Commentaries

Bridging the Week by Gary DeWaal: September 21 to 25 and 28, 2015 (Aggregation, Cybersecurity, Wash Sales, Fund Redemptions, IB Records, CTA Registration)

Jump to: Bridging the Week    Compliance Weeds    My View    Managed Money    Trade Practices (including Disruptive Trading)    Exchanges and Clearing Houses    Registration    Position Limits    Cybersecurity    Position and Trade Reporting    Supervision    Investment Advisers   
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Published Date: September 27, 2015

Many old themes re-emerged in the financial services industry last week. The Commodity Futures Trading Commission revised its proposed new rules dealing with the aggregation of accounts in connection with position limits, while the Securities and Exchange Commission brought an enforcement action against an investment adviser for failing to have a cybersecurity program to protect customer records and information. In addition, the SEC proposed rules to help ensure open-ended funds have enough liquidity to meet redemption demands during a crisis, while the CFTC brought two actions alleging impermissible wash sales – one against a swap execution facility. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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CFTC Revises Aggregation Proposal Related to Position Limits

The Commodity Futures Trading Commission revised its November 2013 proposal related to the aggregation of accounts in connection with its speculative position limits requirements.

Under its earlier proposal, the Commission would have required any entity owning more than 50 percent of another entity formally to apply to the Commission for approval to disaggregate positions of the other entity to the extent it may have qualified for relief.

Under the Commission’s new proposal, any qualified entity owning 10 percent or more of another entity up to 100 percent may file a notice of disaggregation, which would be effective upon submission. The notice would be required to include a description of the relevant conditions that warrant disaggregation and a certification by a senior officer that the conditions have been met.

In addition, under its earlier proposed aggregation rules the CFTC would have disallowed disaggregation for an owned entity if the entity was required to be and was consolidated in the financial statement of its ultimate owner. This provision has been eliminated in the new proposal because the CFTC found “merit” in arguments that “ownership of 50 percent interest in an entity (and the related consolidation of financial statements) may not mean that the owner actually controls day-to-day trading decisions of the owned entity.”

Generally, under the CFTC’s current aggregation rules, a person must combine all positions where it controls the trading decisions with all positions where the person has a 10 percent or more ownership interest in an account or position, as well as the positions of two or more persons acting according to an express or implied agreement. (Click here to access the CFTC’s current aggregation requirements – CFTC Regulation 150.4.) There are currently a number of potential exemptions to the CFTC aggregation requirements, including those pertaining to eligible entities with so-called independent account controllers; ownership interests of limited partners in pooled accounts; discretionary accounts; and customer trading programs of futures commission merchants.

In its November 2013 proposal, the Commission provided for persons meeting certain requirements to disaggregate positions of separately organized entities solely where the person’s ownership interest was between 10 and 50 percent. This ability would have been subject to a notice filing. (Click here for an overview of the CFTC’s November 2013 proposed aggregation rules in a November 7, 2013 Advisory entitled “CFTC Proposes Revised Aggregation Rules” by Katten Muchin Rosenman LLP.)

Under the new revised proposal, this capability is expanded to persons owning between 10 and 100 percent of another entity. Aggregation is still the “default requirement,” says the CFTC, unless a person (including any account such person must aggregate):

The CFTC will maintain its other exemptions from its aggregation rules for eligible entities under its revised proposal.

Commissioner J. Christopher Giancarlo voted to approve the revised aggregation rule proposal along with CFTC Chairman Timothy Massad and Commissioner Sharon Bowen. However, Mr. Giancarlo expressed concern that the Commission’s proposed revised rule prohibited disaggregation where an owner and subsidiary entity has risk management systems that permitted the sharing of trades or trading strategies. According to Mr. Giancarlo,

[this] proposed rule may stymie critical risk-mitigation efforts. Owners and their affiliates may need to share information regarding trades or trading strategy to verify compliance with applicable credit limits as well as restrictions and collateral requirements for inter-affiliate transactions, among other risk-management and compliance related objectives.

Comments will be accepted by the CFTC on its revised aggregation rule proposals for 45 days after publication in the Federal Register. (Click here for further information on the CFTC proposed revised aggregation rules in the article “CFTC Proposes Revisions to Pending Aggregation Rules” in the September 28, 2015 Advisory by Katten Muchin Rosenman LLP.)

Briefly:

Compliance Weeds: Expectations of regulators of registrants in both the securities and futures industry has been increasing during the past year regarding what cybersecurity protections should be in place to protect customer records and information. At the beginning of 2015, the SEC said it would focus on cybersecurity compliance and controls among its 2015 examination priorities for broker-dealers and investment advisers. (Click here for further details in the article “Cybersecurity, Potential Equity Order Routing Conflicts and AML Among the Top Examination Priorities for SEC in 2015” in the January 18, 2015 edition of Bridging the Week.) Just recently, on September 15, 2015, the SEC provided specific guidance on what it would look at in connection with these reviews. The SEC said it would focus on registrants’ governance and risk assessment related to cybersecurity; access rights and controls; data loss prevention; vendor management; training; and incident response. (Click here for further details in the article “SEC Discloses Elements of Cybersecurity Exams in the September 20, 2015 edition of Bridging the Week.) Also at the beginning of 2015, the Financial Industry Regulatory published a report identifying findings from its 2014 targeted examination of firms related to their cybersecurity practices and recommended practices broker-dealers should implement to minimize the impact of cybersecurity threats. (Click here for further details in the article “Industry Watchdogs Warn Brokers and Advisory Firms on Cybersecurity Threats” in the February 8, 2015 edition of Bridging the Week.) Moreover, last month, the National Futures Association submitted to the Commodity Futures Trading Commission for its approval a proposed Interpretive Notice requiring certain NFA members to maintain formal, written information systems security programs. Although the NFA made clear that its “policy is not to establish specific technology requirements,” it will require all relevant members to have supervisory procedures that are “reasonably designed to diligently supervise the risks of unauthorized access to or attack of their information technology systems, and to respond appropriately should unauthorized access or attack occur.” (Click here for further details, in the article “NFA Proposes Cybersecurity Guidance” in the September 13, 2015 edition of Bridging the Week.) Practically, any cyber breach that compromises customer personal information could leave an SEC or CFTC registrant vulnerable to an enforcement action if it had not previously adopted a written policy and procedure designed to minimize the threat of a cyber-attack and followed such procedure – whether or not an express requirement currently exists. (For additional information on how financial service firms might help protect themselves against cyber-threats, click here to access an Advisory entitled “Cyber-Attacks: Threats, Regulatory Reaction and Practical Proactive Measures to Help Avoid Risks” by Katten Muchin Rosenman LLP, dated June 24, 2015.)

Compliance Weeds: This matter is an example of why the greatest threat of cyber-attacks is from inside employees and consultants. Firms’ cybersecurity policies and procedures should address internal threats.

Compliance Weeds: Transfers of positions between non-independently controlled accounts of the same beneficial owner should be accomplished using the transfer rules of the relevant exchange, not through non-competitive trades, including exchange for related position transactions. (Click here for applicable CME rule (853), and here for applicable ICE Futures U.S. rule (4.11).)

My View: Just last week I noted that some would question why the CFTC would bring an enforcement action where an exchange had brought a materially identical disciplinary action previously. In the relevant case involving Robert McMahon, I concluded there likely was arguable justification for the CFTC's "me too" action in light of the fact the allegations involved fraud, and the relevant exchange could not ban the individual from trading on all exchanges but solely its own. (Click here to access full details in the article entitled, "Trader Fined US $171,000 by CFTC for Deceptive Trade Allocation Scheme Utilizing Block Trades; CME Group Previously Alleged Similar Wrongdoing" in the September 20, 2015 edition of Bridging the Week.) This case is different. Here the charges involve a few incidents of a discrete type of trade practice offense  wash sales  and there is no allegation of fraud or any widespread market offense, such as manipulation. As a result, even though the CME Group previously charged only offenses that occurred on its exchange (and not on the Kansas City Board of Trade), the exchange-action carried an appropriate sanction and conveyed an appropriate message. The CFTC's "me too" action here appears a misuse of scarce resources.

And more briefly:

For more information, see:

CFTC Revises Aggregation Proposal Related to Position Limits:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister092215a.pdf

Circle Internet Financial Receives First NYDFS BitLicense:
http://www.dfs.ny.gov/about/press/pr1509221.htm

See also, Circle Internet website:
https://www.circle.com/en/investors

CTA Fined US $280,000 by CFTC for Not Disclosing Principal and Changes to Algorithmic Trading System:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfnordcapitalorder92415.pdf

Déjà Vu All Over Again – CFTC Settles Complaint With Cargill de Mexico for Wash Sales Following Similar CME Group Settlement:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcargillorder92415.pdf

FIA Publishes REMIT Guidance for Market Participants Entering Into Certain European Wholesale Energy Transactions:
https://lc.fia.org/sites/default/files/content_attachments/Customer%20Notice%20Regarding%20REMIT%20Registration%20and%20Reporting.pdf

Former Investment Bank Financial Adviser Pleads Guilty to Illegally Accessing Confidential Client Information:

Complaint:
http://www.justice.gov/usao-sdny/file/777146/download
Announcement of Plea:
http://www.justice.gov/usao-sdny/pr/investment-bank-financial-adviser-pleads-guilty-manhattan-federal-court-illegally

Introducing Broker and COO Agree to Pay US $500,000 to Resolve CFTC Charges of Recordkeeping Violations and Supervision Breakdown:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enffuturesorder092515.pdf

Japan Securities Clearing Corporation Seeks CFTC Exemption From DCO Registration:
http://www.cftc.gov/PressRoom/PressReleases/pr7238-15

Nodal Clear Approved as Derivatives Clearing Organization:
http://www.cftc.gov/PressRoom/PressReleases/pr7242-15

SEC Proposes to Permit Depositions in Administrative Proceeding and Other Changes to Rules of Practice:
http://www.sec.gov/rules/proposed/2015/34-75976.pdf
http://www.sec.gov/rules/proposed/2015/34-75977.pdf

SEC Sanctions Investment Adviser for Not Implementing Policies and Procedures in Advance of Cyber-Attack:
http://www.sec.gov/litigation/admin/2015/ia-4204.pdf

See also, Investor Alert:
http://www.sec.gov/oiea/investor-alerts-bulletins/ia_databreaches.html

SEC Seeks to Enhance Liquidity Management by Mutual Funds and ETFs:
http://www.sec.gov/rules/proposed/2015/33-9922.pdf

Tera Exchange Consents to Cease and Desist Order by CFTC for Encouraging Wash Sale, No Fine Assessed:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfteraexchangeorder92415.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of September 26, 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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ABOUT GARY DEWAAL

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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