Bridging the Week by Gary DeWaal

Bridging the Week by Gary DeWaal: September 16 - 20 and September 23, 2019 (Spoofing; RICO; Appeal of Gag Order Breach; Nick Leeson Redux?)

Bitcoin Ecosystem    Blue Sheets    Bridging the Week    Cryptosecurities    Legal Weeds    Manipulation    My View    Policy and Politics    Position Limits    Registration    Systems and Controls    Trade Practices (including Disruptive Trading)    Uncleared Swaps   
Published Date: September 22, 2019

The Department of Justice raised the stakes in spoofing enforcement actions by including racketeering charges in an indictment filed last week alleging spoofing by three traders over many years. The Commodity Futures Trading Commission filed parallel civil enforcement actions based on the same purported underlying incidents. Separately, the CFTC appealed something related to a federal court’s decision to hold an evidentiary hearing on October 2 regarding its alleged breach of a gag order in a recent enforcement action settlement with two food giants. However, the nature of the appeal is a secret! As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Three Metals Traders Indicted for Racketeering and Other Offenses for Alleged Spoofing Activities; CFTC Files Parallel Civil Charges (includes Legal Weeds);
  • Federal Court to Consider Vacating CFTC Enforcement Consent Settlement During October 2 Hearing; Commission Files Stealth Appeal (includes My View);
  • Alleged Rogue Trader's Unauthorized Energy Bets Result in Approximately US $320 Million Loss to Trading Firm (includes Memory Lane); and more. 

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  • Three Metals Traders Indicted for Racketeering and Other Offenses for Alleged Spoofing Activities; CFTC Files Parallel Civil Charges: Three employees, two current and one former, of JP Morgan were charged by the United States Department of Justice in a federal court in Illinois with engaging in a multiyear scheme to manipulate gold, silver, platinum and palladium futures traded on two CME Group exchanges. The prosecutors charged that such conduct constituted racketeering activity in violation of federal law (a “RICO” conspiracy), as well as manipulation, attempted manipulation, commodities fraud and spoofing, among other offenses. The three named individuals were Gregg Smith, an executive director and trader; Michael Nowak, a managing director and Global Head of Precious and Base Metals Trading; and Christopher Jordan, formerly a trader.

According to the indictment, on thousands of occasions between March 2008 and August 2016, the three individuals and others would purportedly place bids or offers on one side of a relevant metals futures market without any intent of execution. On the other side of the market, the defendants would place genuine orders; often these genuine orders were placed as iceberg orders – exposing only a limited portion of the total order to the marketplace. The objective of the non-genuine orders, claimed the indictment, was to affect market prices in a manner likely to induce execution of the defendants’ genuine orders. Two other former JP Morgan traders – John Edmonds and Christian Trunz – were previously criminally charged for their involvement in the bank’s metals trading scheme and pleaded guilty to the charges. (Click here for background regarding Mr. Edmonds plea in the article "Three Traders Plead Guilty to Spoofing Violations" in the November 11, 2018 edition of Bridging the Week. Click here for background on Mr. Trunz's plea.)

In the indictment against the defendants, the DOJ implied that Mr. Smith and Mr. Trunz – who previously were employed by Bear Stearns – brought to JP Morgan a “new style of layering multiple Deceptive Orders at different prices in rapid succession” when JP Morgan acquired Bear Stearns in 2008.

The indictment against the three defendants also claimed that, in September 2010, Mr. Jordan intentionally provided false answers to the Commodity Futures Trading Commission during questioning by an investigator, and in October 2013, Mr. Smith gave false answers to questions from a CME Group investigator. The DOJ additionally claimed that all the defendants falsely affirmed to JP Morgan in compliance attestations that they adhered to the firm's code of conduct when they did not.

Separately, the CFTC filed a parallel civil enforcement complaint in federal court against Mr. Nowak and Mr. Smith based on the same purported incidents, charging spoofing, engaging in a manipulative or deceptive device and attempted price manipulation. The CFTC resolved a distinct administrative complaint against Mr. Trunz also based on the same allegations; Mr. Trunz admitted to the alleged misconduct in his settlement and agreed to be a cooperating witness going forward.

In 2017, Mr. Smith resolved charges brought by Comex that, in July and August 2013, he often entered and cancelled gold futures orders to discover legitimate support or resistance to order prices and not to execute orders. Mr. Smith resolved this matter without admitting or denying any allegations by agreeing to pay a US $95,000 fine and consenting to a 10-business-day all CME Group access ban. (Click here to access a copy of the relevant Comex Disciplinary Notice.)

In another CFTC action alleging spoofing, Heraeus Metals New York LLC and John Lawrence settled an administrative enforcement action brought by the CFTC. According to the CFTC, from approximately May 2017 through January 2018, Mr. Lawrence, a trader at Heraeus – a US affiliate of a global precious metals fabricator and refiner – allegedly engaged in numerous spoofing transactions involving Commodity Exchange, Inc. gold and silver futures contracts. Heraeus suspended Lawrence at the end of February 2018, after it discovered his purportedly illicit activity. To resolve this matter, Mr. Lawrence agreed to pay a fine of US $130,000 and not access US-registered markets for four months. Heraeus consented to pay a fine of US $900,000. The CFTC charged that Heraeus was liable for Mr. Lawrence’s actions as he was their agent; however, in settling with Heraeus, the CFTC acknowledged remediation actions the firm has implemented since March 2018.

Separately, COMEX resolved a disciplinary action against Mr. Lawrence by accepting payment of a fine of US $70,000 and a four-month all CME Group exchanges’ access prohibition.

Legal Weeds: The criminal indictment against the three JP Morgan traders raises the bar in DOJ enforcement actions alleging spoofing by including a RICO charge. The DOJ claimed that the defendants’ ongoing conduct constituted a “pattern of racketeering activity.” In connection with a RICO indictment, the DOJ has the authority to seek a pretrial order to temporarily seize a defendant’s assets and stop the transfer of potentially forfeitable property. Sometimes solely the threat of seizure in RICO actions prompts defendants to resolve their criminal actions early.

Notwithstanding the aggressiveness of the DOJ in orchestrating the indictments against three JP Morgan's traders, it has not faired well in recent trials alleging spoofing-related offenses. Most recently, the DOJ was unable to achieve a conviction of Jitesh Thakkar, the alleged programmer for Navinder Sarao – the purported “Flash Crash” spoofer – where it charged the defendant with conspiracy to commit spoofing and aiding and abetting spoofing. (Click here for background in the article “Mistrial Declared in Prosecution of Purported Programmer for Alleged Flash Crash Spoofer” in the April 14, 2019 edition of Bridging the Week.) Previously, Andre Flotron, a former UBS trader who had been indicted for conspiracy to defraud in connection with purported spoofing‑type trading activity involving Comex-traded precious metals futures contracts, was found not guilty by a jury hearing his case in a federal court in Connecticut. (Click here for background in the article “Former UBS Trader Found Not Guilty of Conspiracy to Defraud for Alleged Spoofing” in the April 29, 2018 edition of Bridging the Week.)

In 2015, the DOJ was successful, however, in prosecuting Michael Coscia of commodities fraud and spoofing in connection with his trading activities on CME Group exchanges and ICE Futures Europe from August through October 2011. He was sentenced to three years in prison for his violation. (Click here for background on Mr. Coscia’s conviction and subsequent appeal 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.)

  • Federal Court to Consider Vacating CFTC Enforcement Consent Settlement During October 2 Hearing; Commission Files Stealth Appeal: The extraordinary legal battle involving the settlement of the Commodity Futures Trading Commission’s enforcement action against Kraft Foods Group, Inc. and Mondelez Global LLC took another unexpected turn on September 13 when the CFTC apparently filed an appeal related to a federal court’s determination to hold an evidentiary proceeding on October 2 in response to the defendants’ motion for contempt, sanctions and other relief against the Commission. However, the nature of the appeal is unknown because court papers related to the appeal – filed in the United States Court of Appeals for the Seventh Circuit – appear to have been made nonpublic. 

Despite the appeal, the relevant federal court said on September 19 that it will proceed with the October 2 hearing as, to date, “it has made no ruling on any procedural objections or assertions of privilege by any party.” According to the court, the proceeding on October 2 “is a civil proceeding, where . . . a variety of potential measures or remedies may be considered if supported by the record, including civil contempt, referral for a potential investigation into criminal contempt or ethical violations, vacating the consent decree, and/or setting new case management dates (including a trial date).”

The evidentiary hearing now scheduled for October 2 follows a motion made by defendants claiming that the CFTC violated a gag order included in the settlement order that had been mutually agreed by both parties to resolve a CFTC enforcement action charging the two firms with manipulating or attempting to manipulate the price of the December 2011 wheat futures contract traded on the Chicago Board of Trade and cash wheat and their agreement to pay a fine of US $16 million. The defendants claimed the CFTC immediately violated the gag order when it published a press release, a formal statement, and a statement by two commissioners contemporaneously with its August 15 publication of the consent order of settlement. (Click here for details regarding this dispute in the article “Contempt and Sanctions Hearing Against the CFTC Arising From Manipulation Complaint Settlement Delayed to October 2” in the September 2, 2019 edition of Between Bridges.)

My View: It remains entirely unclear what is going on in the post-settlement dispute between Kraft/Mondelez and the CFTC. Even the nature of the hearing on October 2 wrapped in mystery. At one point, Chairman Heath Tarbert, Commissioners Dan Berkovitz and Rostin Behnam, as well as Division of Enforcement Director James McDonald, had all been commanded to appear before the presiding judge – the Hon. John Blakey – in a hearing on September 12. That hearing was postponed to October 2, but it is not clear whether the four CFTC persons are still required to appear. All that is known is that the hearing is an evidentiary hearing apparently intended solely to determine next steps.

Although it is reasonable that the parties to this litigation would want terms of the settlement to be nonpublic in accordance with their initial agreement, it is inappropriate to maintain all records of this post-settlement dispute non-public. It’s not even clear what has been appealed, let alone why or what the arguments are for or against. 

In a free society with the primacy of the First Amendment, nothing less than full transparency regarding a challenge to the conduct of an important regulator like the CFTC should suffice.

  • Alleged Rogue Trader’s Unauthorized Energy Bets Result in Approximately US $320 Million Loss to Trading Firm: Mitsubishi Corporation reported on September 20 that a Singapore-based subsidiary – Petro-Diamond Singapore (Pte) Ltd. – sustained a loss of approximately US $320 million because of unauthorized trading activities by an unnamed former employee. According to Mitsubishi, the employee allegedly entered into unauthorized derivatives transactions for Petro-Diamond, but was able to disguise them within the firm’s risk-management system as being taken on behalf of customers. The purported illicit transactions were discovered when the employee took an absence from work in August 2019. Petro-Diamond fired the employee on September 18, 2019, and made a referral to local police on the following day.

Memory Lane: A multiyear binge of many unauthorized futures trades by another Singapore-based trader – Nick Leeson – ultimately led to the collapse of Barings Bank in 1995 – at the time, the United Kingdom’s oldest merchant bank. Mr. Leeson’s losses – often hidden in an error account – when tallied up exceeded GB £825 million (US $1.4 billion). After fleeing Singapore, Mr. Leeson was extradited back, pleaded guilty to various criminal charges, including forgery and fraud, and was sentenced to six and one half years in prison in Singapore. He ultimately was released early, and now is an author and frequent lecturer on risk, conduct, compliance, corporate governance and company culture, among other topics. A movie – Rogue Trader – starring Ewan McGregor was released in 1999 based on Mr. Leeson’s experiences. (Click here to access a trailer for Rogue Trader.) Unfortunately, there have been many other incidents of rogue trading in the intervening years throughout the world since Mr. Leeson's episode.

More Briefly:

  • Two Broker-Dealers Sanctioned by SEC Over US $4.5 Million for Providing Inadequate Blue Sheet Data: Two broker-dealers – Stifel, Nicolaus & Co. and BMO Capital Markets Corp. – settled allegations made by the Securities and Exchange Commission that they failed to provide securities trading information or provided inaccurate data in response to requests for such information – known as “blue sheet data” – by the Commission for prolonged periods of time.

According to the SEC, from approximately January 1, 2015, through September 30, 2018, Stifel reported only 8 million transactions of 17.8 million requested, and of the transactions it did report, 1.4 million contained inaccurate data. The SEC claimed that Stifel incurred errors because it did not have “adequate processes” to verify that information it was reporting was accurate. Stifel agree to pay the SEC US $2.7 million to resolve the agency’s charges. In agreeing to this amount, the SEC acknowledged the firm’s remediation efforts, which began prior to the SEC contacting Stifel.

Similarly, the SEC alleged that BMO, from approximately January 6, 2014, through August 13, 2018, made 4,074 submissions containing data for 5.4 million transactions – all of which were deficient in one or more ways. BMO agreed to pay US $1.95 million to resolve the SEC’s allegations. The SEC also acknowledged BMO’s remedial efforts in accepting the firm’s settlement.

Late in 2018, the SEC fined three broker dealers in excess of US $6 million for their failure to submit accurate blue sheet data records as a result of undetected coding errors. (Click here for details in the article "Undetected Coding Errors Lead to More Than US $6 Million in SEC Fines for Three Broker-Dealers for Blue Sheet Reporting Violations" in the December 16, 2018 edition of Bridging the Week.) 

  • Broker-Dealer Agrees to Pay US $1.1 Million for Not Timely Filing Adverse Information Regarding Terminated Employees: JP Morgan Securities, LLC agreed to pay a fine of US $1.1 million to the Financial Industry Regulatory Authority to resolve allegations that, from January 1, 2012, through April 10, 2018, it did not disclose on U5 forms (the Uniform Termination Notice) filed with the self-regulatory organization, or provided disclosures on U5 forms more than 60 days late, 89 instances of reportable events involving current or former firm-registered representatives. The events not reported or reported late included reviews or allegations involving fraud, wrongful taking of property or violations of investment-related laws or rules. FINRA claimed JPM failed to make such filings correctly because of a lack of a “reasonably designed” supervisory system for disclosing such information. According to FINRA, JPM only made 66 disclosures after it was advised by the SRO; on average, said FINRA, when the required information was ultimately filed, it was two years late. Under its settlement, JPM must file a certification with FINRA within 60 days confirming it has revised its relevant supervisory systems.
  • Recordkeeping and Reporting Requirements for Security-Based Swap Dealers Approved by SEC: The Securities and Exchange Commission adopted final rules establishing recordkeeping and reporting requirements for security-based swap dealers, as was required under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The requirements are similar to those to which broker-dealers are currently subject. The new rules also require non-broker-dealer SBSDs to make and keep current financial and accounting records related to their security-based swaps activity and establish notification requirements when their capital declines below required amounts. Non-US-based SBSDs may potentially take advantage of substituted compliance with home jurisdiction requirements to satisfy their SEC recordkeeping and reporting requirements, while SBSDs that are not otherwise SEC-registered but are registered with the Commodity Futures Trading Commission as swap dealers may apply solely with CFTC requirements. The SEC’s new rules are effective 60 days after publication in the Federal Register, while the compliance date is not until 18 months after the effective date of final rules regarding the cross-border application of certain security-based swap obligations.
  • CFTC Adopts Final Rule for Position Limits on Security Futures and Amendments to the Volcker Rule: The Commodity Futures Trading Commission issued final rules increasing the default maximum amount of equity security futures products that designated contracts may approve in expiring contracts to 25,000 (100-share) contracts from the current default level of 13,500 contracts. The CFTC also modified the criteria DCMs should employ to set higher position limits and accountability levels (i.e., rely principally on estimated deliverable supply evaluated at least semiannually) and amended the time such limits and levels should be in place. Position limits may also be applied by DCMs either to net or one side of the market positions. Separately, the CFTC proposed eliminating existing rules that articulated procedures for adopting new and amending or repealing existing Commission regulations. The CFTC said such existing rules were redundant of provisions in the Administrative Procedures Act. Over the dissent of two commissioners – Dan Berkovitz and Rostin Behnam – the CFTC also approved changes to the Volcker Rule. Among other things, the final rules adopt a three-tiered approach for compliance programs, matching more onerous requirements to banking organizations with the greatest amount of trading assets and liabilities, and  exclude from prohibitions from proprietary trading underwriting and market making-related activities, risk-mitigating hedging, and trading by foreign banking entities solely outside the United States. (Click here for a summary of the amendments by the Federal Deposit Insurance Company dated August 20, 2019 and here for a copy of the final rules.)
  • Company and Founder Sued by SEC for Illegal ICO and Acting as Unregistered Broker-Dealer: ICOBox and its founder Nikolay Evdokimov were sued by the Securities and Exchange Commission in a federal court in California for conducting an unregistered securities offering in the form of an initial coin offering, and for engaging in securities brokerage activities without being registered as a broker-dealer. The SEC alleged that ICOBox – which purportedly holds itself out as a facilitator to companies that seek to sell their products through ICO crowdsales – offered and sold approximately US $14.6 million of “ICOS” digital assets between August 9 and September 15, 2017, to over 2,000 persons in the United States and elsewhere. According to the SEC, ICOBox claimed that proceeds from the ICOS ICO would be used to help defray the costs of ICOBox’s services to users who could not afford them and that ICOS tokens were valuable because of the management efforts of ICOBox. The SEC acknowledged in its complaint that the enterprise has helped 30 clients issue digital tokens, raising over US $650 million from investors; one of the clients assisted by ICOBox was Paragon Coin, which previously settled another SEC enforcement action for engaging in its own unregistered ICO. (Click here for details in the article “ICO Promoter Settles SEC Enforcement Action for No Fine After Self-Reporting Potential Securities Law Violations” in the February 24, 2019 edition of Bridging the Week.) The SEC seeks an injunction against defendants as well as disgorgement and profits.

In other legal and regulatory developments regarding cryptoassets:

  • Exchange Formally Withdraws Application to Trade Bitcoin Shares: Cboe BZX Exchange withdrew a proposed rule change to list and trade SolidX Bitcoin Shares by the VanEck SolidX Bitcoin Trust. Cboe BZX has now twice tried to enable shares of SolidX Bitcoin Shares to be traded on its exchange and twice withdrawn rule change proposals in light of SEC apparent opposition. (Click here for background in the article “Try It Again, VanEck SolidX Bitcoin Trust” in the February 3, 2019 edition of Bridging the Week.)
  • Proposed Law Amendment Would Require CFTC-Regulated Trading Facilities to Have “Unconstrained Access” to Virtual Currency Spot Market Information: Senator Sean Mahoney of New York introduced an amendment to the Commodity Exchange Act that would require any designated contract market or swap execution facility that lists a derivatives contract referencing a virtual contract traded on a spot market to have “unconstrained access to all trade and trader data information” related to digital currency on the spot market platform and the “capability” to provide the data to the CFTC upon request. The proposed law provides no insight as to what might constitute unconstrained access or an adequate capability.
  • Speculative Position Limits and Noncompetitive Trading Among Violations Charged by CME Group Exchanges: The Chicago Board of Trade fined Wherrett Trading LLC US $45,000 for two purported speculative limit violations in November 2017 and February 2018. Each violation involved corn futures contracts and occurred on one day. Both matters were resolved by a settlement agreed by the firm. Separately, the Chicago Mercantile Exchange alleged that three members of the same brokerage group – Scott Moore, Christian Reynoso and Casey Tangney – traded opposite each other on a noncompetitive basis on multiple occasions involving Eurodollar options between May and October 2017. To resolve this matter, each individual agreed to a 10-day all CME Group access prohibition and paid fines ranging from US $25,000 to US $40,000. Finally, Leonid Uvarov agreed to pay a fine of US $15,000 to the CBOT for engaging in purported wash sales for accounts with the same beneficial ownership in order to flatten positions between accounts; Gregory Kobus consented to a sanction of US $5,000 by CME and an all CME Group access prohibition for six months for allegedly engaging in disruptive trading involving cattle and hog futures contracts on multiple occasions from December 1, 2015, through June 30, 2016; and Syntex Energy, LLC agreed to pay a fine of US $40,000 to the New York Mercantile Exchange for not reporting block trades in crude oil futures with correct execution times.

For further information

Alleged Rogue Trader’s Unauthorized Energy Bets Result in Approximately US $320 Million Loss to Trading Firm:

Broker-Dealer Agrees to Pay US $1.1 Million for Not Timely Filing Adverse Information Regarding Terminated Employees:

CFTC Adopts Final Rule for Position Limits on Security Futures and Amendments to the Volcker Rule:

Company and Founder Sued by SEC for Illegal ICO and Acting as Unregistered Broker-Dealer:

Exchange Formally Withdraws Application to Trade Bitcoin Shares:

Federal Court to Consider Vacating CFTC Enforcement Consent Settlement During October 2 Hearing; Commission Files Stealth Appeal:

Proposed Law Amendment Would Require CFTC-Regulated Trading Facilities to Have “Unconstrained Access” to Virtual Currency Spot Market Information:

Recordkeeping and Reporting Requirements for Security-Based Swap Dealers Approved by SEC:

Three Metals Traders Indicted for Racketeering and Other Offenses for Alleged Spoofing Activities; CFTC Files Parallel Civil Charges:

Speculative Position Limits and Prearranged Trading Among Violations Charged by CME Group Exchanges:

Two Broker-Dealers Sanctioned by SEC Over US $4.5 Million for Providing Inadequate Blue Sheet Data:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of September 21, 2019. 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 employees.


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