In a week punctuated by the beginning of trading on Swap Execution Facilities and the simultaneous shut down of the US Commodity Futures Trading Commission, other important developments occurred internationally and in the US relevant to all financial service participants. These matters included:

• Compliance officers are in the cross hairs once again of the UK FCA and the US SEC: UK Compliance Officer sued by the FCA, while the SEC issued a Frequency Asked Questions regarding the potential liability of legal and compliance officers for business persons under a failure to supervise theory (with Valuable Lessons Learned);
• ADM Investor Services, Inc. was fined by the CFTC for segregation violations (with Valuable Lessons Learned);
• CFTC issued FAQs related to commodity options;
• CFTC issued No-Action relief related to SEFs just prior to closing its doors, including to an Australian (but not European) multilateral trading facility offering swaps to US persons;
• ESMA finalized alternative investment funds’ reporting requirements;
• EUREX scheduled implementation of its Excessive System Usage Fee and Order to Trade Ratio to discourage High Frequency Trading; and additional articles too.

Video Overview:

 

Article Overview:

Compliance Officers in the Cross Hairs by the UK FCA and the US SEC (with Valuable Lessons Learned)

Last week, the UK Financial Conduct Authority again took disciplinary action against a UK-based compliance officer, while the US Securities and Exchange Commission issued guidance regarding what activities compliance and legal officers at broker dealers can take in furtherance of their roles without being regarded as supervisors of business line personnel and potentially being liable for such persons’ law or rule violations under a failure to supervise theory.

FCA Action

The FCA enforcement action involved Alison Moran, the former compliance officer of Catalyst Investment Group Limited, a UK-based company authorized by the FCA to engage in a wide-range of investment activities.

From October 2007 through May 2010 Catalyst had promoted and arranged transactions involving bonds for ARM, a Luxembourg incorporated securitization vehicle. However, beginning in November 2007, ARM believed it required a license from the Commission de Surveillance du Secteur Financier (CSSF), the Luxembourg financial regulator, to issue such bonds (“ARM Bonds”). However, it never obtained a license.

According to the FCA, Catalyst (1) became aware of ARM’s views on licensing during November 2007; (2) knew ARM applied for a license from CSSF in July 2009; yet (3) continued to promote and arrange transactions in ARM Bonds through May 2010 knowing that ARM never obtained a license. This was even after November 20, 2009, when CSSF issued a notice expressly requiring ARM to cease promoting and arranging transactions in ARM bonds until ARM was licensed, and Catalyst became aware of this notice too.

Previously, on July 27, 2009, Ms. Moran became aware that ARM had earlier that month applied for a license from CSSF. On December 10, 2009, Ms. Moran became aware of CSSF’s notice to ARM to cease issuing bonds on November 20, 2009. Finally on December 24, 2009, Ms. Moran became aware it was mandatory for ARM to have a license to issue bonds. ARM’s request for a license from CSSF was formally rejected by CSSF on August 29, 2011.

FCA charged Ms. Moran with a breach of its Principle 6, which required her to exercise due skill, care and diligence in managing Catalyst’s compliance function. The basis for this charge was that Ms. Moran did not seek to understand why ARM might be applying for a license from CSSF during July 2009 and the consequence of ARM not obtaining a license. As a result she did not seek to amend Catalyst’s financial promotions related to ARM bonds.

Moreover, even after Ms. Moran became aware during December 2009 that CSSF had requested ARM not to issue bonds any further because it required a license, she still did not seek to amend Catalyst’s financial promotions. Among other things, Ms. Moran permitted Catalyst to send a letter to financial intermediaries during December 2009, and investors during March 2010, that FCA adjudged misleading regarding the status of ARM. According to FCA, Ms. Moran accepted that, in hindsight, these letters ‘did not give the full picture.”

As a result of these matters, Ms. Moran was fined by FCA GB £20,000 (US $32,000) while Catalyst was censured. Were Catalyst able to pay a fine, FCA says it would have fined the company GB £450,000 (US $720,000).

In addition, the former CEO of Catalyst, Timothy Roberts, has been fined GB £450,000 (US $720,000) and permanently banned from the industry, while Andrew Wilkins, a former director, has been fined GB £100,000 (US $160,000) and barred from holding senior roles in the industry, as a result of their involvement with Catalyst’s promotion and arrangements to sell ARM bonds.

In July 2012, the UK Financial Services Authority (predecessor to the FCA) issued total penalties of GB £70,258 against David Davis, the former chief compliance officer of the broker Paul E Schweder Miller & Co. related to his violation of FCA Principle 6 too. (For more information on this matter see: http://www.garydewaalandassociates.com/bridging-the-week-august-5-9-and-august-12-2013/.)

SEC Frequently Asked Questions regarding Legal and Compliance Officers’ Potential Liability under a Failure to Supervise Theory

Separately, on September 30, the US SEC issued a “Frequently Asked Questions,” about the potential liability of compliance and legal personnel of US registered broker dealers for failure to supervise. While acknowledging “the critical role” compliance and legal personnel perform in efforts by BDs to comply with legal and regulatory requirements, applicable law “does not presume that a BD’s compliance legal personnel are supervisors solely by virtue of their compliance or legal functions.”

However, claims the SEC, compliance and legal personnel could be responsible as supervisors of business persons - even where they have no express supervisory authority for such persons — because liability for supervision requires a “fact and circumstances determination.” According to the SEC:

“…the question is whether compliance or legal personnel have supervisory authority over business units or other personnel outside the compliance and legal departments as could be the case, for example, if a chief executive or operating officer also is the firm’s chief compliance officer. Supervisory authority also can be implicitly delegated to, or assumed by compliance or legal personnel.”

Although the SEC’s FAQs did not break new ground, they are a reminder to compliance and legal personnel at BDs that the SEC might seek to hold them liable for violations of law by business line personnel under certain circumstances. The SEC might consider supervision of such persons implicitly delegated to compliance or legal personnel (even where the organization chart of a firm clearly shows no supervisory link) if such personnel had,

“…the power to affect another’s conduct. Did the person for example, have the ability to hire, reward or punish that person… Did the person otherwise have the authority and responsibility such that he or she could have prevented the violation from continuing even if he or she did not have the power to fire, demote or reduce the pay of the person in question?”

Valuable Lessons Learned: The expectations of regulators regarding Chief Compliance Officers and other compliance and legal staff are increasing. Under applicable US Commodity Futures Trading Commission regulations, for example, CCOs must have the authority to perform a number of express responsibilities, including taking reasonable steps to ensure their firm’s compliance with applicable provisions of the Commodity Exchange Act and CFTC rules. As a result, firms’ Board of Directors and Chief Executive Officers, as well as the CCOs themselves, must ensure that CCOs have that authority not just in theory but in practice too. Red flags of potential law violations (particularly material ones) that come to CCOs’ attention should be systemically followed-up and appropriate actions taken. CCOs should consider maintaining a log or other documentation of all such red flags and follow-up.

For more details regarding the obligations of CCOs under CFTC regulations and the Annual Compliance Report, see an article on this website: http://www.garydewaalandassociates.com/its-10-pm-fcms-sds-msps-do-you-know-the-status-of-your-firms-2013-annual-compliance-report-preparation/.

ADM Investor Services, Inc. Fined by CFTC for Segregation Violations (with Valuable Lessons Learned)

The CFTC again last week charged and settled with a Futures Commission Merchant related to its violations of requirements related to the handling of customer funds. In this matter involving ADM Investor Services, Inc., the firm included in its positions and funds separately set aside for customers (as required by applicable law and regulations), positions and funds associated with accounts of various of its affiliates. These accounts should have been considered “non-customer” says the CFTC and not included among customer-segregated funds.

ADMIS transferred its non-customer positions and associated funds out of customer segregated accounts during July 2011. For this matter, ADMIS was fined US $425,000.

Valuable Lessons Learned: As a result of various actions against FCMs by the CFTC over the past few months, FCMs have a useful checklist of technical offenses they should seek to avoid in connection with their handling of customer funds. Again, given the “zero tolerance” stand of the CFTC in connection with customer funds’ offenses, FCMs should review their policies and procedures, as well as staffing, to ensure that that they comply with all requirements regarding the handling of customer funds, including that,

• they have sufficient processes and resources to help ensure that customer funds are placed in the first instance, and subsequently maintained, in the right funds’ protection bucket (i.e., segregated, secured, or cleared swaps);
• no affiliated persons’ positions or funds are included in such buckets;
• customer funds are held only at approved depositories with proper acknowledgements; and
• they timely report to the CFTC and their Designated Self Regulatory Organization any violations related to their handling of customer funds as required by applicable rules.

Periodic testing of firms’ compliance with these requirements by firm’s’ internal audit or other control functions, or by a third party, may also be advisable.

Briefly:

• CFTC Issues FAQs related to Commodity Options: On September 30, the CFTC’s Division of Market Oversight issued “Frequently Asked Questions regarding Commodity Options.” Among other matters addressed were whether there are any exceptions to the requirement that commodity options must be regulated as swaps (yes — an option involving a physical as opposed to a financial commodity, including a trade option), and the record-keeping and reporting obligations for trade option participants.

• CFTC Issues No Action related to Swap Execution Facilities: The CFTC issued a flurry of no action relief to accommodate the rollout of Swap Execution Facilities on October 2 just prior to closing its doors on October 1. Among other no action relief granted was relief to:

• Yieldbroker Pty Limited, an Australian-based and regulated multilateral trading facility that offers swaps to buyers and sellers, including US persons. Until November 1 at 12:01 am, Yieldbroker may continue to accommodate US persons without being registered as a SEF (Yieldbroker filed with the Division of Market Oversight on September 27 a provisional application as a SEF). No equivalent relief was granted to any European-based MTF; and
• Clearing FCMs, who were provided additional time to pre-screen orders automatically for compliance with risk-based limits, and certain SEFs who were granted additional time to comply with their requirement to facilitate such pre-screening by clearing FCMs. This relief also expires as of 12:01 am on November 1 and SEFs seeking to take advantage of the relief must file certain information with the CFTC by October 10.

For my reflections on the inauguration of SEFs, check out an article on this website: http://www.garydewaalandassociates.com/today-there-are-sefs-the-final-piece-in-a-pablo-picasso-abstract-rendition-of-effective-swaps-regulation/.

• CFTC Reminds Registrants Through an Enforcement Action That It Requires Mandatory Books and Records to Be Produced When It Asks: The CFTC commenced an administrate enforcement action against Dominick Anthony Cognata, a registered floor broker on the Commodity Exchange Inc. in NY (now part of the Chicago Mercantile Exchange) for his failure to comply with requests for books and records related to his trading activity. At the same time, the Commission issued a Notice of Intent to Revoke the Registration of Mr. Cognata. The documents requested by the CFTC included trading cards, order tickets and other records related to Mr. Cognata’s trading of silver and gold futures and futures options. Mr. Cognata declined to produce the requested documents invoking his Fifth Amendment privilege against self-incrimination. According to the CFTC, “[t]he Fifth Amendment privilege against self-incrimination does not apply to records such as those requested by the Division staff…which are required by law to be kept as records of transactions subject to government regulation.”

• ESMA Finalizes Alternative Investment Funds Reporting Requirements: Last week the European Securities and Market Authority issued final guidelines on the reporting obligations of alternative investment fund managers (e.g., hedge funds, private equity and real estate funds). Among other matters, AIFs will have to report to their national supervisors on a regular basis information related to their investment strategies, exposure and portfolio concentration. ESMA also proposed that AIFs be required to report information related to their risk measures, liquidity profile and leverage. Following publication of these guidelines on ESMA’s website in the official languages of the EU, national authorities will have two months to confirm to ESMA whether they comply or intend to comply with these Guidelines.

• EUREX Schedules Implementation of Excessive System Usage Fee and Order to Trade Ratio to Discourage High Frequency Trading: EUREX announced on September 27 that beginning December 1, 2013, it will introduce its Order to Trade Calculation regime. If during a month, a EUREX participant’s order volume exceeds the exchange established order volume limit for a particular product, the participant may be fined by EUREX. Also on December 1, EUREX will be introducing daily limits for the number of transactions sent by a Participant and assessing fees for transactions in excess of those limits. These provisions have been adopted by EUREX to reduce the volume of orders by High Frequency Traders in particular.

For source documents, visit:

CFTC v. ADM Investor Services Inc:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfadmorder093013.pdf

CFTC v. Dominick Cognata:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfcognatanotice093013.pdf

CFTC FAQs related to Commodity Options:
https://forms.cftc.gov/_layouts/TradeOptions/Docs/TradeOptionsFAQ.pdf

CFTC SEF-related Relief:
Pre-execution Screening:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-62.pdf
Yieldbroker:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-59.pdf

Compliance Officer Potential Liability:
FCA v. Catalyst:
http://www.fca.org.uk/static/documents/final-notices/catalyst-investment-group-limited.pdf
FCA v. Alison Moran:
http://www.fca.org.uk/static/documents/final-notices/alison-moran.pdf
SEC FAQs about the Potential Liability of Compliance and Legal Personnel at Broker Dealers:
http://www.sec.gov/divisions/marketreg/faq-cco-supervision-093013.htm

ESMA Reporting Requirements for Alternative Fund Managers:
http://www.esma.europa.eu/system/files/2013-1368_press_release_aifmd_reporting_guidelines.pdf

EUREX
Excessive System Usage Fee:
https://www.eurexchange.com/blob/exchange-en/4060-649056/649034/2/data/er13212e.pdf
Order to Trade Ratio:
http://www.eurexgroup.com/blob/group-en/46532-649314/649312/2/data/er13213e.pdf

Last week, brokers once again learned through enforcement actions against ICAP Europe that failure to maintain a robust supervisory system over their employees can be costly and embarrassing. However, brokers also learned in a NY court decision involving Amaranth Advisors, that the threshold to hold futures commission merchants liable for their clients’ possible manipulative practices is very very high.

This week swap dealers and other users of swaps will learn whether the decision of the US Commodity Futures Trading Commission to force trading of certain swaps by US persons onto registered Swap Execution Facilities on October 2 promotes transparency and liquidity, engenders anger and confusion, results in a bit of both, or ends up being postponed at least in part. And, who can keep up with all the last minute flurry of guidance and no action letters?

These and other matters covered this week on Bridging the Week are:

• Yet another trader was sued by the CFTC after allegedly causing large losses to his employer following efforts to disguise trading losses by making false entries into his employer’s internal bookkeeping system;
• Industry organizations and participants continued to fight against proposed mandatory top up to customer funds’ requirements and a proposed BIS leverage ratio framework that could materially hurt FCMs and their customers;
• ESMA considers the application of its rules to transactions between non-EU entities; it will make a proposal to the European Commission by November 15;
• FINRA offered guidance to Broker Dealers regarding suitability while NFA offered guidance to Commodity Pool Operators and Commodity Trading Advisors regarding disclosures;
• Vision Financial Markets, a US-based FCM, was fined in two separate CFTC actions, one for segregation violations, and one for failure to supervise (in connections with positions limits monitoring);
• RJ O’Brien, also a US-based FCM, was fined too by the CFTC related to a one day segregation violation; and more.

Here’s a video summary of this week’s top developments:

And here are the details (with Valuable Lessons Learned):

CFTC and UK FCA Sue and Settle with ICAP Europe; Three Non-US Individuals Indicted by the US Department of Justice

As widely reported elsewhere, ICAP Europe Limited was sued by and settled with the US Commodity Futures Trading Commission and the UK Financial Conduct Authority related to the actions of three of its non-US based employees who endeavored to manipulate the Yen London Interbank Offered Rate (Yen LIBOR) from at least October 2006 through January 2011. The three employees also were charged by the US Department of Justice with conspiracy to commit wire fraud and wire fraud in connection with their conduct.

In settling these matters, ICAP agreed to pay a fine of US$ 65 Million to the CFTC and a fine of GB £14 Million (US$ 22.4 Million). ICAP also agreed with the CFTC to augment its internal controls by (1) strengthening certain compliance procedures, (2) routinely reviewing certain electronic and audio communications, (3) placing compliance personnel among certain brokers, (4) enhancing certain monitoring and electronic exception reporting systems, (5) requiring recording and retaining of recordings of certain communications for at least one year, (6) enhancing internal training, and (7) using third party auditors to conduct annual audits for at least four years of certain broker desks, among other matters.

Each of the non-US employees of ICAP faces a maximum penalty of 30 years in prison for each count charged if convicted.

Essentially, two of the ICAP employees charged by the DOJ are alleged to have encouraged a third ICAP employee to provide false information to third party banks regarding Yen borrowing rates. This false information was then used by the banks in a process that led to the worldwide dissemination each business day of Yen Libor fixing rates that benefited a third party client of ICAP (in large part UBS AG – which previously settled FCA and CFTC enforcement actions too regarding this matter), and did not reflect the banks’ true assessment of borrowing rates. The evidence against the employees (and included by the CFTC, FCA, and DOJ in their enforcement actions) included much colorful electronic communication that contained explicit references to the alleged manipulative scheme.

The FCA and CFTC cited a breakdown in supervision at ICAP as the cause of the Firm’s problems. According to the CFTC,

“ICAP’s ineffectual supervision of the Yen derivatives and cash desks, its misplaced reliance on the expectation that Yen desk heads would enforce a compliance regime on their desk colleagues, and its failure to audit the Yen derivatives desk or adequately review the Yen brokers’ communications with clients, among other internal controls and supervisory deficiencies, allowed this misconduct to continue for years.”

Although all the actors and nefarious conduct involved in this matter were situated outside the USA, the CFTC asserted jurisdiction saying that the three employee’s conduct to influence the Yen LIBOR rate “…affect[ed] or tend[ed] to affect the prices of commodities in interstate commerce, including the daily rates at which Yen LIBOR is fixed.” ICAP was held liable for the acts of its employees and managers who engaged in wrongful conduct.

In connection with the FCA matter, ICAP was charged with failing (1) to observe proper standards of market conduct, and (2) to take reasonable care to “organize and control its affairs responsibly” and to maintain adequate risk management systems.

In commenting upon his Firm’s settlements, ICAP Group CEO Michael Spencer said, “We have learned from this, we will further improve our risk and compliance systems and we will continue to provide our clients with the highly professional service that they expect across many markets and geographies.”

A costly lesson hopefully learned once again is that inadequate internal controls, especially involving poor supervision of employees, coupled with arrogant employees who value compensation above all else, can hurt a firm economically – both in substantial fines by regulators and litigation expense, as well as loss of business due to impaired reputation and distraction of internal staff who must deal potentially with both government investigations and litigation. However, does the authority of the US regulators know no bounds? In these days of severely limited government resources is it an efficient use of resources for US regulators to pursue an overseas incident involving solely overseas-based persons already prosecuted by the local regulator?

Valuable Lessons Learned: Requiring Desk Heads and Front Office supervisors to participate in the oversight of their Front Office subordinates is a good practice. However, this should not be in lieu of Compliance’s and other control functions’ routine monitoring and periodic formal review of such subordinates, as well as of the managers, too; compliance should never be entrusted solely to Front Office personnel. Determining the appropriate amount of Compliance and other control function resources to dedicate to routine monitoring and periodic review should be done using a risk-based analysis, especially reviewing desks that have a high proportion of their business involving just a few customers (let alone just one) or seem to have customers subject to a high incidence of regulatory requests. Review the specific commitments of ICAP Europe to the CFTC and assess whether any measures might be appropriate to be adopted by your firm too.

Amaranth Litigation: Standards for Aiding and Abetting Violations by Brokers for Clients Are Very Rigorous

In an important decision in the Amaranth Natural Gas Commodities Litigation, the Federal Circuit Court of Appeals Court in NY ruled that the requirements to demonstrate successfully that a futures commission merchant is responsible for a client’s manipulative activities are quite rigorous.

Specifically, in this matter Amaranth Advisors LLC was sued by a class of traders who claimed that the company had manipulated the price of natural gas futures during 2006, and that its clearing broker, JP Morgan Futures, Inc., a CFTC registered FCM, had aided and abetted Amaranth’s manipulation. A lower court previously rejected the traders’ initial and subsequently amended claim against JPM.

The traders had argued that JPM was liable for Amaranth’s manipulation, because as its clearing broker, JPM was aware of Amaranth’s positions and trading activity including the fact that Amaranth violated New York Mercantile Exchange natural gas position limits and exceeded the Exchange’s accountability levels at various times. The traders also alleged that JPM knew that Amaranth engaged in “slamming the close” activities (an indicia of manipulative activity), as well as of a NYMEX and CFTC investigation into Amaranth’s trading.

In upholding the lower court’s rejection of the traders’ claim, the Circuit Court held that to establish aiding and abetting there must be proof of an unlawful intent to further the underlying violations. In the words of a former judge, aiding and abetting requires the defendants “…in some sort [to] associate himself with the venture, that he participate in it as in something that he wishes to bring about, that he seek by his action to make it succeed.”

Here claims the Court, JPM solely provided routine clearing services. Although JPM may have known about Amaranth’s large positions, large positions in and of themselves do not imply manipulation. This is even when such large positions violated applicable position or accountability levels as the goals of such limits are not just to preclude manipulation, but also to ameliorate excessive speculation, to ensure effective price discovery of markets, and to ensure sufficient liquidity for hedgers.

Likewise even where JPM was aware of Amaranth’s slamming the close activities and could not provide any “legitimate economic reason” why Amaranth would engage in such conduct, such knowledge by itself was not sufficient to satisfy an aiding and abetting charge. Although slamming the close may suggest manipulative conduct, it is not dispositive, says the Court.

According to the Court,

“It suffices to conclude that in the circumstances presented here, the provision of routine clearing services, when combined only with allegations that the clearing firm knew of trading activity that was highly suggestive but not dispositive of manipulation, is not enough to state a claim for aiding and abetting under [the Commodity Exchange Act].”

Valuable Lessons Learned: This decision is an important and favorable decision for FCMs. However, FCMs should still be investing in monitoring systems to help detect potential trade practice and speculative limit violations by their customers, and have appropriate personnel to review the output of such systems and act on at least some criteria of exceptions.

SEFs Go Live October 2: Chilton and O’Malia Recommend Delay; A Flurry of Guidance and No Action Letters Is Released September 25-27

Despite wide-spread public expressions of concern, including from at least two CFTC Commissioners, Bart Chilton and Scott O’Malia, the CFTC seems determined to go forward with the October 2 go live date for Swap Execution Facilities. As of September 27, 17 SEFs were approved for trading and two SEFs applications were pending.

As of October 2 all multiple to multiple swap trading venues must register as SEFs if they facilitate transactions on behalf of US persons, even if they only offer products that, as of that date, are not subject to a trade execution mandate – the so-called “Footnote 88” issue. Single dealer platforms not offering products subject to the trade execution mandate are not required to register as SEFs by October 2.

Among the concerns regarding the go live date for SEFs is that such requirement may cause serious issues for European-based multilateral trading facilities that accommodate US persons. According to Commissioner O’Malia:

“…the Commission is facing serious problems regarding its treatment of EU-regulated multilateral trading facilities (“MTFs”). In the Barnier-Gensler “Path Forward” document, the Commission assured European regulators that it will extend appropriate time-limited transitional relief to certain EU-regulated MTFs, in the event that the Commission’s trade execution requirement is triggered before March 15, 2014. However, the flexibility embodied in this agreement appears to be in direct contradiction to the SEF final rules that expressly require all platforms meeting a SEF definition to register by October 2, or cease operation. I don’t think the current registration requirement on October 2is consistent with either the spirit or the letter of the “Path Forward” document. It is unclear to me what the impact on liquidity will be if as a result of this problem, all U.S. persons are required to trade exclusively on U.S. SEF platforms or else to be forced to revert to bilateral trading.”

In suggesting a two month delay for the reporting rules related to the October 2 go live date, Commissioner Chilton cited technological and other impracticalities. According to Commissioner Chilton:

“We have heard from many quarters that, absent providing some relief, we are at risk of causing serious market disruptions and possible serious liquidity crises. At this particular time, given the possibility of a federal government shut-down, it is simply not reasonable to turn a deaf ear to these requests. Let’s be reasonable.”

In anticipation of this go-live date, CFTC staff issued guidance on September 26 regarding swaps straight-through processing. Among other things, staff provided its view that (1) a clearing FCM cannot reject a trade executed on a SEF that previously passed its pre-execution risk-based limits while an order; (2) Designated Clearing Organizations must accept or reject trades executed on a SEF or Designated Contract Market (for which the SEF or DCM has established processes for clearing) as soon as technologically practical which is now regarded as within 10 seconds (previously this was 60 seconds); and (3) any trade executed on a SEF or designated contract market that is not accepted for clearing should be regarded as void. As a result, FCMs, Swap Dealers, SEFs and DCMs should not require breakage agreements as a condition for access to trading on a SEF or DCM.

In addition, during the evening on September 27, the CFTC’s Division of Market Oversight (DMO) issued a flurry of limited no action relief to facilitate the October 2 go live date. In one letter, DMO extended the date on which SEFs must make real time reports of swaps transactions and pricing data to Swap Data Repositories (SDR). This relief expires at 12:01 AM eastern time on October 30, 2013, for swaps in the FX asset class, and 12:01 AM eastern time on December 2, 2013, for swaps executed in equity and commodity asset classes. In another letter, DMO provided temporary relief to reporting counterparties to uncleared swaps transactions executed initially on a SEF for errors or omissions in swap continuation data reported to an SDR to the extent such errors or omissions were caused by incomplete information provided by a SEF. This relief expires no later than October 29, 2013, for swaps executed in the FX asset class, and December 1, 2013 for swaps executed in the equity and commodity asset classes. And finally, DMO provided temporary relief to SEFs temporarily registered by October 2 from fulfilling certain of their enforcement responsibilities with regard to activities of market participants who trade on or through such SEFs; this relief expires November 1, 2013. A myriad of conditions apply to all participants desiring to take advantage of the offered relief.

Is this really the most effective way to roll out a significant new regulatory requirement?

Briefly:

CFTC Sues Yet Another Trader For Hiding His Trading Losses: Late on Friday afternoon, the CFTC filed an enforcement action against John Aaron Brooks related to his alleged efforts to hide trading losses from his employer, an affiliate of an unnamed “large NY-based commercial bank,” from November 2010 through October 2011. As a result of his activities, the CFTC alleges that the affiliate sustained US$ 40 Million in losses.

According to the CFTC, Mr. Brook’s committed his fraud by manually entering false values for CBOT-traded ethanol futures into the bank’s computer system. The CFTC charged Mr. Brooks with violations of the anti-fraud and new fraud-based manipulation sections of the Commodity Exchange Act and related regulations.

Hopefully by now, firms are prohibiting their traders from manually entering their own trades into internal bookkeeping systems.

CME to Allow Excess LSOC Collateral Value to Cover Variation Margin Losses: Effective October 21, 2013, CME will permit clearing firms that offer their cleared swaps customers LSOC “with-excess” to use a client’s excess LSOC value to cover its variation loss to the extent the customer’s required cash on deposit is in the currency for which the variation loss occurs. LSOC refers to Legal Segregation with Operational Commingling and is a mandatory segregation practice by FCMs for cleared-swaps customers that is aimed to reduce fellow customer risk and to expedite the porting of swaps positions and collateral in the event of an FCM default. The use of this CME LSOC enhancement will be optional.

Industry Organizations and Participants Continue to Fight Against Proposed CFTC Segregation and BIS Leverage Ratio Frameworks that Could Materially Hurt FCMs. The week before last a large group of organizations representing a wide cross section of the agricultural futures market (Ag Group Consortium) filed a letter with the CFTC arguing against the CFTC’s November 2012 proposals to require FCMs to maintain an amount of their own funds in their customer segregated accounts 24/7 at least equal to the amount of their customers’ aggregate deficit balances. According the Ag Group Consortium, this proposal, if adopted, most likely will require customers to pre-margin hedge accounts, discourage farmers from using futures markets to manage their risks, and expose farmers more to FCMs — “the last thing customers want to do now, in the wake of MF Global and Peregrine Financial Group.” This past week, a bipartisan group of senior legislators from both Senate and House CFTC oversight committees wrote a letter to the CFTC echoing these sentiments and reminding the Commission that “[t]he goal of increasing futures customer protections should be to strengthen the markets without harming the ability of American farmers, ranchers, and end-users to hedge their legitimate business risks.”

Separately, the week before last, a consortium of industry organizations, including GFMA, SIFMA, ISDA, and the Financial Services Roundtable filed one letter, and the Futures Industry Association another, that cautioned the Basel Committee on Banking Supervision from adopting rules that might penalize banks that have FCM subsidiaries that engage in cleared swaps, futures or options business for their customers. The proposed rules might do this by requiring banks to take leverage capital charges for the exposure BIS posits FCMs have to clearing houses on the one side, and customers, on the other, in connection with each cleared customer swap, futures or options transaction. In other words, BIS proposes to deconstruct what FCMs consider to be agency transactions on behalf of their customers into two separate principal-like transactions for capital computation purposes. However, the proposal seems to ignore that FCMs should have no liability to their customers if a clearinghouse fails, and that customers post margin to offset their exposure to FCMs. According to FIA, the proposed leverage capital charges,

“…will make client clearing economically unviable for clearing member banks and prohibitively expensive for end users. These high capital charges will be passed down to customers in the form of fees. Where derivatives must be cleared through CCPs (such as swaps in the United States), end-users may elect not to hedge with these derivatives at all rather than pay the high fees associated with client clearing. Where derivatives are not mandated to be cleared through CCPs, end-users may elect to engage in bilateral, uncleared trades. All of these consequences would make the market less, rather than more, safe.”

When will regulators step back and think about regulation holistically? If the goal is to lessen customers’ exposure to their brokers, why propose regulations potentially to increase their exposure (reversing decades of law interpretation to do so)? If the goal is to promote central clearing why propose regulations to discourage central clearing?

Help to Broker Dealers (Regarding Suitability Assessments) and CPOs and CTAs (Regarding Disclosures): The US Financial Industry Regulatory Authority (FINRA) issued a Regulatory Notice setting forth observations and recommendations regarding firms’ compliance with its new suitability rule (2111; keep in mind, that for broker dealers suitability assessments are required for institutional customers in addition to retail customers unless certain criteria are satisfied). Separately, the National Futures Association issued a revised guide for Commodity Pool Operators and Commodity Trading Advisors in connection with their preparation of disclosure documents, to reflect changes in CFTC rules that became effective during August 2013.

More Madoff Fallout: SEC Charges Madoff Accountant for Role in Creating False Books and Records: The SEC charged Paul Konigsberg with creating false books and records in connection with Bernard Madoff’s Ponzi scheme. These books and records, including inaccurate trade confirmations, were alleged to have been used to help defraud many of Madoff’s oldest and wealthiest clients. The US Attorney’s Office for the Southern District of NY filed criminal charges against Mr. Konigsberg too related to this matter. The SEC seeks return of ill-gotten gains, penalties and an injunction. In connection with his criminal matter, Mr. Konigsberg faces up to 40 years in prison in addition to fines and disgorgement requirements.

Just Like the CFTC, ESMA is Considering the Application of its Rules to Transactions between non-EU entities: The European Securities and Markets Authority (ESMA) had been scheduled to submit to the European Commission by September 25, 2013, its proposed technical standards related to the application of EMIR – the European equivalent of Title VII of Dodd Frank – to transactions between non-EU entities with a direct, substantial and foreseeable effect within the EU. The new deadline is November 15, 2013.

When a Regulator Announces it Will Not Bring an Enforcement Action, That’s News; CFTC Ceases 2008 Silver Markets’ Investigation: The CFTC announced this week that it will not bring an enforcement action related to alleged manipulation of the silver markets in 2008 that its Division of Enforcement began investigating that year. The CFTC commenced its investigation (and publicly confirmed it) after receiving complaints regarding silver prices. The CFTC made its decision not to bring any charges, after spending more than 7,000 enforcement staff hours and reviewing market fundamentals and trading between cash, futures and over the counter markets.

In an interview on RT America on November 13, 2012, Commissioner Bart Chilton said that he believed there had been “nefarious actions” and “violations of the law” in connection with silver trading during the relevant time.

You Think You Had a Bad Week?: Vision Financial Markets Fined in Two Separate CFTC Actions, One for Segregation Violations, One for Failure to Supervise: Vision Financial Markets LLC — a US-based FCM (and also a broker dealer registered with the US SEC) — was the subject of not one, but two enforcement actions by the CFTC last week, both of which it settled for an aggregate of US$ 665,000. In the first matter, Vision was charged by the CFTC with failure to supervise because of its failure to aggregate multiple accounts of a customer in order to assess whether the customer was violating Chicago Mercantile Exchange speculative position limits. Apparently Vision relied on faulty software in making its error. After Vision discovered the error in July 2012, the error was not corrected until January 2013.

In the second matter, Vision was charged by the CFTC with failing to segregate properly its customer funds from August 2008 through May 2009. In this matter, Vision purchased securities with customer funds, but commingled these securities with its own funds in a single account at the Depository Trust Company. After Vision was alerted to this issue following a routine examination by the CME, it recalculated its customers’ segregated funds and learned that it had been under-segregated from December 2008 through May 2009. Prior to the CME audit, Vision did not report it was under segregated either to the CFTC or CME. Vision was charged both for being under segregated and failing to notify the CFTC and CME that it was under segregated.

Vision’s segregation issues did not result in any loss to any customer.

How do you report something you are not aware of?

RJO O’Brien Also Fined for a Segregation Violation: R.J. O’Brien & Associates — a US-based FCM — also was sued and settled with the CFTC for payment of a US$ 125,000 fine related to a violation of the CFTC’s segregation rules related to customer funds in support of the trading of non-US futures and options. In this matter, RJO carried an account for another FCM (non-clearing FCM), and on one day in February 2012 transferred funds from the non-clearing FCM’s secured foreign futures and options customer omnibus account to reduce a margin deficiency in the non-clearing FCM’s segregated domestic futures and options omnibus account. This transfer was made without calling the non-clearing FCM for margin or advising the non-clearing FCM it was making the transfer. The transfer caused the non-clearing FCM to have insufficient funds to meet its obligation to its own foreign futures and options customers.

RJO’s segregation issue did not result in any loss to any customer.

Valuable Lessons Learned: Post MF Global, the CFTC appears to have a zero tolerance for any violation of law or rule related to the handling of customers funds — even if the violation is for a very short duration and never harmed any customer. As a result, FCMs must consider whether there are any double checks or “four eyes” approaches that will help reduce the possibility of any error in the handling of customer funds going undetected. At a minimum, the handling of customer funds should be at least annually reviewed by Internal Audit, absent good cause.

What do each of these matters mean practically for your business? For questions or assistance, do not hesitate to contact Gary DeWaal and Associates at (212) 382-4615 or at: [email protected].

For more background, see:

In re Amaranth Natural Gas Commodities Litigation:
http://www.gpo.gov/fdsys/pkg/USCOURTS-ca2-12-02075/pdf/USCOURTS-ca2-12-02075-0.pdf

Basel III Proposed Leverage Ratio Framework

Consultative Document:
http://www.bis.org/publ/bcbs251.pdf
Industry Responses:
FIA:
http://www.futuresindustry.org/downloads/FIA-Leverage_Ratio_Comment_Letter_092013.pdf
GFMA et al:
http://www.gfma.org/correspondence/item.aspx?id=536

CFTC v. John Aaron Brooks:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfbrookscomplaint092713.pdf

CFTC Proposed Enhancements to Customer Protection

CFTC Proposal:
http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2012-26435a.pdf
Agricultural Consortium Letter:
https://www.cotton.org/issues/2013/cftclet.cfm
Congressional Letter:
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59348&SearchText=

CFTC v. R.J. O’Brien and Associates:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfobrienorder092713.pdf

CFTC: SEFs Go Live October 2

Staff Guidance on Swaps Straight-Through Processing:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/stpguidance.pdf
DMO No Action Letter on SEF Reporting:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-55.pdf
DMO No Action Letter regarding Continuation Data Reporting:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-56.pdf
DMO No Action Letter regarding SEF Enforcement Responsibilities:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-57.pdf
Statement of Commissioner Chilton regarding the October 2 Go Live Date:

http://www.cftc.gov/PressRoom/SpeechesTestimony/chiltonstatement092713
Statement of Commissioner O’Malia regarding the October 2 Go Live Date:
http://www.cftc.gov/PressRoom/SpeechesTestimony/opaomalia-29

CFTC Silver Markets Investigation:

Announcement of Closure of Investigation:
http://www.cftc.gov/PressRoom/PressReleases/pr6709-13
Bart Chilton 2012 RT America Interview:
http://rt.com/shows/capital-account/bart-chilton-regulations-global/

ESMA Revised Delivery Date on Cross Border Application of EMIR:
http://www.esma.europa.eu/system/files/gallaae_2013.09.16_14.41.39_5c4n7472_1.pdf

FINRA: Suitability Guidance:
http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p351220.pdf

ICAP Enforcement Actions:

CFTC:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enficaporder092513.pdf
Department of Justice:
http://www.justice.gov/iso/opa/resources/838201392583237891746.pdf
FCA:
http://www.fca.org.uk/static/documents/final-notices/icap-europe-limited.pdf
ICAP Statement:
http://www.icap.com/news-events/in-the-news/news/2013/130925-icap-europe-ltd-reaches-settlements-with-fca-and-cftc.aspx

CME Excess LSOC Proposal (search for Advisory 13-440):
http://www.cmegroup.com/tools-information/advisorySearch.html

Madoff – Actions involving Paul Konigsberg

SEC civil action:
http://www.sec.gov/litigation/complaints/2013/comp-pr2013-202.pdf
US Attorney’s Office criminal action:
http://www.justice.gov/usao/nys/pressreleases/September13/PaulKonigsbergArrestPR/Konigsberg,%20Paul%20S11%20Indictment.pdf

National Futures Association: Disclosure Document Guide to CPOs and CTAs:
http://www.nfa.futures.org/NFA-compliance/publication-library/disclosure-document-guide.pdf

Vision Financial Markets Actions:

CFTC action re: segregation:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfvisionorder092713.pdf
CFTC action re: failure to supervise (position limits):
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfvisionorder092413.pdf

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of September 26, 2013, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.

During the week of September 16 to 20, 2013, the biggest news was the coordinated enforcement actions by four international regulators against JP Morgan related to its London Whale incident. But what also was big news was that the US Commodity Futures Trading Commission was not among the regulators joining in this coordinated enforcement action — for now. Why?

However, the JP Morgan matter was just the tip of the iceberg in a very hectic week featuring many interesting US litigation developments, new regulatory requirements, regulatory proposals, and an important speech by the CEO of the UK Financial Conduct Authority — all potentially impacting a wide-range of industry participants worldwide. These matters – all covered in this week’s Bridging the Week – include:

• four regulators sued JP Morgan; why was the CFTC not the fifth;
• DRW Investments sued the US CFTC to avoid a possible enforcement action;
• an amended complaint was filed by MF Global Holdings litigation trustee against John Corzine and other principals;
• the US SEC charged 23 firms (many from the managed money industry) in connection with unlawful short sales related to initial public offerings; simultaneously the SEC issued a Risk Alert;
• the US CFTC seeks public comment on CME’s proposed new EFRP rules (including banning transitory EFRPs);
• IBs’, FCMs’, RFEDs’ and certain CTAs’ taping requirement becomes effective December 21;
• ICE Clear US will require a greater percentage (50%) of clearing member guaranty fund deposit in cash, effective December 31;
• UK FCA CEO Martin Wheatley gave his view on derivatives’ cross border regulation at last week’s London ISDA conference: why can’t we all just get along (internationally);
• CTAs’ first quarterly report is due at NFA November 14; and more.

Four Regulators Sue JP Morgan; Why Was the CFTC Not the Fifth?

Last week JP Morgan consented to and was assessed fines by four international regulators totaling US$ 920 Million related to what has been colloquially referred to as the “London Whale” trades during 2012.These trades caused the Bank to suffer losses of US$ 6.2 Billion. The four regulators were the Financial Conduct Authority in the UK (GB£ 137,610,000 (US$ 220 Million); the US Federal Reserve Bank (US$ 200 Million); the US Office of the Comptroller of the Currency (US$ 300 Million), and the US Securities and Exchange Commission (US$ 200 Million).

According to a Form 8-K filed by the Bank with the SEC on September 19, apparently three regulator investigations related to this matter continue, ones conducted by Massachusetts Securities Division, the US Commodity Futures Trading Commission and the US Department of Justice. The Bank has disclosed, in fact, that the CFTC has provided a so-called “Wells” notice to it notifying the Bank that the Commission staff intends to recommend an enforcement action related to the London Whale incident. JP Morgan has indicated that it will respond to the CFTC’s notice in due course.

Previously, the US Attorney for the Southern District of NY filed criminal charges, and the Securities and Exchange Commission filed civil charges against two JP Morgan employees — Julien Grout, and his supervisor, Javier Martin-Artajo — for over-valuing certain trading positions they initiated to hide the trading losses that are at the heart of the London Whale incident.

The facts of the London Whale incident are relatively well known by now, and both the FCA’s and the SEC’s settlement orders provide detailed insight into the breakdown of internal controls at JP Morgan that gave rise to the Firm’s issues as well as the delay in uncovering the Firm’s issues.

Another article on this website provides my detailed analysis of lessons learned from this matter, as well as my caution regarding the CFTC’s expansive new anti-manipulation authority post Dodd Frank. Check it out at:
http://www.garydewaalandassociates.com/my-view-reflections-on-the-jp-morgan-settlements-human-nature-internal-controls-and-the-cftcs-broad-new-anti-manipulation-authority/

Valuable Lessons Learned: I don’t think it’s uncommon for firms to underestimate, initially, the potential seriousness of problems. This is why it is critical that the employees (or their direct supervisors) potentially responsible for a problem not to be the persons entrusted to investigate the problem. Surely such employees need to be questioned and even, perhaps consulted, but where there are potentially material issues, it is important for senior management to obtain a view of the potential problem and other analyses from impartial persons. Similarly, allowing traders to mark their own trading positions or input their own trades into internal systems must be avoided.

DRW Investments Sues the CFTC to Avoid a Possible Enforcement Action

DRW Investments, a Chicago-based proprietary trading firm, and its principal, Don Wilson, filed a complaint in federal court in Chicago seeking to prevent the Commodity Futures Trading Commission from filing an enforcement action against them for unlawful manipulation related to certain orders they placed during January through August 2011.

The relevant orders involved interest rate swap (IRS) futures contracts cleared by the International Derivatives Clearinghouse (IDCH). This matter arises, according to the complaint, following a CFTC investigation into these orders, and notice to plaintiffs that an enforcement action is imminent.

During the relevant time, DRW placed orders for IRS futures contracts both through a voice broker and through IDCH’s electronic trading platform; these orders were for different prices than prices prevailing for over the counter IRS transactions. “This was because,” says the Complaint, “DRW believed, based on its analysis of the economic difference between the two derivatives, that the IDCH Contracts should be trading a different price than those of the comparable uncleared OTC swap.” IDCH apparently based its daily settlement prices, during the relevant time, on DRW’s electronic orders. The Complaint suggests that the basis for the CFTC’s complaint against it will be the CFTC’s belief that DRW’s orders were placed purposely to affect the settlement price “at something other than a fair and reasonable value.”

The Complaint argues that the “CFTC’s theory of liability depends upon a novel and legally untenable claim,” and that the matter “…is ripe for adjudication because the filing and pendency of an enforcement action…would subject DRW to hardship and cause it immediate and irreparable harm.”

Amended Complaint filed by MF Global Holdings Litigation Trustee against John Corzine and Other Principals

Less than a week after both John Corzine and Edith O’Brien filed on September 10, 2013, motions to dismiss the CFTC enforcement actions against them related to the MF Global collapse and misuse of customer funds in October 2011, the Litigation Trustee for MF Global Holdings (Holdings) filed an amended complaint naming John Corzine, Bradley Abelow, and Henri Steenkamp. According to the Trustee, the defendants’ design and implementation of highly leveraged transactions in foreign debt to enhance the Firm’s “apparent profitability” constituted breaches of their fiduciary duties of care and loyalty. For this, the Trustee seeks an unspecified amount of damages against the defendants.

(Mr. Corzine was the former Chairman and CEO of Holdings and CEO of MF Global Inc. (MFGI; formerly registered as a futures commission merchant with the CFTC), Mr. Abelow, the President of Holdings at the time of its collapse and previously its Chief Operating Officer since September 2010, and Mr. Steenkamp, Holding’s Chief Financial Officer at the time of the Firm’s collapse, and previously Group Controller and Chief Account Officer.)

The defendants’ decision to invest specifically in European sovereign debt instruments, shortly after Mr. Corzine joined the Firm in 2010, ultimately led to the Firm’s collapse and MFGI’s misuse of customer funds, argues the Trustee. According to the amended complaint:

“Defendants embarked on their scheme without informing themselves (or the Board) of the true risks and without adequate processes and controls despite the fact that, throughout their tenures, they were repeatedly warned by internal auditors, risk managers and outside consultants that the [Firm]’s systems, controls and procedures were inadequate.

In his Memorandum of Law in support of his Motion to dismiss the CFTC’s enforcement action against him filed the on September 10, Mr. Corzine acknowledged that he recommended “strategic investments,” including in European sovereign debt, but that “[t]he risks attendant to the [investment] strategy were at all times disclosed to and approved by the Board of Directors of [Holdings], and that “[a]t no point in time was Mr. Corzine made aware of any failure in MFGI’s systems and controls that were designed to protect customer funds.”

The Amended Complaint by the Litigation Trustee was filed in the United States Bankruptcy Court in New York City, while Mr. Corzine’s and Ms. Obrien’s Motions to Dismiss were filed in the United States District Court in New York City.

US SEC Charges 23 Firms in Connection with Unlawful Short Sales related to Initial Public Offerings; Simultaneously Issues a Risk Alert

The US Securities and Exchange Commission commenced and settled enforcement actions against 22 firms, alleging that they unlawfully engaged in short sales, within a restricted period — generally five days before a public offering — and then purchased the relevant securities during the public offering. This conduct is prohibited by SEC Rule 105 of its Regulation M. An additional firm was sued by the SEC for this conduct, but did not settle.

The 22 firms represent a cross section of the managed money industry, a pension plan administrator, and a non-US based firm, among others.

In connection with these matters, the 22 settling firms paid US $14.4 Million in fines and disgorgement of profits.

Simultaneously, the SEC issued a Risk Alert reminding investment advisers, investment companies and broker dealers to ensure they have adopted and implemented robust controls to ensure compliance with Rule 105 that prohibit purchases of securities in follow-on and secondary offerings when the purchaser engaged in short sales of the same securities during specified time periods before the pricing of the offering. Intent is not required for a Rule 105 violation. There are some limited exceptions to the prohibitions under Rule 105, however.

US CFTC and US NFA Sue and Simultaneously Settle with a Retail Foreign Exchange Dealer for Practices that Amount to “Heads I Win, Tails I Win Too” Practices

Both the US CFTC and US NFA sued and settled with FXDirectDealer LLC, a NY-based retail foreign exchange dealer and futures commission merchant related to the Firm’s customer order entry system that, after a customer placed an order, in the case of an interim price move (i.e., slippage), rounded off the transaction in a way that routinely benefited the Firm and not the customer. Previously, NFA had charged the Firm with violations of its anti-money laundering requirements; this complaint was settled too.

The CFTC charged FXDirectDealer with failure to supervise and required the Firm to reimburse impacted customers US$ 1.83 Million and pay a fine of US$ 914,121, while NFA also required the Firm to reimburse impacted customers related to the FX slippage offense, and pay an additional fine of US$ 1.1 Million in connection with both offenses.

And briefly:

• CME and EFRPs (Encore): The CFTC formally requested public comment by close of business October 18 regarding the CME’s proposal to prohibit all transitory exchange of futures for related products and to amend certain recordkeeping and compliance obligations relating to non-transitory EFRPs. These proposed rules were described on this website last week. For more, see last week’s Bridging the Week at:
  http://www.garydewaalandassociates.com/gary-dewaals-bridging-the-week-september-9-to-13-and-16-2013/.

• CFTC Registered IBs’, FCMs’, RFEDs’ and Certain CTAs’ Taping Requirement Effective December 21: The NFA issued a reminder of new CFTC books and records requirements that become effective for US Futures Commission Merchants, Introducing Brokers and Registered Foreign Exchange Dealers on December 21, 2013, that generally require recording and retention of recordings for at least one year of all oral communications provided or received related to orders or solicitation of orders leading to the execution of a commodity interest (e.g., futures or swaps trade) and related cash or forward transaction whether it occurs on a firm-provided or personal telephone or other digital or electronic media device (these requirements also apply to Commodity Trading Advisors that are members of Designated Contract Markets or Swap Execution Facilities). There are exceptions for Introducing Brokers that generate US$ 5 Million or less in aggregate gross revenues in total over the preceding three years and an invitation to apply for no action relief to everyone if implementation if recording is technologically or economically impractical.

Valuable Lessons Learned: Firms now should be amending their policies and procedures, as well as investigating and obtaining technology that will permit them to comply with this taping requirement — particularly in connection with mobile telephones and other means of electronic communication (e.g., Skype). It probably is not sufficient solely to prohibit all communication with clients on company-issued cell phones, because it is likely to happen on private cell phones instead without taping, and in such case, not only will requisite conversations likely not be taped (despite the requirement), but there will be no company records of any kind related to such conversations, unless by happenstance. Because of this, firms should consider, as part of their policies and procedures, to require all employees to certify at least annually that they did not have relevant communications with customers on un-taped personal cell phones, or by other digital or electronic means.

• More Clearing Member Guaranty Fund in Cash: ICE Clear US advised clearing members that, effective December 31, 2013, all guaranty deposits must be met 50% in cash, an increase from its current requirement of $50,000.

• Didn’t Mom Say Don’t Lie: Both the CFTC and SEC brought cases last week against respondents who lied to the agencies during investigations while under oath. In the CFTC case, In the Matter of Susan Butterfield, the respondent simultaneously settled her complaint by agreeing to pay a fine of US$ 50,000 for saying she never pre-stamped order tickets when previously she expressly had advised her supervisor that she engaged in such conduct (and also subsequently to the CFTC). In the SEC case, SEC v. Fredrick D. Scott, the respondent was sued for defrauding investors as well as making false statements to SEC examiners.

• Martin Wheatley -Why Can’t We All Get Along (Internationally): In a wide ranging speech delivered to last week’s ISDA conference in London, Martin Wheatley, CEO of the UK FCA questioned the wisdom of individual jurisdictions endeavoring to regulate all derivatives activity with any link to themselves. Particularly in light of the October 2 go-live date for Swap Execution Facilities in the United States, he urged urgent adoption of a mutual recognition regime where there is equivalence of regulations. According to Mr. Wheatley, “[U]ntil nations agree on more than they disagree you will create opportunities for regulatory arbitrage – a ‘race to the bottom’ if you like — that inevitably colours the way we look at issues like CCP margin requirements between the EU and US.”

• CTAs’ First Quarterly Report Due November 14: This year, Commodity Trading Advisors s were required to file an annual report on Form PR providing general information about their trading programs, pool assets they direct; and the identity of Commodity Pool Operators of such pools. The NFA proposed to have CTAs file these reports also on a quarterly basis and this proposal was approved by the CFTC on March 30. In connection with this, the first quarterly report by CTAs for the quarter ending September 30, 2013, is due to be filed with the NFA on quarterly Form PR by November 14, 2013. The new form consists of the annual CFTC Form PR as well as additional questions related to certain trading programs offered by the CTA and amount of assets and monthly rates of return in connection with such programs. Both the CFTC and NFA filings are made through the NFA’s EasyFile system.

• Compensation Secrets No More: This past week the SEC proposed a rule requiring public companies to disclose the ratio of the compensation of its chief executive officer to the median compensation of its employees. This proposed rule was required by Dodd Frank. Similarly US FINRA approved a proposal that it will now submit to the SEC that requires brokers to disclose to their customers any large recruitment payments they will receive should customers follow them from one firm to another. Exact amounts are not required to be reported, just bands. Broker Dealers hiring new brokers would also be required to report to FINRA certain information too.

For questions or assistance, do not hesitate to contact Gary DeWaal and Associates at (212) 382-4615 or at: [email protected].

For more background, see:

CFTC: In the Matter of Susan Butterfield
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfbutterfieldorder091613.pdf

CFTC Request for Public Comment re: CME EFRP Rule Amendments:
http://www.cftc.gov/PressRoom/PressReleases/pr6696-13

FCA: CEO Martin Wheatley Address to ISDA:
http://www.fca.org.uk/news/future-into-focus

FINRA Recruitment Compensation Proposal:
http://www.finra.org/Newsroom/NewsReleases/2013/P347341

FXDirectDealer regulatory actions:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enffxddorder091813.pdf
http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seqnum=3725

ICE Clear US Notice: September 16, 2013 (50% of guaranty fund deposit required in cash):
https://www.theice.com/publicdocs/clear_us/notices/13-093_New_Cash_MinimumReq_GuarantyFund_2013_09_16.pdf

JP Morgan regulatory actions:
http://www.federalreserve.gov/newsevents/press/enforcement/enf20130919a.pdf
http://www.fca.org.uk/static/documents/final-notices/jpmorgan-chase-bank.pdf
http://www.occ.gov/static/enforcement-actions/ea2013-140.pdf
http://www.sec.gov/litigation/admin/2013/34-70458.pdf

National Futures Association CFTA Quarterly Recordkeeping Requirement:
http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4297

SEC: SEC v. Fredrick D. Scott (USDC EDNY):
http://www.sec.gov/litigation/complaints/2013/comp-pr2013-180.pdf

SEC Announcement regarding short sale charges and settlements with 22 firms in connection with public offerings; Risk Alert of Rule 105 Compliance
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539804376#.UjofvBaDrFJ
http://www.sec.gov/about/offices/ocie/risk-alert-091713-rule105-regm.pdf

SEC proposed rule regarding public company CEO compensation:
http://www.sec.gov/rules/proposed/2013/33-9452.pdf

Copies of the following documents are available on request to [email protected]:

CFTC v. MF Global, Inc., MF Global Holdings, Ltd., Jon S. Corzine and Edith O’Brien: Memorandum of Law in Support of Defendant Jon S. Corzine’s Motion to Dismiss Counts I and IV of the Complaint

DRW Investments LLC and Donald R. Wilson, Jr. v. US Commodity Futures Trading Commission: Declaratory Judgment Complaint

Nader Tavakoli, as Litigation Trustee of the MF Global Litigation Trust v. Jon S. Corzine, Bradley L. Abelow and Henri J. Steenkamp: First Amended Complaint and Demand for Jury Trial

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of September 21, 2013, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.