Commentaries

Bridging the Weeks by Gary DeWaal: January 17 to 27 and January 30, 2017 (Priorities; Whistleblowing; How Could They Know?; AML Officer Sued)

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Published Date: January 29, 2017

During the past two weeks, the new acting Chairman of the Commodity Futures Trading Commission, J. Christopher Giancarlo, provided a preview of his priorities, while the Securities and Exchange Commission brought two more enforcement actions against publicly traded companies for including in standard severance agreements language that the SEC considered to impede potential whistleblowing. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:

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Briefly:

My View: Since I began practicing derivatives law in 1982, the so-called “white book” containing the Commodity Exchange Act and CFTC regulations has become considerably thicker, and the requirements more obtuse. Moreover, too often regulations seem drafted for a different age – let alone different technology. The CFTC’s proposed overhaul of its current recordkeeping rule – which still references microfiche – provides a stark reminder of how outdated many existing rules have become. Moreover, the Commission’s proposed Regulation Automated Trading – which in many cases replicates already existing exchange requirements and contains unconstitutional (let alone unworkable) authority for CFTC and Department of Justice staff to take trading firms’ source code without subpoena (whether proprietarily or third-party developed) – is a stark example of the type of proscriptive regulation that should not be adopted in its current form. (Click here for background on the CFTC’s latest proposal regarding Regulation AT in the article “Proposed Regulation AT Amended by CFTC; Attempts to Reduce Universe of Most Affected to No More Than 120 Persons” in the November 6, 2016 edition of Bridging the Week.) Additionally, the Division of Enforcement – while continuing to bring many important cases – has too often been distracted by investigating and bringing cases of questionable merit and theory. The CFTC’s recent action against a HK cotton merchant or dealer for not filing CFTC reports of its physical positions – when the requirement for such reports is poorly publicized by the Commission in the first place – and against JP Morgan Chase Securities for miscomputing exchange fee rebates for customers – in the face of admittedly very complicated and confusing exchange processes regarding the assessment of exchange and clearing fees – are just two examples where the CFTC’s use of its enforcement hammer seems misplaced. (Click here to access the article in this edition of Bridging the Week regarding the HK cotton trading firm, and here to access the article on JP Morgan Securities’ fine for miscalculating exchange fees rebates, entitled “FCM Agrees to Settle With CFTC Related to Purported Exchange Fees Overcharges” in the January 16, 2017 edition of Bridging the Week.) The Commission has an important mission: to help ensure that the important commodity markets under its jurisdictions function fairly and that customers are protected against fraud and other malfeasance. However, regulations should be principals-based, to allow for the rapid evolution of technology, and enforcement must be meaningful and fair. Anything less compromises the mission of the CFTC. That being said, it’s also appropriate at this time to consider the organization of the Commission. Off and on for many years, proposals have floated to create a single financial services regulator that oversees both our securities and commodity markets and participants – much as now exists in most of the developed world. Now is the time to re-evaluate these proposals and implement a path to more holistically regulate financial services in the United States.

Compliance Weeds: In 2016, the SEC brought and settled a number of enforcement actions against firms that included in their standard severance agreements language that the Commission determined potentially impeded an employee from disclosing to the SEC a possible securities law violation. (Click here for background in the article “Two Companies Charged by SEC for Whistleblower Infractions” in the January 8, 2017 edition of Bridging the Week.) It is clear that the SEC reads its anti-retaliation clause broadly. All persons subject to SEC and Commodity Futures Trading Commission oversight should review their form employment and severance agreements to ensure they are consistent with regulatory requirements regarding employee whistleblower rights. (Click here to access existing CFTC whistleblower protections in Part 165 of its rules.) In 2016 the CFTC proposed to amend its whistleblower program to more closely emulate that of the SEC. Among other things, the CFTC proposed (1) new procedures to review whistleblower claims; (2) to clarify that the CFTC may bring enforcement actions against any employer that violates its anti-retaliation provisions; and (3) to prohibit any agreement or condition of employment, including a confidentiality or pre-dispute arbitration agreement, from containing a provision that might “impede” an individual from communicating a possible violation of law to CFTC staff. No final action on the CFTC's proposed amended rules has been taken. (Click here to access the CFTC proposal.)

Compliance Weeds and My View: Part III of CFTC Form 304 (Unfixed Price Cotton “On-Call”) must be filed by any cotton merchant or dealer that holds a so-called reportable position in cotton (i.e., pursuant to large trader reportable levels; this is currently 100 contracts) regardless of whether or not it constitutes a bona fide hedge. Form 304 (Part III) must be prepared as of the close of business on Friday every week, and received by the CFTC in New York by no later than the second business day following the date of the report. CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bona fide hedging position under CFTC rules. These documents must be prepared as of the close of business on the last Friday of each relevant month. Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Parts I and II Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report. In announcing its settlement with CNCGC, the CFTC summarized its prior recent actions involving cotton call reporting violations since 2013 – all of which involved foreign entities (click here to access). However, despite CFTC staff issuing an advisory in 2013 regarding Part III of its Form 304 – which currently is buried on a page of assorted CFTC advisories on various topics (click here to access the CFTC Advisory; click here to access the page on which the CFTC advisory is located) – it is not really clear why or how a non-US cotton merchant or dealer would ordinarily be aware of its obligations to the CFTC. It would be a better use of CFTC resources to more effectively educate non-US market participants regarding their obligations, than to prosecute them. The CFTC recently proposed changes to its Form 204s and 304s as part of its re-proposed regulations establishing position limits for 25 core physical commodity futures contracts and their economically equivalent futures, options and swaps. (Click here for details in the December 19, 2016 Advisory, “CFTC Finalizes Aggregation Rules and Re-Proposes Positions Limits Rules” by Katten Muchin Rosenman LLP.)

Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers, and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions or patterns of transactions involving at least US $5,000, which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. According to a recent FinCEN advisory, SARs may also be required to be filed for certain cyber events (click here for details). In 2014, the Financial Industry Regulatory Authority also fined Brown Brothers Harriman & Co. US $8 million for failing to file SARs in connection with similar activity involving penny stocks as alleged to be at issue in the Meyers Associates administrative proceeding. In Brown Brothers, FINRA also fined and suspended the firm’s global anti-money laundering compliance officer for his alleged role in the firm’s alleged misconduct. (Click here for details in the article “FINRA Says Brown Brothers Harriman Had an Unsatisfactory Anti-Money Laundering Program; Sanctions Firm and Former Global AML Compliance Officer,” in the February 10, 2014 edition of Bridging the Week.) More recently, Albert Fried & Company, LLC, an SEC-registered broker-dealer, agreed to pay a fine of US $300,000 to resolve charges by the SEC that, from August 2010 through October 2015, it failed to file SARs. According to the SEC, during this time on multiple occasions, Albert Fried received large-volume deposits of penny stocks from a number of customers. Afterwards, the customers sold the stocks in transactions that often constituted a “substantial portion” of the daily volume in the thinly traded securities. These liquidations, alleged the SEC, were often accompanied by other suspicious indicators. (Click here for further details in the article “Broker-Dealer Sanctioned by SEC for Anti-Money Laundering Breakdowns” in the June 5, 2016 edition of Bridging the Week.) Covered entities should continually monitor transactions they effectuate and ensure they maintain written procedures they follow to identify and evaluate red flags of suspicious activities and file required SARs with FinCEN when appropriate.

Compliance Weeds: CME Group Rule 536B.2 (click here to access) requires clearing members guaranteeing a client that has direct market access to maintain or cause to be maintained an electronic audit trail for such client that includes certain minimum information. These audit trails must be kept for at least five years. However, the same rule authorizes a clearing member not to keep the electronic audit trail of its direct access clients that are other clearing members or equity member firms. To take advantage of this option, a clearing member must notify its clearing member or equity member client that it is their obligation to maintain the electronic audit trail — thus excusing the guarantor clearing member from maintaining the record itself. However, as a result of a December 2015 amendment to this rule, this authority does not relieve a guarantor clearing member “from compliance with the applicable recordkeeping provisions of CFTC Regulations, including Regulation 1.31 or 1.35.” As I wrote in December 2014 when this rule was amended, “[t]he odd wording of this new sentence seems to imply the CFTC may believe that clearing member FCMs have an obligation to retain electronic audit trails they otherwise are not required to keep under the applicable CME Group rule—a trick even the great Harry Houdini likely could not master!” (Click here to access CFTC Rule 1.31 and here for CFTC Rule 1.35.) Earlier this month, the CFTC proposed overhauling its records retention rule to eliminate many existing antiquated requirements and to be “technology neutral” in order to accommodate future advances in recordkeeping technology. (Click here for detail in the article “New Records Retention Regime for 21st Century Proposed by CFTC” in the January 16, 2017 edition of Bridging the Week.)

And more briefly:

For more information, see:

Affiliated FCMs Settle CFTC Enforcement Action Related to Alleged Non-Preservation of Customer Orders Audit Trail Records:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfetradeorder012617.pdf

Alleged Failure of HK Trading Firm to File Reports Regarding Physical Cotton Results in Enforcement Action by CFTC:
http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcncgcorder011717.pdf

Australia Regulator Proposes to Consolidate Market Integrity Rules:
http://www.asic.gov.au/regulatory-resources/find-a-document/consultation-papers/cp-277-proposals-to-consolidate-the-asic-market-integrity-rules/

CBOT BCC Fines Former Corn Futures Floor Broker US $35,000 for Noncompetitive Trading With Other Locals:
http://www.cmegroup.com/notices/disciplinary/2017/01/CBOT-10-04523-BC-3-KELLY-KING.html#pageNumber=1

CFTC Staff Authorizes Withdrawal of Certain Excess Residual Interest Amounts Prior to Next Day Formal Segregation Computation Subject to Strict Conditions:
http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-03.pdf

Cooperate and Maybe Benefit Says CFTC Division of Enforcement:

FINRA Seeks Comments on Implications of Distributed Ledger Technology:
http://www.finra.org/sites/default/files/FINRA_Blockchain_Report.pdf

Investment Adviser Settles Charges Related to Overcharging Clients and Misplacing Client Contracts:
https://www.sec.gov/litigation/admin/2017/34-79882.pdf

More Firms Sanctioned For  Whistleblower Offenses by SEC:

New Acting CFTC Chairman Provides Insight Into Priorities:
http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-19
http://www.cftc.gov/PressRoom/PressReleases/pr7519-17
http://www.cftc.gov/PressRoom/PressReleases/pr7523-17#PrRoWMBL
http://www.cftc.gov/PressRoom/PressReleases/pr7520-17

SEC Files Charges Against Broker-Dealer and Chief AML Officer for Failure to File Suspicious Activity Reports:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of January 28, 2017. 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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