Bridging the Week by Gary DeWaal

A review by the Inspector General of the Securities and Exchange Commission concluded there was no home court advantage for cases tried before the agency's own administrative tribunals, while the Financial Industry Regulatory Authority announced a sweep to help evaluate broker-dealers’ compliance cultures. Meanwhile, the Singapore Exchange proposed to amend its rules to ratchet down a somewhat prescriptive approach to regulating automated trading systems accessing its electronic platform to a far more principles-based manner. As a result, the following matters are covered in this week’s edition of Bridging the Week:

• FINRA Seeks to Identify How Some Members Implement Cultural Values (includes Culture and Ethics);
• Former Broker-Dealer CEO Sentenced to Six Months Imprisonment for Creating False Documents for SEC Production;
• No Home Court Advantage in Administrative Proceedings Says SEC Inspector General;
• CFTC Provides Reporting Relief to Trade Option Users;
• Research Analyst Fined by SEC for Falsely Rating Client to Keep Relationship;
• Singapore Exchange Consults on Adopting Principles-Based Not Prescriptive Pre-Trade Risk Control Requirements (includes My View); and more.

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Briefly:

• FINRA Seeks to Identify How Some Members Implement Cultural Values: The Financial Industry Regulatory Authority advised some broker-dealers through a targeted exam letter that it will soon meet with them to learn how they establish, communicate and implement their cultural values. In particular, FINRA seeks to determine how BDs reinforce their cultural values through compensation and how they monitor “for implementation and consistent application of those values” throughout the organization. FINRA implied it considers a good firm culture one “that consistently places ethical considerations and client interests at the center of business decisions.” FINRA has requested from each BD with whom it will meet, among other documents, a summary of key policies by which the BD establishes cultural values, and a description of the processes by which the firm (1) communicates and implements cultural values; (2) assesses and measures the impact of such values; (3) identifies breaches; (4) employs compensation to reinforce cultural values; and (5) identifies and remedies subcultures within the firm that do not follow the firm’s cultural standards. All documents must be provided to FINRA by March 21, 2016, or a selected firm must disclose that such documents do not exist. Identified BDs were alerted by FINRA that “[t]his inquiry is not an indication that [it] has concerns about your firm’s culture or has determined that your firm violated any rules or regulations.” Instead FINRA suggested it is solely seeking information to develop potential industry guidance.

Culture and Ethics: FINRA’s reflection on the elements of what constitutes an exemplary compliance culture superficially sounds good, but saying that a good compliance culture is one “that consistently places ethical considerations and client interests at the center of business decisions” is fraught with danger. Regrettably, not all client interests are legitimate, and a broker that only does what clients want will likely run into regulatory problems at some point. At a minimum, only legitimate client interests should be honored. In addition, elevating ethical considerations to the center of business decisions sounds noble, but, in the end, there may be disagreement among reasonable persons as to what constitutes appropriate ethical standards. It is far better for companies to mandate that their employees endeavor at all times to comply with the spirit let alone the letter of all applicable legal and regulatory requirements. But, in any case, the danger of regulating and micromanaging (including quantifying) compliance culture is that something surely will be missed and the proverbial forest will be lost but for the trees. Firms should mandate the application of a far more simple and direct test to ensure good culture: the grandmother test. If you would be embarrassed to sit at breakfast with your 90-year-old grandmother when she picks up her morning tabloid and reads about your conduct on the front page, don’t do it! It’s simple, but it works – at least for most grandmothers!

• Former Broker-Dealer CEO Sentenced to Six Months Imprisonment for Creating False Documents for SEC Production: Charles Moore, the former chief executive officer of broker-dealer Crucible Capital, Inc., was sentenced to six months in prison for obstructing a Securities and Exchange Commission regulatory investigation. The US Attorney’s Office in New York City previously filed criminal charges against Mr. Moore for having a Crucible employee falsify certain invoices received from third-party vendors by removing mention of past due balances in order to support certain Crucible SEC-required capital computations. The US Attorney’s Office claimed these altered invoices were subsequently given to the SEC during an examination of Crucible. (Click here for additional background in the article, “SEC Charges So-Called 'Nickel' Broker-Dealer and President With Net Capital and Recordkeeping Violations; President Also Criminally Charged for Obstructing SEC’s Investigation” in the August 10, 2014 edition of Bridging the Week.)
   
• No Home Court Advantage in Administrative Proceedings Says SEC Inspector General: The Office of the Inspector General of the Securities and Exchange Commission issued a Report of Investigation that concluded that SEC-related hearings before administrative law judges were not conducted under improper influence nor did they reflect a home court advantage. OIG’s inquiry was prompted by a complaint of bias by administrative law judges leveled by Erica Williams, a former deputy chief of staff in the SEC’s Office of the Chair. In June 2015, Ms. Williams complained about “alleged potential issues of fairness and bias in the SEC’s administrative proceedings,” including similar allegations previously made by Timbervest, LLC in connection with an SEC administrative proceeding against it brought by the agency’s Division of Enforcement. As part of its investigation, OIG interviewed numerous current and former SEC ALJs and reviewed relevant documents. In the end, OIG noted “it did not develop any evidence to support the allegations of improper influence.” However, OIG did identify some issues related to the timeliness of some ALJ decisions and the procedural quality of some ALJs’ work. (Click here for a related article regarding Timbervest LLC entitled, “Federal Judges in NY and Georgia Rule Against SEC for Enforcement Action Forum Choice Because of ALJ Selection Process” in the August 14, 2015 edition of Bridging the Week.)
   
• CFTC Provides Reporting Relief to Trade Option Users: Last week, staff of the Commodity Futures Trading Commission extended and expanded reporting relief to certain persons who purchase and sell trade options. Trade options are options on tangible commodities where (1) the offeror is either a highly sophisticated or financially well-off person or entity (a so-called “eligible contract participant”) or a producer, processor, commercial user of or merchant involved in the relevant commodity and is involved in the transaction for business-related purposes; (2) the option offeree is, and the offeror reasonly believes the offeree to be, a commercial party that will enter into the trade option related to its business ; and (3) the option is intended to be physically settled. In general, trade options are exempt from the swap requirements instituted by the CFTC following passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. However, since Dodd-Frank, trade options have been subject to certain swaps reporting requirements or, for non-swap dealers and non-major swap participants, less onerous reporting requirements utilizing a Form TO. Last year, the CFTC proposed rules to eliminate Form TO entirely; however, these rules have not been adopted. Under staff’s no-action relief, a party to a trade option that has not been subject to the CFTC’s swap reporting requirements in connection with any non-trade option during the prior 12 months is not required to report their trade options for 2015 on Form TO. Other requirements remain, however, for other trade option participants. (Click here for details on the CFTC’s rule proposal in the article, “CFTC Proposes Reduction in Reporting and Recordkeeping Requirements for Trade Options” in the May 3, 2015 edition of Bridging the Week. Click here for more detailed information on CFTC staff’s relief in the article, “CFTC Grants Relief for End Users from Trade Option Filing Requirements,” in the February 19, 2016 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)
   
• Research Analyst Fined by SEC for Falsely Rating Client to Keep Relationship: Charles Grom, a former managing director and equity research analyst at Deutsche Bank Securities Inc., agreed to settle charges brought by the Securities and Exchange Commission that, in 2012, he rated in a certification and promoted a company stock as a “buy” at the same time his personal view was that the stock rating should be downgraded. According to the SEC, this certification caused Mr. Grom to violate an SEC regulation that requires research analysts to certify research reports, attesting that all of the views expressed in a report accurately reflect the analyst’s personal views (click here to access SEC Rule 242.501). According to the SEC, on March 29, 2012, Mr. Grom issued a research report on Big Lots, Inc. where he recommended the company as a “buy.” On the prior day, Mr. Grom allegedly recommended selling the stock to four hedge funds because of his personal concerns about the company’s financial performance. According to the SEC, Mr. Grom rated the company as a “buy” to maintain a good relationship with the company’s management. Mr. Grom agreed to pay a fine of US $100,000 to resolve the SEC’s charges.
   
• Singapore Exchange Consults on Adopting Principles-Based Not Prescriptive Pre-Trade Risk Control Requirements: The Singapore Exchange proposed a host of new rules to reflect the replacement of its current derivatives trading system and SGXClear, its current clearing system, with a new trading and clearing system, SGX Titan. This new system is expected to be implemented by the end of 2016. Among the many proposed rule changes are rule amendments addressing pre-execution checks, error-prevention alerts and fictitious transactions, aimed to accomplish many of the same objectives of the Commodity Futures Trading Commission’s recently proposed rules known as Regulation AT. (Click here for background on Regulation AT in the article, “CFTC’s Proposed New Algorithmic Trading Rules Augur Potential Increased Obligations and Costs, and a New Registration Requirement” in the November 29, 2015 edition of Between Bridges.) Among other things, SGX’s amended provisions transform formerly detailed prescriptive requirements into broad principles-based obligations. For example, instead of mandating that a host of specifically enumerated pre-execution checks be conducted on all orders, SGX’s new proposed rules broadly require that “Members … ensure that automated pre-execution risk management controls checks are conducted on all orders. … [T]he checks must be appropriately set to effectively limit the firm’s risk exposure arising from all orders to prevent the taking on of excessive risk.” Comments on the new rules will be accepted through March 10, 2016.

My View: SGX is commended for proposing to amend its current rules to transform somewhat prescriptive requirements to principles-based requirements. This reflects that obligations around automated trading should not be one-size-fits-all, but must be tailored to meet firms’ and clients’ specific businesses and practices as well as potential risk to a marketplace.

And more briefly:

• CFTC Motion to Expand Proof in Spoofing Case Denied: A US court in Illinois denied a motion of the Commodity Futures Trading Commission to potentially introduce evidence of new trading allegedly consistent with prior trading engaged in by two defendants that the agency last year charged constituted prohibited spoofing under a novel “flipping” theory. The court said the CFTC’s motion was premature and denied it “without prejudice.” (Click here for details regarding the CFTC’s motion in the article, “Defendants in Pending Alleged Spoofing Case Told by CFTC Evidence Might Be Expanded to Include New February 2016 Conduct” in the February 14, 2016 edition of Bridging the Week.)
   
• Comment Period Extended for CFTC Draft Technical Specifications for Certain Swap Data Elements: The Commodity Futures Trading Commission has extended until March 7, 2016, the comment period for its draft technical specifications for certain swap data elements. The CFTC previously proposed the draft specifications dealing with descriptions, allowable values and formats for certain swap data elements reportable under CFTC rules, as well as certain swap data elements not currently reportable. Through February 19, 2016, the CFTC posted on its website only four comment letters it has received in response to this proposal (click here to access filed comment letters).
   
• Canadian Regulator Announces 2016 Compliance Priorities: The Investment Industry Regulatory Organization of Canada issued its Compliance Priorities Report for 2015/2016. This report constitutes a brief summary of issues identified by the regulator during the prior year at its dealer members to assist them plan for the upcoming year. Among the topics that IIROC recommends investment firms address in 2016 are cyber-security and outsourcing arrangements; electronic trading, including third-party access; and social media.

For more information, see:

Canadian Regulator Announces 2016 Compliance Priorities:
http://www.iiroc.ca/Documents/2016/c4c52ff7-26a5-421a-9621-1e6692687566_en.pdf

CFTC Motion to Expand Proof in Spoofing Case Denied:
/ckfinder/userfiles/files/Oystacher%20CFTC%20Motion%20Denied%202%2017%2016.jpeg

CFTC Provides Reporting Relief to Trade Option Users:
http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/16-10.pdf

Comment Period Extended for CFTC Draft Technical Specifications for Certain Swap Data Elements:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/specificationsswapdata122215.pdf

FINRA Seeks to Identify How Some Members Implement Cultural Values:
http://www.finra.org/industry/establishing-communicating-and-implementing-cultural-values

Former Broker-Dealer CEO Sentenced to Six Months Imprisonment for Creating False Documents for SEC Production:
http://www.justice.gov/usao-sdny/pr/ceo-broker-dealer-sentenced-manhattan-federal-court-obstructing-regulatory-examination

No Home Court Advantage in Administrative Proceedings Says SEC Inspector General:
https://www.sec.gov/oig/reportspubs/Final-Report-of-Investigation.pdf

Research Analyst Fined by SEC for Falsely Rating Client to Keep Relationship:
https://www.sec.gov/litigation/admin/2016/34-77150.pdf

Singapore Exchange Consults on Adopting Principles-Based Non-Prescriptive Pre-Trade Risk Control Requirements:
http://www.sgx.com/wps/wcm/connect/fe9179cd-c15d-43bd-9412-10bb1cb44d67/TitanDTDC_PubConsult_F_18Feb2016.pdf?MOD=AJPERES

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of February 20, 2016. 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.