Bridging the Week by Gary DeWaal: October 27 to 31 and November 3, 2014 (Election Prediction; Reg SHO; Custody Rule; More Liquid Assets)

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Published Date: November 02, 2014

Three regulators—the Commodity Futures Trading Commission, the Securities and Exchange Commission and the Korea Financial Services Commission—took practical approaches to operational hurdles posed by their previously adopted rules. Has the pendulum of knee-jerk regulation in response to the financial crisis beginning in 2007 finally started to inch back towards a more sensible position? Meanwhile, the CFTC also approved one university to begin taking orders for binary contracts to help predict certain US election outcomes, but solely for research purposes.

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

Video Version:

Article Version:

CFTC Staff Authorizes University to Offer Election and Economic Indicator Binary Options Without Registration as an Execution Facility:

The Division of Market Oversight of the Commodity Futures Trading Commission authorized the Victoria University of Wellington, New Zealand to operate a marketplace for the trading of certain winner-take-all event contracts, and to offer such contracts to US persons without registration as a trading facility under relevant law and CFTC rules.

The university’s contracts—often generically known as binary options—are designed to help predict (1) events related to the selection of the US president and vice president, as well as which party will control Congress, and (2) decisions of the Federal Open Market Committee regarding the federal funds target rate.

In its approval, DMO distinguished the university’s political event contracts from those proposed by the North American Derivatives Exchange and disapproved by the CFTC in 2012. The university, said DMO, unlike Nadex, did not claim that its proposed contracts could be used for hedging or as a price-basing utility. Instead, they are proposed solely as “an academic exercise demonstrating the information gathering and predictive capabilities of markets.” Moreover, said DMO,

…because participation levels and maximum allowable investments in the University’s proposed contracts would each be capped at very low levels, the University’s proposed political event contracts would not have the same potential for compromising the integrity of elections as would Nadex’s disapproved political event contracts, which were much larger.

In connection with its proposed marketplace, DMO will not require the university to register as a designated contract market, swap execution facility, or foreign board of trade. DMO condoned limited advertising that prominently discloses that the marketplace is “unregulated, experimental and being operated for academic purposes.”

In 1993, the CFTC’s Division of Trading and Markets approved a smaller-scale non-for-profit marketplace listing binary political event and economic indicator options by the University of Iowa.

Goldman Sachs Receives SEC Approval for New Approach to Satisfy Certain Reg SHO Obligations:

Goldman Sachs Execution & Clearing, LP requested and obtained relief from the Securities and Exchange Commission related to certain of its close-out obligations under Regulation SHO.

Regulation SHO requires a firm to close-out short sales where an account has failed to deliver the required security by certain deadlines. Close-out is achieved by the firm borrowing or purchasing the like kind and quantity of the relevant security. However, a firm will not be deemed to have satisfied its Regulation SHO requirements, if, on the same day of its mandatory close-out activity, it re-establishes a short position without being able to demonstrate a legitimate economic purpose. By end of a required close-out deadline day, a firm on an aggregate net basis, including all its cleared client activity, must be a net purchaser of the number of relevant shares at least equal to its close-out obligation.

Goldman Sachs claimed it had difficulty meeting its requirement for various operational reasons, including that some of its clients effect transactions very near market close, while a substantial majority of its custodial customers execute transactions through other broker-dealers where often it is not informed of the trades until “well after” market close.

To address SEC staff’s concerns regarding subsequent sales and its operational challenges, Goldman Sachs proposed a “new approach” that would authorize it to close out  impermissible positions of derelict clients through so-called "buy-ins" (purchases) of relevant securities by no later than the beginning of the trading day on the day following the ordinary close-out deadline. However, in return, among other steps, the firm would endeavor better to identify and hold accountable relevant clients to their own close-out obligations and escalate problematic customers and transactions to the firm’s compliance department for consideration of other actions.

Earlier this year, Goldman Sachs paid a US $325,000 fine to the Financial Industry Regulatory Authority for not having adequate supervisory policies and procedures in connection with its Regulation SHO close-out procedures during two time periods from April 1, 2006 through September 9, 2013.

(Click here for further details regarding this fine. Click here for further information on this extended relief in the article, “SEC Provides Relief to GSEC from Rule 204 Close-out Requirements” in the October 31 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

Compliance Weeds: Regulation SHO, although superficially straight forward, poses many operational hurdles for firms endeavoring to comply, and reports of violations on the FINRA website read like a who’s who of principal US broker-dealers. As seen in the Merrill Lynch matter elsewhere reported on this website (click here for access), FINRA nowadays increasingly couples allegations of Reg SHO violations with other violations, including those related to anti-money laundering. It is encouraging to see the SEC take this practical approach to address Goldman Sach’s operational issues. Further information on Regulation SHO can be found on the SEC’s website (click here for access).

And briefly:

Compliance Weeds: It is not the easiest task for clearing members to keep track of the specific identifications of each trader accessing exchange electronic systems. However, each designated contract market has a requirement like the CME’s requirement regarding identification of individual electronic system users, and firms, as a result, should maintain an accurate inventory containing such information—not only for their own personnel, but for traders of clients sponsored for access. Clients should often be reminded to comply with exchange requirements that each electronic order be accompanied by the identification of the specific trader placing the trade.

And even more briefly:

And finally:

For more information, see:

Another Individual Charged by the UK Serious Fraud Office Related to LIBOR:

Basel Committee Wants Banks to Have More Liquid Assets:

Canada IIROC to Implement New Debt Transaction Reporting Rule in November 2015:

CFTC Extends Deadline Related to Single Wire Margin Payments:

CFTC Staff Authorizes University to Offer Election and Economic Indicator Binary Options Without Registration as an Execution Facility:

See also:
No Action Letter related to the University of Iowa (1993):
Order Prohibiting the Listing or Trading of Political Event Contracts (2012):

CFTC Staff Says Negative Consent OK in Connection With Certain Segregation Rights Notification Requirements of Swap Dealers for Uncleared Swaps Initial Margin:

CME Brings Over 20 Disciplinary Actions for Incorrectly Identifying Globex Terminal Operators:

Sample actions:

European Commission Recognizes Four CCP Regulatory Regimes as Equivalent—Not US:

FIA Announces Departure of Barbara Wierzynski From General Counsel Role:

Global Regulator Coordinator Notes Growth of Shadow Banking Sector Worldwide:

Investment Adviser and Senior Officials Charged by SEC With Custody Rule Violations:

See also SEC Investor Bulletin

IOSCO Updates OTC Derivatives Central Clearing Requirements Database:

Korea Regulator Proposes Lessening Certain Burdens on Financial Holding Company Structures:

See PDF Associated with Plan to Improve Financial Holding Company System:

Merrill Lynch Fined US $6 Million by FINRA for Reg SHO Violations and Supervisory Lapses:

NFA Reminds IBs to File Financial Reports Electronically:

SEC Approves New FINRA Rule Permitting Arbitrators to Refer Serious Matters During Arbitration Proceedings:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of November 1, 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. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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