Commentaries

Bridging the Week by Gary DeWaal: February 27 to March 3 and March 6, 2017 (EFRPs; Sanctions; Regulator Hide and Seek; Red Flags Missed (Again))

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Published Date: March 05, 2017

Little news emanated from the Commodity Futures Trading Commission or the Securities and Exchange Commission last week. However, a few interesting matters came out of self-regulatory organizations that reminded me of some valuable compliance tips. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Video Version:

Article Version

Briefly:

Compliance Weeds: Both parties to an EFRP must ensure their transaction is bona fide. Most basically, one party to an EFRP must be the seller of the exchange contract and the purchaser of the related position (or long exposure associated with such position), while the other party must be the purchaser of the exchange contract and the seller of the related position (or short exposure associated with such position). Although generally there are no qualification requirements for parties to an EFRP, where the related position is a swap, each party to the EFRP must be a so-called “eligible contract participant” (click here to access Commodity Exchange Act § 1a(18) for a definition of ECP). Other requirements also apply to EFRPs. (Click here for background regarding EFRPs in the article “Alphabet Soup Under CFTC Scrutiny: CFTC Review of CME Handling of EFRPs (EFPs, EFRs, and EOOs) Suggests Tougher Times for Traders and FCMs; Time to be Pro-Active!” in the August 6, 2013 edition of Between Bridges.) Under CME guidance, brokers or FCMs that execute or clear EFRPs for customers “are responsible for ensuring” their customers who engage in EFRPs are “fully informed regarding Exchange EFRP requirements and should “exercise due diligence in identifying circumstances” where a customer’s EFRP may be non-bona fide. (Click here to access the relevant CME Group Market Regulation Advisory Notice regarding EFRPs – Q/A25.) ICE Futures U.S. has more prescriptive requirements for firms that execute or clear EFRPs for customers. On ICE Futures U.S. such firms are expected to “establish, document and execute controls that are reasonably designed to determine a customer’s suitability to engage in EFRP transactions and detect the execution of non-bona fide EFRPs.” (Click here to access ICE Futures U.S. FAQs – Q/A8.) Any party that facilitates the execution of an EFRP that it knows is non-bona fide and fails to take “appropriate action” could be held liable under the relevant CME rule (click here to access CME Group Rule 538C – last paragraph; see also, ICE Futures U.S. FAQs – Q/A8). Under CFTC rules, all FCMs, introducing brokers and members of designated contract markets or swap execution facilities must, upon a request by DCM, SEF, the CFTC or Department of Justice, “request from its customers, and, upon receipt,” provide to the requesting entity records supporting the related position to an EFRP. (Click here to access CFTC Rule 1.35(c)(1).) Clearing firms have equivalent obligations under exchanges’ rules regarding their customers’ documents supporting EFRPs, although exchanges may call on the customers directly to provide such documents.

Compliance Weeds: Hide and seek is not a good game to play with regulators. However, determining when there is an event that requires an “immediate,” “same day” or “within 24 hours” mandatory notice filing to the Commodity Futures Trading Commission, the Securities and Exchange Commission or both by a futures commission merchant, futures-industry introducing broker or a broker-dealer often requires quick judgments under highly pressured circumstances. Unfortunately, material facts may sometimes be assessed incorrectly in the heat of a moment, and after some brief research, an apparent precipitous circumstance may turn out to be a false alarm. Accordingly, it is important that registrants are cognizant of all mandatory extraordinary reporting requirements, and when a possible reporting event occurs, first pause (calm the environment), second reflect (understand all available facts), and third, challenge (ensure that a perceived problem is truly a problem). Only after there is confirmation of a problem (or near certain confirmation), however, should a required report be made. By then, the full scope of the problem should be known and hopefully fixed -- at least on an interim basis; however, failure to assemble full information and/or implement an immediate fix will not excuse a delay in required reporting. If there is ongoing doubt one way or another about the occurrence of a potential reportable event, consider at least an interim, informal report to a relevant regulator to advise it of the potential of a reportable event. To the extent practical, a look-back to consider lessons learned and more permanent fixes to prevent a future occurrence should also occur as soon as possible. (Click here to access a handy chart published by the National Futures Association of Futures Commission Merchant Reporting Requirements, and here for Introducing Broker Reporting Requirements. Click here to access a summary chart of broker-dealer regulatory notification requirements by the Financial Industry Regulatory Authority.)

And more briefly:

For more information, see:

Correspondent Broker Charged by FINRA With Failing to Monitor Customers’ Potential Spoofing Activity:
/ckfinder/userfiles/files/FINRA%20Lighspeed.pdf

CTA and Principal Barred as NFA Members for Not Cooperating With NFA Examination:
http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seqnum=4428

ICE Futures Canada Enacts Trader Identification FAQs Just Like ICE Futures U.S.:
https://www.theice.com/publicdocs/futures_canada/Trader_Identification_FAQs_March2017.pdf

ICE Futures Europe Proposes Tough Prohibitions to Avoid Interaction With Sanctioned Countries or Persons:
https://www.theice.com/publicdocs/circulars/17021.pdf

IOSCO Issues Guidance on Unique Transaction Identifiers:
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD557.pdf

NASDAQ Futures Modifies Self-Match Functionality:
http://www.nasdaqtrader.com/MicroNews.aspx?id=FTA2017-5

Non-Member Sanctioned by NYMEX Business Conduct Committee for Non-Bona Fide EFRPs; Can’t Shift Blame to Broker or FCM Despite Try:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of March 4, 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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