Bridging the Week by Gary DeWaal: August 17 - 21 and 24, 2015 (Block Trades, Front Running, Failure to Supervise, Conflicted Audit, Exempt Clearinghouse)

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Published Date: August 23, 2015

Last week was a week of many firsts in the exchange-traded and centrally cleared derivatives industry in the United States. CME Group brought its first actions against an employer for allegedly failing to supervise an employee engaging in disruptive trading activities, while both an employer and its employee were charged for allegedly pre-hedging block trades. Separately, the CFTC granted its first exemption from registration to an overseas clearinghouse clearing swaps for certain US persons, while the Commission also brought its first case against a swap dealer under its new failure to supervise provision intended solely for swap dealers and major swap participants. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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CME Group Files Disciplinary Actions for Trading Ahead of Block Trades and Failure to Supervise an Employee Engaging in Disruptive Trading Activities

In two cases of first impression, CME Group exchanges brought and settled charges against a company for alleged disruptive trading activities by its employee, and against another company and its employee for the employee’s alleged pre-hedging of block trades entered into for his employer.

In a disciplinary action brought by the New York Mercantile Exchange, Banco BTG Pactual, S.A. agreed to pay a fine of US $50,000 for the alleged disruptive trading activities of an unnamed employee. According to the exchange, on multiple occasions from January 2013 through February 2014, the employee entered into orders in Palladium futures contracts on one side of the market without the intent to trade. Instead, said NYMEX’s Business Conduct Committee, the orders were entered into to induce market participants to trade opposite smaller orders entered by the trader that were resting on the opposite side of the order book. The trader allegedly cancelled the larger orders on one side of the market after he obtained fills of the smaller orders on the other side. NYMEX’s BCC said, “BTG failed to ensure that its trader conducted these trading activities in compliance with exchange rules.”

In another disciplinary action brought by NYMEX, Koch Supply & Trading, LP and its trader Arian Fouquet settled charges alleging that, on four dates in January 2014, Mr. Fouquet used CME Group’s Globex platform to pre-hedge block trades with a proposed counterparty, prior to concluding such transactions with the counterparty.

NYMEX specifically claimed that, after being solicited to enter into a block trade, Mr. Fouquet pre-hedged the proposed transaction on Globex in order to lock in a potential profit for his employer. This violated CME Group’s prohibition against using nonpublic information regarding block trades prior to execution.

To resolve this matter, Koch agreed to pay a fine of US $50,000 and disgorge profits of $51,315.60. Mr. Fouquet agreed to pay a fine of US $15,000 and be barred from trading CME Group products for five business days.

In other disciplinary actions, Wolverine Trading, LLC settled charges related to the alleged breakdown of its automated trading system and unintended self-matches.

In one action brought by the Chicago Mercantile Exchange, Wolverine agreed to pay a fine of US $125,000 for an alleged breakdown of its ATS on March 21, 2014, that resulted in the firm sending over 27,000 resend requests to the exchange (a resend request is a repetitive transmission to the exchange of the same message (e.g., order, request for quote); it can increase latency for other traders). Apparently, the exchange endeavored to contact Wolverine on the relevant date to ameliorate the situation, but was unsuccessful; the exchange ultimately closed all of the firm’s access ports to it in order to stop the resend requests. According to CME’s BCC, “Wolverine’s monitoring and internal notification processes were insufficient to recognize or stop the ATS from continuing to submit resend requests.”

Wolverine also settled charges in response to three separate disciplinary actions brought by the Chicago Board of Trade, CME and NYMEX, that on “several occasions” in 2012 and 2013 it failed to prevent buy and sell orders generated by its ATS from crossing. The relevant BCCs found that, although the firm’s ATS was not “designed to execute self-matches,” Wolverine should have reasonably anticipated that orders entered by the ATS would match. The BCCs found that Wolverine did not implement “effective functionality” to avoid self-matches. Wolverine paid US $125,000 in aggregate to resolve these matters.

CME Group also announced settlements of three other matters involving alleged disruptive trading practices. Two involved William Silva, who settled his actions by agreeing to pay an aggregate fine of US $75,000 and to incur a two-week CME Group trading suspension. The other involved Michael Franko, who settled his matter by agreeing to pay a fine of US $100,000 and to serve a three-week CME Group trading suspension.

Finally, two firms – Blenheim Capital Management, LLC and Noble Americas Corp. — agreed to settle charges they engaged in improper exchange for related position transactions by not having proper documentation to support the related position, or not transferring the related position between the two parties. Blenheim agreed to pay a fine of US $10,000 in connection with two EFRPs, while Noble, in connection with two disciplinary actions, agreed to pay fines in aggregate of US $30,000 for two EFRPs too.

Compliance Weeds: Rules on block trades are detailed and must be followed strictly. CME Group Rule 526, for example (click here to access), expressly prohibits “[p]re-hedging or anticipatory hedging of any portion of a block trade in the same product or a closely related product based upon a solicitation to participate.” Moreover, parties involved in the solicitation or negotiation of a block trade may not disclose any elements of those discussions to any other party except as necessary to consummate the transaction. In general, parties with access to nonpublic information regarding a block trade may not trade in the same product or any closely related product to take advantage of such knowledge in advance of the public report of the block trade to the exchange. This prohibition is not meant to preclude parties from trading in their ordinary course, however. (Click here for the latest CME Group advisory notice regarding block trades.)


Legal Weeds: In a complaint of first impression, FCStone was charged by the Commission with a violation of its new Rule 23.602(a), which requires all swap dealers and major swap participants to “establish and maintain a system to supervise, and shall diligently supervise, all activities relating to its business performed by its partners, members, officers, employees, and agents” (emphasis added). (Click here to access the full text of CFTC Rule 23.602(a).) This provision sets forth different standards than the CFTC’s traditional supervisory requirements for registrants under its Rule 166.3. That provision does not expressly require registrants to establish a supervisory system. It solely states that “[e]ach Commission registrant, except an associated person who has no supervisory duties, must diligently supervise the handling by its partners, officers, employees and agents … of all commodity interest accounts carried, operated, advised or introduced by the registrant, and all other activities of its partners, officers, employees and agents … relating to its business as a Commission registrant.” (Click here to access the full text of CFTC Rule 166.3.) However, in its FCStone Order, the Commission noted that Rule 166.3 “has been interpreted as requiring that, in order to establish a failure to supervise, the Commission establish that a registrant’s supervisory system was generally inadequate or that the registrant failed to perform its supervisory duties diligently” (emphasis added). Although it seems reasonable that a registrant should have robust policies and procedures to help ensure it can adequately oversee its business, this is different than saying the rule requires a supervisory system when, by its plain language, it does not. This incongruity seems clearer now that Rule 23.602(a), in fact, imposes such an express requirement.

And more briefly:

And finally, Letters and Comments:

For more information, see:

ASX Clear Approved as Exempt Clearinghouse for Swaps by CFTC:

Broker-Dealer Fined US $15 Million for Compliance and Surveillance Failures Related to Handling of Nonpublic Information:

CFTC Proposes Changes to Swap Data Recordkeeping and Reporting Requirements:

Fact Sheet:
Proposed Rules:

CFTC Seeks Comments on KRX Petition to Be Exempt From DCO Registration for Swaps:

CFTC Settles Enforcement Action Against FCStone Markets for Unauthorized Swaps Transactions of Former Trader:

CME Group Files Disciplinary Actions for Trading Ahead of Block Trades and Failure to Supervise an Employee Engaging in Disruptive Trading Activities:

Banco BTG Pactual:

Blenheim Capital:
Arian Fouquet:
Michael Franko:
Koch Supply& Trading:
Noble Americas:
William Silva:
Wolverine Trading, LLC:

Court Approves MF Global Inc. Trustee to Make Final Distribution to Unsecured General Creditors:

CPMI and IOSCO Issue Recommendations on Unique Transaction Identifiers:

European Systemic Risk Overseer Recommends Skin in the Game for Clearinghouses:

Funds Marketed as Safe and Low Risk Cost Citigroup Affiliates US $180 Million as a Result of SEC Charges:

OIG Criticizes CFTC’s DMO for Inadequate Rule Enforcement Reviews, Blames Insufficient Staff:

Promontory Financial Agrees to Pay US $15 Million to Resolve Allegations Regarding Conflicted Audit:

See also, Promontory Financial press release:

Student Internships Result in Bank’s Settlement With SEC Over Alleged FCPA Violations:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 21, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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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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