when they were charged and fined by the Securities and Exchange Commission for acting contrary to certain of the exchanges’ own rules, or for not having certain rules at all. Also not celebrating were respondents who were charged with violating speculative position limits, as well as EFRP and block trade requirements, and sanctioned by the Chicago Mercantile Exchange, and in one case, the Commodity Futures Trading Commission too.

As a result, the following matters are covered in this week’s Bridging the Week:

• SEC Charges and Settles with the New York Stock Exchange and Two Affiliates for Acting Contrary to Their Own Rules or Without Certain Rules at All; Affiliated Broker Dealer Also Charged (includes Compliance Weeds);
• CFTC and CME Bring and Settle Actions for Speculative Position Limit Violations; One CME Action Is for an Intra-day Violation (includes Compliance Weeds);
• CME Initiates and Resolves Still More Disciplinary Proceedings for EFRP and Block Trade Violations (includes Compliance Weeds);
• CFTC Announces Phased Roll-in of Mandatory Trading Requirement for Package Transactions That Starts May 16;
• CFTC Obtains a Federal Court Order Against an Accounting Firm and Its Sole Owner in Connection with an FCM Audit;
• Former UBS Employee John Hughes Banned from Industry for Life for His Role in the Use of an Unauthorized Financial Account Instrumental to Help Disguise the Unauthorized Trading of Kweku Adoboli;
• ICE Clear Europe Rule Proposes to Require Clearing Members to Cover Certain Clearinghouse Investment and General Business Losses;
• Three More Former Employees of Barclays Bank Are Subject to Criminal Proceedings for Their Role in the Alleged LIBOR Manipulation; and more.

Video version:

Article version:

SEC Charges and Settles with the New York Stock Exchange and Two Affiliates for Acting Contrary to Their Own Rules or Without Rules at All; Affiliated Broker Dealer Also Charged

In a sweeping criticism of the New York Stock Exchange’s and two affiliates’ course of conduct from 2008 to 2012, the Securities and Exchange Commission brought an administrative proceeding against the exchange and its affiliates for failing to comply with their own rules, or for not having certain required rules in the first place, on numerous occasions.  This resulted in the organizations’ failure to comply with their obligations as self-regulatory organizations under law, says the Commission.

Also sued was the NYSE’s affiliated broker dealer, Archipelago Securities, LLC (ArcaSec). ArcaSec was charged with failing to meet SEC regulatory capital requirements on two days in 2010, and not having required policies and procedures regarding the handling of non-public information. The two NYSE-affiliated exchanges involved in this matter are NYSE Arca, Inc. and NYSE MKT LLC (formerly NYSE Amex; Amex).

To settle this matter, NYSE, its affiliated exchanges, and ArcaSec agreed to pay a fine of US $4.5 million and to retain an independent consultant to review their rule compliance programs. Last year, NYSE, Arca, Amex and ArcaSec were all acquired by the IntercontinentalExchange, Inc. Previously, NYSE’s parent was NYSE Euronext.

Among the specific violations found by the SEC was that,

• since 2005, Arca maintained an error account at ArcaSec. Arca (and later, NYSE and Amex) used this account from time to time to liquidate error trades that arose from, among other situations, computer system breakdowns, unmatched orders or errors from routing to other exchanges. However Arca never filed a proposed rule with the SEC requesting approval to use an error account for this purpose. This failure occurred even (1) after SEC staff advised Arca senior management in late February 2010 that error account trading should be the subject of an SEC-approved rule; and (2) after NYSE Euronext compliance officials instructed Arca and ArcaSec management in February 2011 to stop using the ArcaSec error account until after an approved rule was in place. NYSE, Arca and Amex did not propose the requisite rules until 2012, and the rules were not effective until May 2012 for Arca, and October 2012 for NYSE and Amex.
   
• prior to October 2010, ArcaSec did not have polices, procedures and systems aimed at precluding its trade operations desk (TOD) personnel from trading on material non-public information while conducting error account transactions for NYSE and its two affiliated exchanges. During this time, TOD personnel had access to the three exchanges’ entire depth of book, including non-public liquidity information, while engaging in error account trading. Access to this information, could have allowed TOD personnel to anticipate possible price movements in securities they were liquidating and trade accordingly. SEC staff alerted ArcaSec management of this issue during February 2010, but the broker did not address this problem adequately until October 2010. The SEC did not charge ArcaSec with mishandling any non-public information, however.
   
• on January 11, 2010, a trading system error caused ArcaSec to acquire positions in 12 securities with a total value in excess of US $4 billion. Without notifying the SEC, ArcaSec’s TOD traded out of these erroneous positions after hours on January 11 and during market hours on January 12, sustaining a loss of US $1.175 million. As a result, ArcaSec sustained a regulatory capital deficiency of almost US $100 million on January 11 and 12, but failed to provide written notice of this to the SEC on these days, as required. In fact, ArcaSec did not provide written notice until 11 days later.
   
• from at least 2006 through September 2010 NYSE, through a number of affiliates, offered co-location services at various data centers. At the time, NYSE had no rule governing co-location services. The prices of these services were not publicly disseminated, and were different for different customers, depending on their individual negotiations. Following an SEC inspection in 2009, NYSE proposed a draft rule governing co-location services; however, the rule provided for standard fees only to new customers.  It was not until September 2010 that NYSE implemented an appropriate rule providing for standardized co-location fees.

In its complaint, the SEC also took issue with NYSE’s handling of certain block trades of securities through the New York Block Exchange, a joint venture involving NYSE and an unaffiliated entity, as well as its offer of a continuous electronic feed of closing order imbalance information to floor brokers earlier each day than the SEC had approved.

NYSE, Arca, Amex and ArcaSec settled this SEC complaint without admitting or denying any of the findings. NYSE previously was subject to three SEC enforcement actions, including in 2012 when the Commission found that the exchange failed to provide market data information to market participants on a manner that was “fair and reasonable” and “not unreasonably discriminatory.” Arca was subject to an SEC enforcement action in 2000, while Amex was sued twice by the Agency prior to being acquired by NYSE Euronext in 2008.

Compliance Weeds: Maintaining strong internal controls is important for all registrants, whether they are brokers, traders, fund managers, or even exchanges and clearing houses. Under current rules of the Commodity Futures Trading Commission, certain registrants are now formally required on at least an annual basis to itemize all relevant regulatory requirements and to assess how they meet such requirements through adequate policies and procedures. In fact, this exercise is a valuable drill for all registrants whether required or not. Certainly, when a regulator points out a potential deficiency in following a requirement, a registrant should timely assess whether the regulator’s assessment is correct, and if it is, then address that deficiency promptly.

CFTC and CME Bring and Settle Actions for Speculative Position Limit Violations; One CME Action Is for an Intra-day Violation

The Commodity Futures Trading Commission and the Chicago Mercantile Exchange brought and settled enforcement proceedings last week related to quite a few respondents’ failures to comply with speculative position limits. In most instances, including the CFTC matter, the offense involved a violation of speculative limits calculated at the end of a day; however, in one CME matter, the offense involved a violation of a speculative position limit intraday.

In the CFTC action, James Yadgir agreed to pay $130,000 for violating CME position limits in live cattle futures contracts on one day in 2011 and feeder cattle futures contracts on two days in 2012. The amounts of the excess over position limits were 70 futures equivalent contracts for the live cattle futures contracts, and approximately 82 futures equivalent contracts on one day and less than one futures equivalent contract on the other day for the feeder cattle futures contracts.

(A futures equivalent contract involves the conversion of options positions to futures contracts using the prior day’s risk factor provided by the relevant exchange. This allows futures and options positions to be aggregated to assess speculative position limit compliance, among other reasons.)

Separately, DRW Commodities, following a full evidentiary hearing before a CME (NYMEX) business conduct committee panel, was found to have violated CME position limits on June 20, 2011, in the July 2011 crude oil futures contract when it maintained an intraday long position of 3,734 lots, including 2,973 positions executed as trading at settlement (TAS) transactions and 761 non-TAS positions; the combined position exceeded NYMEX position limits by 734 lots. According to NYMEX,

“…the Panel found that market participants had fair notice that their positions established via TAS were included in the same underlying contract for purposes of determining compliance with the Exchange’s position limits.”

The panel ordered DRW to pay a fine of US $10,000 and to disgorge profits in excess of US $20,000 related to this matter.

(TAS trading is a means of trading intraday with the price of any position assigned as of the end of the day either using the actual settlement price or a price derived from a pre-agreed increment from the settlement price.)

Likewise, D.E. Shaw & Co and certain affiliates were alleged by CME (NYMEX) to have provided investment management services to certain funds that had approximately 1,478 open positions in the December 2012 Henry Hub natural gas look-alike last day financial futures contract (financial nat gas) on November 27, 2012, while at the same time holding 750 positions in the related December 2012 Henry Hub natural gas futures contract (physical nat gas). During the last three trading days, a trader can hold up to 5,000 financial nat gas futures contracts provided it does not hold any physical nat gas futures contracts. D.E. Shaw settled this matter by paying a US $25,000 fine. D.E. Shaw also agreed to pay a fine of US $75,000 to settle another matter involving alleged violations of position limits in the November 2013 financial nat gas futures contracts one one day in October 2013.

D.E. Shaw is not a member of CME, but the exchange exercised jurisdiction over it in these matters because affiliates of the company were CME members. (In fact, the CME regards any person who trades any of its products to have submitted to the exchange's jurisdiction for investigations and disciplinary matters; see CME rule 418 by clicking Here.)

Finally, last week the Ontario Teachers Pension Plan also settled with the CME for a position limit violation involving lean hog futures contracts on March 5, 2013. The Ontario Plan paid a fine of US $15,000 for this incident and disgorged profits in excess of US $17,500.

Compliance Weeds: With the impending re-issue of CFTC position limit rules, these cases are a reminder of the need for traders to maintain robust monitoring systems to compare open positions against position limits not only at the end of each day but intraday too. Positions must also be converted to futures equivalent contracts. Even a violation of less than one lot apparently might warrant CFTC attention, while violations of positions that are not priced until the end of day (e.g., TAS trades) can also cause regulatory issues. (For a discussion of the CFTC’s proposed new position limits, see the article in Bridging the Week entitled “CFTC Proposes New Position Limit Rules,” published November 11, 2013, by clicking Here.)

CME Initiates and Resolves Still More Disciplinary Proceedings for EFRP and Block Trade Violations:

A number of firms and one individual settled disciplinary proceedings in the CME’s seemingly ongoing crackdown related to violations of its exchange of futures for related positions and block trade requirements (for more, see the February 24, 2014, article on this website entitled “CME Publicizes a Plethora of EFRP Fines Involving Incomplete Documentation, Late Submissions and Improper Parties," by clicking Here).

In seemingly the most serious matter, the CME and Blake Strohofer agreed to his 10-year ban from trading CME products, as well as from being a CME member, as a result of Mr. Strohofer's misallocation of certain natural gas futures trades for one of his customers on June 28 and July 28, 2010, to an account of a former CFTC registrant. Mr. Strohofer subsequently used block trades to offset these transactions for the CFTC registrant against Mr. Strohofer’s customer, to the customer’s detriment.

In addition, the CME fined Republic Metals Corporation US $85,000 because the company, apparently on numerous occasions between February and August 2013, used EFRP transactions to transfer futures positions from one Republic account to another, and did not maintain documentation of corresponding cash positions. These transfers constituted wash sales, said the CME, and were non bona-fide EFRPs.

Separately, CME fined ING Bank NV US $25,000 for two transactions, and Somitekno Ltd. US $15,000 for one transaction, where the companies failed to have documentation of the related swap transaction in connection with executed EFRPs. Nomura Securities International was fined US $30,000 and PVM  Futures, Inc. was sanctioned a total of US $100,000, for failing to report timely and to have accurate records regarding certain block trade transactions.

Compliance Weeds: Typically, under CFTC rules, all futures transactions must be competitively executed on a regulated exchange (designated contract market; DCM). However, there are exceptions for EFRPs and block trades provided the transactions are undertaken precisely in accordance with CFTC-approved DCM rules. If the transactions are not handled accordingly, they are technically unlawful non-competitive transactions. Accordingly, futures commission merchants and their clients, should augment or implement internal compliance programs to ensure that all EFRP and block trade transactions they execute and post comply with all applicable requirements, including those related to authorized parties, documentation and the timing of information submitted to an exchange regarding a transaction. Sales and operations staff that physically handles such transactions should be alerted to indicia that may indicate potential issues with EFRPs or block trades and set up a process for consultation with the firm’s compliance department in such circumstances. Periodically, firms' compliance or internal audit departments should review the firm’s adherence to relevant CFTC and contract market rules related to EFRPs and block trades. Just a few weeks ago, the CME issued a revised frequently asked questions regarding EFRPs (for details, see article on this website entitled “Lord Voldemort Hovers over the Futures Industry: CME Prohibits All Transitory Exchange of Futures for Related Positions by Name” by clicking Here).

CFTC Announces Phased Roll-in of Mandatory Trading Requirement for “Package Transactions” That Starts May 16:

The Commodity Futures Trading Commission announced last week a schedule when all so-called package transactions that include at least one swap subject to a made available to trade (MAT) mandate, must begin to trade on, or subject to the rules of, a swap execution facility or designated contract market.

Previously, the CFTC temporarily had exempted such transactions from mandatory execution on such facilities through at least May 15, 2014.

(A package transaction involves two or more instruments executed between two or more counterparties that have one leg subject to the Commission’s requirement for mandatory execution on or subject to the rules of a SEF or DCM, and where the execution of one leg is dependent on the execution of all legs.) 

Under its new requirements, package transactions must begin trading on or subject to the rules of a SEF or DCM:

1. where all legs are subject to the MAT requirement, beginning May 16, 2014;
2. where one leg is a swap subject to MAT, and all the other legs are swaps subject to the CFTC’s mandatory clearing requirement, beginning June 2, 2014;
3. where one leg is subject to MAT and the other legs are US Treasury securities, beginning June 16, 2014; and
4. beginning November 16, 2014, where one leg is subject to the MAT requirement and at least one leg is under the CFTC’s exclusive jurisdiction but not subject to a clearing requirement; is not under the CFTC’s exclusive jurisdiction; or is not a swap (e.g., a futures contract or a security). 

At the same time, the Commission also granted certain relief through September 30, 2014, to accommodate the clearing of package transactions. This additional relief is necessitated because of the possibility that an individual leg of a package transaction could be rejected for clearing for risk reasons, while the overall risk in aggregate of all the legs of the transaction is not problematic.

(For further details on this matter, review an article in last Friday’s Katten Muchin Rosenman LLP Corporate and Financial Weekly Digest, “CFTC Provides Relief Regarding Package Transactions,” by clicking Here.)

And briefly:

• CFTC Obtains a Federal Court Order Against an Accounting Firm and Its Sole Owner in Connection with an FCM Audit: Tunney & Associates PC, an accounting firm, and its sole owner, Michael Tunney, agreed to pay a fine of US $100,000 related to its audits of The Linn Group (TLG), a futures commission merchant, for its fiscal years 2007 to 2011. The CFTC had alleged in a complaint filed in a federal court in Chicago that the respondents did not have “…the requisite technical training and proficiency to audit an FCM,” and that the audits failed to comply with Generally Accepted Auditing Standards and CFTC requirements. Among others things, the respondents failed to detect that TLG from 2007 to 2011 held non-customer and proprietary funds in a customer omnibus account or that TLG failed to obtain required acknowledgement letters from banks holding customer funds, all in violation of CFTC rules. Respondents also failed to provide timely notice of material inadequacies in internal control that it discovered at TLG, or no notice at all, also as required by Commission rules. In addition to payment of a fine, respondents agreed never directly or indirectly to practice before the CFTC again.
   
• Former UBS Employee John Hughes Banned from Industry for His Role in the Use of an Unauthorized Financial Account Instrumental to Help Disguise the Unauthorized Trading of Kweku Adoboli: The UK Financial Conduct Authority has banned for life John Christopher Hughes for his role in facilitating the use of an unauthorized financial account that was instrumental in the unauthorized trading scheme of Kweku Adoboli that caused UBS to sustain losses in excess of US $2.3 billion in 2011. During the relevant time, Mr. Hughes was the most senior trader on the same trading desk as Mr. Adoboli. The FCA claims that Mr. Hughes not only was aware of how Mr. Adoboli was using a certain account to misrepresent his trading desk’s profits and losses, but “made enquiries about the [account’s] size and influenced decisions about how it would be funded and used." Accordingly, says FCA,

“Mr. Hughes did not consider the [account] to be honest and knew that the Firm would not have authorized its use. Mr. Hughes conduct in relation to the [account] was dishonest and demonstrates that he is not a fit and proper person to perform functions in relation to any regulated activity carried on by an authorized or exempt person.”

• Proposed ICE Clear Europe Rule Will Require Clearing Members to Cover Certain Investment Losses: ICE Clear Europe has submitted to the CFTC proposed amended rules that would require clearing members to cover certain losses the clearinghouse might sustain as a result of investments of clearing members’ margin and guaranty fund contributions, as well as from its own general business operations.  These losses would be unrelated to losses ICE Clear Europe might sustain as a result of the default of a clearing member. Just a few weeks ago, the Futures Industry Association objected to a similar proposal by LCH.Clearnet Limited to cover losses as a result of its treasury management activities (to see FIA’s letter, click Here).

And even more briefly:

• Three More Former Employees of Barclays Bank Subject to Criminal Proceedings for Their Role in the Alleged LIBOR Manipulation: Twelve total ex-employees of Barclays Bank in the UK are now subject to criminal proceedings brought by the Securities Fraud Office related to their role in the alleged effort to manipulate LIBOR, as a result of new actions against three former employees commenced last week.
   
• Peregrine Financial Forex and OTC Metals Customers Offered One Time Opportunity to Settle for 30% of Their Claims: The trustee overseeing the bankruptcy estate of the Peregrine Financial Group is offering Forex and OTC Metals Customers an opportunity to settle their claims for a onetime payment of 30%. Interested parties must return a settlement agreement to the trustee by June 1, 2014. The court overseeing the PFG bankruptcy approved this process.
   
• CFTC Issues Revised Technical Guidance for New Ownership and Control Reports: With the compliance date of August 15, 2014, rapidly approaching for brokers and reportable traders to comply with new CFTC requirements aimed at enhancing the identification of large or frequent futures and swaps traders, the Commission issued new technical guidance regarding data submission standards and procedures. New reports required by the Commission are known as ownership and control reports.

For more information, see:

CFTC Requires Certain Package Transactions to Trade on SEFs or DCMs Beginning May 16:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-62.pdf

CFTC v. Tunney & Associates et al.:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enftunney042814.pdf

CFTC v. James C. Yadgir:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfyadgirorder42314.pdf

CFTC Technical Guidance Regarding OCRs:
http://www.cftc.gov/ucm/groups/public/@forms/documents/generic/ocrtechguideapr292014.pdf

CME Disciplinary Actions:

D.E. Shaw (NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0245715&case=13-9632-BC+D.E.+SHAW+AND+CO.+LP&contrib=NYME
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0245715&case=12-9156-BC+D.E+SHAW+AND+CO.+LP&contrib=NYME

DRW Commodities (NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0474952&case=11-8379-BC+DRW+COMMODITIES+LLC&contrib=NYME

ING Bank (NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0268266&case=13-9462-BC+ING+BANK+NV&contrib=NYME

Nomura Securities (CBOT):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0089946&case=11-8060-BC&contrib=CBOT

Ontario Teachers Pension Plan:
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0476896&case=13-9339-BC&contrib=CME

PVM Futures (COMEX, NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0386857&case=12-8924-BC+PVM+FUTURES+INC.&contrib=CEI
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0386857&case=13-9267-BC+PVM+FUTURES+INC.&contrib=NYME

Republic Metals Corporation (NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0476758&case=13-9621-BC+REPUBLIC+METALS+CORP.&contrib=CEI

Somitekno (NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0476759&case=13-9462-BC+SOMITEKNO+LTD.&contrib=NYME

Blake Strohofer (NYMEX):
https://www.nfa.futures.org/BasicNet/Case.aspx?entityid=0331774&case=10-07596-BC+BLAKE+STROHOFER&contrib=NYME

FCA Final Notice re: John Hughes:
http://www.fca.org.uk/static/documents/final-notices/john-christopher-hughes.pdf

ICE Clear Europe Proposal to Have Clearing Members Cover Certain Investment Losses:
https://www.theice.com/publicdocs/regulatory_filings/ICEU_CFTC_043014.pdf

PFG Forex and OTC Metals Claimants:
http://omnimgt.com/CMSVol/CMSDocs/pub_46535/465079_Notice%20of%20Forex-OTC%20Metals%20settlement.pdf

SEC v. New York Stock Exchange et al.:
http://www.sec.gov/litigation/admin/2014/34-72065.pdf

UK SFO Issues Criminal Proceeding Against Three More Ex-Barclays Employees Related to Their Role in the Alleged LIBOR Manipulation:
http://www.sfo.gov.uk/press-room/latest-press-releases/press-releases-2014/further-charges-in-libor-investigation.aspx

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 3, 2014.  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 and/or Gary DeWaal may represent one or more entities mentioned in this article. 

Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained in this article is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

 

---

© 2024 Gary DeWaal and Associates LLC | 1 (212) 382-4615 | 1180 Avenue of the Americas, Suite 809, New York, NY 10036