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Last week, a futures commission merchant settled an enforcement action brought by the Commodity Futures Trading Commission, claiming that it failed to supervise a third-party technology provider it engaged to implement “critical” elements of the FCM’s information system security program. As a result of the breakdown, claimed the CFTC, an unauthorized individual improperly infiltrated the FCM’s technology system and copied files containing customers’ records and private information. Unrelatedly, a Chicago-based trader was criminally charged in a federal court in Chicago with fraud for misappropriating his employer’s cryptocurrencies.
(There is no regular edition of Bridging the Week on February 19 because of the Presidents' Day holiday in the United States.)
On February 12, AMP Global Clearing LLC, a CFTC-registered FCM, agreed to pay a fine of US $100,000 to resolve an enforcement action brought by the Commission claiming that it failed to supervise a third party’s implementation of “critical” provisions of its information system security program (ISSP). As a result of this failure, said the Commission, AMP’s technology system was compromised by an unauthorized individual (Infiltrator) who impermissibly copied approximately 97,000 files, including many files that contained confidential personal information.
According to the CFTC, in June 2016, an unnamed IT provider engaged by AMP installed a storage device – known as a network attached storage device (NASD) – on the firm’s computer network to store back-up data. However, the IT provider failed to alert AMP that the NASD had a feature to copy data to and from other NASDs over the Internet and that a data port used by AMP’s NASD to effectuate this functionality was left open by default. This feature could potentially permit permissionless access to AMP’s data from the Internet.
AMP apparently maintained an ISSP that required assessment of potential vulnerabilities in its computer systems and engaged the IT provider to maintain strict firewall rules and to conduct regular assessments, including of access routes into AMP's network. However, alleged the CFTC, the IT provider “did not identify or perform a risk assessment… in accord with the ISSP” and the potential vulnerability was not detected. Moreover, the IT provider failed to detect this vulnerability during September 2016, December 2016 and March 2017 quarterly network penetration tests, vulnerability scans and firewall audits.
In March 2017, the Infiltrator detected AMP’s open data port and the following month, he copied the 97,000 files without detection by AMP. Later in April, the Infiltrator advised AMP of the security breach and the firm reported it to the firm’s customers, the CFTC and the National Futures Association. At about the same time, the Infiltrator alerted federal authorities regarding its unauthorized access and that the information it copied “had been secured, and was no longer in the [Infiltrator’s] possession.”
Previously, from December 2016 through March 2017, the Infiltrator “and his colleagues” publicized on blog posts about their unauthorized access to NASDs used by entities other than AMP through data ports also left open by default. At least three of these incidents were reported in the media. However, despite this publicity, the IT provider failed to identify any vulnerability in AMP’s NASD during its March 2017 network security tests or risk assessments.
No third party other than the Infiltrator accessed AMP’s customer files through the open data port.
According to the CFTC, AMP’s failure to diligently supervise how its ISSP policies and procedures were implemented and how its customers’ records and information were electronically protected constituted a regulatory breach (click here to access CFTC Regulation 166.3). The Infiltrator was not named as a defendant in the CFTC's action.
The CFTC said that AMP’s substantial cooperation in this enforcement action was rewarded by a reduced fine. In addition to paying a fine to resolve this matter, AMP agreed to provide written reports after six months and one year summarizing its efforts to improve the integrity of its computer network and confirming its adherence to the requirements of its ISSP.
(Click here for a copy of the CFTC’s settlement order in this matter.)
My View: Huh? First off, the facts of this CFTC enforcement action read like the plot of a bad cliché television show where the purported hero may have been the villain all along. Apparently, prior to compromising AMP’s data files, the Infiltrator may have alerted AMP regarding its system’s vulnerabilities. Why? What was going on? Was the Infiltrator making a bid to be hired? Was the Infiltrator a non-hired vendor scorned? There are many questions not answered by the Commission’s settlement order. It appears, however, at a minimum, AMP may not have acted on the Infiltrator’s tip.
The oddity of this enforcement action aside, the message of this case is quite disturbing. Even when a registrant develops and institutes a reasonably sound ISSP and employs a responsible third party to administer it in recognition of its own lack of technical acumen, it may be held liable by the CFTC if the third party fails to detect a system flaw and act on it promptly.
This standard imposes an incredibly harsh burden on registrants where they may not be technologically savvy and must (and should) rely on the assistance of a qualified third party.
Moreover, the CFTC’s approach seems to run directly counter to a 2016 guidance issued by the National Futures Association requiring members to develop and maintain ISSPs. Although members must maintain ISSPs “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,” the NFA recognized that one size does not fit all. According to the self-regulatory organization,
NFA recognizes that given the differences in the type, size and complexity of operations of Members’ businesses including but not limited to their customers and counterparties, markets and products traded, and the access provided to trading venues and other industry participants, Members must have an appropriate degree of flexibility to determine how best to diligently supervise information security risks.
(Emphasis added. Click here to access NFA Interpretive Guidance 9070, Information Systems Security Programs.)
This NFA approach is consistent with guidance provided by the CFTC’s own Division of Swap Dealer and Intermediary Oversight in 2014 that likewise recognized that
Each covered entity should develop, implement and maintain a written information security and privacy program that is appropriate to its size and complexity [and] the nature and scope of its activities, and which requires it to, at a minimum [address certain enumerated elements].
(Emphasis added. Click here to access CFTC Staff Advisory 14-21, Graham-Leach Bliley Act Security Safeguards.)
However, through this enforcement action and settlement, the CFTC seems to be suggesting that there may be only one way for a registrant to manage the risk to its data infrastructure: hands-on, by itself, no matter how unqualified it assesses itself to be for such a task. As a result, that one way may be impractical for all but the largest organizations with the deepest technology staff.
This is now the second enforcement action brought and settled by the CFTC within the past six months where a registrant was held liable for failure to supervise when the registrant expressly engaged a third party to assist it to detect potential regulatory problems when it believed it lacked expertise, and the third party apparently did not fulfill its objective. (Click here for details of this other enforcement action in the article “Two Commodity Pool Operators Charged by the CFTC With Failure to Supervise “ in the October 1, 2017 edition of Bridging the Week.)
Compliance Weeds: Since March 1, 2016, every NFA member FCM, retail foreign exchange dealer, commodity trading advisor, commodity pool operator and introducing broker is required to maintain a formal written ISSP that, among other things, establishes a government framework “that supports informed decision making and escalation within the firm to identify and manage information security risks.”
ISSPs must also require assessment and prioritization of the risks associated with the use of information technology systems; the deployment of safeguards against identified threats and vulnerabilities; and implementation of a formal incident response plan to respond and recover from cyber-breaches.
Employee training and the risks posed by critical third-party service providers that access a member’s system or provide outsourcing must also be addressed in an ISSP.
A relevant member’s chief executive officer, chief technology officer or other executive-level officer should approve its ISSP. Moreover, “sufficient information” should be provided about the ISSP to a relevant member’s board or governing body (or delegated committee) “to enable it to monitor the Member’s information security efforts.” NFA contemplates that a member that is part of a group may comply with its ISSP requirements through participation in a consolidated entity ISSP. An NFA member must retain all records related to its adoption and implementation of an ISSP in accordance with ordinary CFTC recordkeeping requirements.
ISSPs should be regularly monitored by NFA members, and ISSPs’ effectiveness should be reviewed at least once every 12 months by either in-house staff with appropriate knowledge or an independent third-party specialist.
A criminal complaint was filed against Joseph Kim on February 15 for allegedly misappropriating Bitcoin and Litecoin – two virtual currencies – from his former employer, Consolidated Trading, LLC, a proprietary trading firm; Franklin & Wacker, LLC, an affiliate; and the two firms’ principals. Mr. Kim was charged with committing wire fraud.
According to the Complaint, which was filed in a federal court in Chicago, Mr. Kim was hired by Consolidated as an assistant trader in July 2016. In September 2017, Mr. Kim was transferred by Consolidated to a newly established Cryptocurrency Group at Franklin.
Shortly after this move, alleged the Complaint, Mr. Kim transferred 980 Litecoins from Consolidated’s account at Bitfinex – a non-US spot virtual currency exchange – to his own account. When this transfer was discovered by a Consolidated director, Mr. Kim indicated that “he moved these funds to his personal digital wallet for safety reasons.” Mr. Kim purportedly made similar misleading comments to other of Consolidated’s management regarding the location of the Litecoin until Mr. Kim’s alleged misappropriation was uncovered on approximately November 28, said the Complaint.
Similarly, the Complaint claimed that, on November 17, 2017, the same Consolidated director discovered that 55 Bitcoin were missing from a Consolidated account at Bithumb – another non-US cryptocurrency exchange. In response to the same director’s inquiry, Mr. Kim claimed that he was taking steps to unlock the virtual currencies that had been blocked by Bithumb. Later in November, Mr. Kim returned 27 Bitcoin to Consolidated’s Bithumb account. Within a few days, however, Mr. Kim transferred more Bitcoin from his company’s to his own account, returned some, and lost some Bitcoin through personal trading.
Overall, the Complaint alleged that Mr. Kim withdrew from company accounts and transferred to his own accounts without authorization Bitcoin and Litecoin, such that Consolidated sustained an overall US dollar loss in excess of US $600,000.
Although the Complaint indicated that Consolidated maintained written policies regarding employee trading of securities and futures, these policies did not address cryptocurrencies. However, the Complaint indicated that Mr. Kim was expressly told by a Consolidated director that he could not engage in personal trading in cryptocurrencies consistent with the firm’s policy for all traders for other financial instruments. Mr. Kim supposedly agreed to comply with the instruction but, in fact, he did not comply.
According to the Complaint, after his alleged misappropriation was discovered, Mr. Kim wrote, “It was not my intention to steal for myself from [Consolidated] and until the end I was perversely trying to fix what I had already done.” The Complaint also alleged that Mr. Kim told another trader at Consolidated that he was a “degen,” a slang term the trader understood to mean a degenerative gambler.
If convicted, Mr. Kim faces imprisonment of up to 20 years.
(Click here for a copy of the criminal complaint against Mr. Kim.)
Compliance Weeds: If they have not already done so, registered financial services firms and proprietary-trading entities should consider whether they should amend existing employee personal trading polices to expressly address cryptocurrencies. This may be appropriate even if such firms are not engaged in cryptocurrency activities today.
The easiest approach would be for firms to ban all personal cryptocurrency trading by employees because of reputational or other perceived risks. However, such a policy may impede hiring or retention of some employees, especially so-called “millennials.”
Alternatively, if firms already have policies addressing employees’ trading of securities, including participation in new offerings of securities, it might be appropriate to consider extending these policies to digital tokens issued as part of initial coin offerings that the Securities and Exchange Commission has said are likely securities. (Click here for background regarding the SEC’s views in the article “SEC Chairman Warns Lawyers Providing ‘It Depends’ Advice on ICOs” in the January 28, 2018 edition of Bridging the Week.)
Moreover, to the extent firms have existing polices addressing employees’ trading of gold or similar commodities, they may wish to extend such policies to employees’ trading of virtual currencies like Bitcoin or Litecoin.
However, because of the SEC’s views, it is not definitively clear today what is the bright line between virtual currencies and security tokens.
Firms that engage in cryptocurrency activities should consider the potential impact of employees front-running firm or a firm’s customers’ trading or engaging in other wrongful conduct. Firms not engaged in cryptocurrency activities but contemplating engagement should consider the potential implications of employees purchasing virtual currencies in advance of any firm announcement with the expectation that the announcement might cause prices of relevant cryptocurrencies to rise.
The monitoring of employee cryptocurrency activity may also be difficult as cryptocurrency exchanges may not be willing or able to provide statements of employee activity to employers automatically. At best, it may be up to an employee to authorize such third-party transmissions that he or she could activate or deactivate at his/her discretion.
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of February 10, 2018. 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.
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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Between Bridges by Gary DeWaal – February 19, 2018: CFTC Says Futures Brokerage Firm’s Failure to Supervise Led to Unauthorized Cyber Attack; Trader Criminally Charged for Allegedly Misappropriating Employer’s Cryptocurrencies
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