J. Christopher Giancarlo, Chairman of the Commodity Futures Trading Commission, proposed reforms to enhance swaps trading and reporting, the central clearing of swaps, swaps dealers’ capital, and persons subject to mandatory clearing and margin requirements. He said that implementing his recommended trading reforms would justify expanding the number of swaps required to trade on swap execution facilities. Unrelatedly, Andre Flotron — a former trader for a worldwide investment bank — was acquitted of conspiracy to defraud in connection with allegations that he engaged in spoofing-type futures trading activity from 2008 to 2013. As a result, the following matters are covered in this week’s edition of Bridging the Week – which, belatedly, marks the fifth-year anniversary of this publication:
(Click here to access to the initial publication of Bridging the Week on April 22, 2013.)
In a wide-ranging report entitled “Swaps Regulation Version 2.0,” Mr. Giancarlo also called for further study to (1) ensure the safety and soundness of clearinghouses and how the CFTC and Federal Deposit Insurance Corporation might better coordinate the resolution of a collapsed systemically important clearinghouse; (2) improve real-time reporting of swaps trades by calibrating requirements to the nature of the relevant products, entities, markets and asset classes; (3) enhance regulators’ capability to approve and monitor internal models for capital computations that more effectively measure the risk of swaps positions by considering the benefits of offsetting positions as well as the risk mitigation of posted margin; and (4) potentially exempt smaller financial end users from obligations to clear swaps and post margin on uncleared swaps.
In his white paper, Mr. Giancarlo stated that the CFTC did not follow Congressional instruction when implementing swaps trading rules as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Rather than permitting SEFs to operate by “any means of interstate commerce” as Congress instructed, the CFTC limited transactions required to be executed on a SEF to two means – an order book or a request for quote from three-persons. According to Mr. Giancarlo, the CFTC’s SEF trading rules have caused a “sharp fragmentation of global trading liquidity into numerous disjointed market segments.”
Mr. Giancarlo indicated that, consistent with expanding the ways swaps should be executed on SEFs, the CFTC should make the mandatory SEF execution requirement – the so-called “MAT determination” (made available to trade) for a swap coterminous with a determination that the swap must be centrally cleared. According to Mr. Giancarlo, this would bring “‘daylight to the marketplace’ subjecting a much broader range of swaps products to SEF recordkeeping and regulatory supervision and oversight.”
Mr. Giancarlo also suggested that, in the future, swaps reporting might be enhanced through application of distributed ledger technology, and that the CFTC should explore this possibility with other regulators.
Although Mr. Giancarlo provided no timetable to implement his recommendations, he indicated, “[w]e will move forward in regular order and in good order – we will get this done.”
In 2015, before he was nominated as CFTC chairman, Mr. Giancarlo issued another white paper that also severely criticized the Commission’s swaps trading rules and proposed an alternative framework that he claimed more accurately reflected congressional intent. (Click here for background in the article “CFTC Commissioner Laments Flawed US Swaps Trading Model” in the February 1, 2015 edition of Bridging the Week.)
Swaps Regulation Version 2.0 was co-written by Bruce Tuckman, the CFTC’s chief economist.
My View: Mr. Giancarlo’s latest overview of US swaps regulation provides a thoughtful reflection on central clearing, trade reporting, trade execution, swap dealer capital and the end user exception. As before, in most areas, he and his co-author get it totally right. However, I still think Mr. Giancarlo’s path for arriving at his conclusions still overly depends on the nature of swaps being swaps, as opposed to the characteristics of the swaps themselves. To me this is an incorrect starting point, although it is appropriate given the constraints of current law.
As I wrote in 2015, “[i]t is not that all swaps behave one way and all futures another that they should be regulated differently—it is because some swaps are much less liquid than many futures. However, many delivery months of futures are equally illiquid as are many strike prices of options.
Regulators, particularly in the United States—because of artificial divisions created by law—, have gotten it wrong when they base regulation on the name of the product they are overseeing rather than on its characteristics. It is simply not relevant whether a financial product is called a futures contract, a security or a swap. What is relevant is solely (1) whether a financial product is sold for future settlement (where payment now represents a partial down payment to ensure performance later), (2) how distant in the future is the settlement scheduled, and (3) if a financial product that is sold is settled today, can the product be purchased on leverage and, if yes, for how much and what are the conditions? Moreover, at any time, how liquid is the financial product today and over time?
Viewing the characteristics of products rather than their names would permit regulators to develop more appropriate trading and business conduct rules. It certainly would avoid scenarios where cleared swaps can be transformed over a weekend to cleared futures, options can be regulated both as securities and futures, and highly correlated but differently named financial products can have different regulatory and tax treatments.”
Mr. Flotron, who allegedly engaged in the conduct that was subject to his indictment from July 2008 through at least November 2013, most recently resided in Switzerland. He was arrested and criminally charged in a federal court in Connecticut after he came to the United States to visit his girlfriend in September 2017.
(Click here for background regarding Mr. Flotron’s arrest and indictment in the article “Spoofing Case Filed in Connecticut Against Overseas-Based Precious Metals Trader” in the September 17, 2017 edition of Bridging the Week.)
Subsequently, the Department of Justice attempted to dismiss its own case against Mr. Flotron in Connecticut in order to refile it in Illinois to include other charges. The court held that the DoJ’s motion would unfairly deprive Mr. Flotron of a speedy trial and was in bad faith. According to the court, “The Government’s real wish [in prevailing on the motion] is to decorate its broad conspiracy charges with baubles of substantive charges that serve little or no function other than to run up defendant’s sentencing exposure beyond the 25 years imprisonment he already faces if convicted on the conspiracy charges alone.” (Click here for a copy of the relevant court decision.) Mr. Flotron remains the defendant in an enforcement action by the Commodity Futures Trading Commission related to the same alleged trading conducted filed in January 2018. (Click here for a copy of the relevant complaint.)
Unrelatedly, Mark Johnson, HSBC Bank plc’s former head of foreign exchange cash trading, was sentenced to 24 months’ imprisonment and subject to other penalties, following his conviction for front-running a customer’s trading in British Pounds in November and December 2011. Mr. Johnson was criminally charged for his conduct by the US Attorney’s office in Brooklyn, New York, in July 2016, and was found guilty of eight counts of wire fraud by a federal jury in October 2017. (Click here for background in the article “Global Head of FX Cash-Trading Desk of Global Investment Bank Arrested for Front-Running” in the July 24, 2016 edition of Bridging the Week.)
In his indictment, Mr. Flotron was not charged with spoofing or commodities fraud, as was, for example, Michael Coscia, who was convicted of such offenses in 2015. (Click here for background on Mr. Coscia’s criminal action in the article “Federal Appeals Court Upholds Conviction and Sentencing of First Person Criminally Charged for Spoofing Under Dodd-Frank Prohibition” in the August 7, 2017 edition of Between Bridges.) Indeed, part of Mr. Flotron’s alleged wrongful conduct — spoofing – was not expressly prohibited by law until July 16, 2011, three years after he commenced his purported illegal activity.
Rather, Mr. Flotron was charged under a provision of law that solely prohibits “two or more persons to commit any offense against the United States or to defraud the United States… and one or more of such persons to do any act to effect the object of the conspiracy.” (Click here to access the exact text of 18 U.S. Code §371.) This provision lays out a high burden for prosecutors, particularly in a case like Mr. Flotron’s where the alleged spoofing was manually conducted, and there was no audit trail of specially designed algorithms, as there was with Mr. Coscia, that might help to establish his intent to effect his purported prohibited conduct. All prosecutors could offer was the testimony of alleged co-conspirators who could speculate what Mr. Flotron was thinking.
Moreover, not only was the Department of Justice unable to have Mr. Flotron’s Connecticut criminal action dismissed and re-filed in Illinois as it wanted, it was prohibited by the federal judge overseeing his trial in Connecticut from introducing evidence of potentially other problematic conduct, e.g., alleged front-running. (Click here for background in the article “Trader Criminally Charged for Alleged Spoofing Prevails in Effort to Quash Evidence of Front-Running at Trial” in the April 8 edition of Bridging the Week.)
As a result, it would be a mistake to draw any conclusion about the status of spoofing under current law solely from the outcome of this case – other than intent is always tough to prove and prosecutors, in a rush, sometimes file the wrong indictment.
Follow-up: The oral argument for the motion to dismiss in the criminal prosecution of Maksim Zaslavskiy for allegedly engaging in an initial coin offering of an unregistered security and securities fraud was postponed from April 27 to May 8. (Click here for details regarding this motion in the article, "Department of Justice Argues Against Motion to Dismiss Indictment of ICO Sponsor Claiming That Relevant Digital Tokens Are Securities" in the March 25, 2018 edition of Bridging the Week.)
Compliance Weeds: Written cybersecurity supervisory procedures must not only address the prevention of breaches but contain policies and procedures that deal with what to do when a breach is discovered. These should address internal escalation of information reporting and reporting to regulators and the public, as appropriate.
Separately, a California federal appeals court upheld a lower court's decision that Brandon Leidell, the plaintiff, was not required to arbitrate a claim against Coinbase, Inc., a cryptocurrency exchange, where he alleged that Coinbase, in violation of its obligations under applicable law, permitted its services to be used by another cryptocurrency exchange, Cryptsy and its founder, president, and chief executive officer – Paul Vernion – to misappropriate customers' Bitcoin. Mr. Leidell had argued that Coinbase had an obligation to monitor the Cryptsy account, to detect its theft of customers' Bitcoin, and to report suspicious activities to appropriate government authorities as part of its anti-money laundering obligations. Coinbase had argued that Mr. Leidell, as a customer of Cryptsy, was bound by the arbitration clause in the user agreement acknowledged by Cryptsy when it opened its account. The appeals court disagreed, claiming that Mr. Leidell alleged law violations, not contractual claims, and thus, was not subject to the arbitration clause. Mr. Leidell filed his initial lawsuit as a purported class action.
For further information:
CFTC Chairman Says Commission Should Focus on Raising Standards for Swaps Trading Not Restricting Execution Models:
CFTC Warns Against Manufactured Credit Events for Credit Default Swaps:
Efficacy of Annual Compliance Meeting Subject of FINRA Retrospective Review:
Former UBS Trader Found Not Guilty of Conspiracy to Defraud for Alleged Spoofing:
North Carolina Stops Purported Crypto Mining Pool From Selling Shares in State:
Proprietary Traders Tricked Into Investing in Scam Enterprise Charges CFTC in Federal Court Enforcement Action
SEC Seeks Public Comment on NYSE Arca Intent to List Certain Bitcoin Futures ETFs; Federal Appeals Court Holds Arbitration Clause Does Not Help Cryptocurrency Exchange for Law Violation Claims by Indirect Customers:
Leidell v. Coinbase:
Singapore Regulator Seeks to Heighten Accountability of Financial Institutions’ Senior Managers:
Yahoo! Agrees to Pay US $35 Million Fine for Not Telling Investors of Massive 2014 Data Breach:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 27, 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. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or other employees.