Bridging the Week by Gary DeWaal: April 28 to May 2, and May 5, 2014 (Exchanges Must Also Comply with SEC Rules; More EFRP and Block Trades Fallout)

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Published Date: May 04, 2014

Today may be Cinco de Mayo and a cause for festive partying. However, last week the New York Stock Exchange and two affiliates were not celebrating when they were charged and fined by the Securities and Exchange Commission for acting contrary to certain of the exchanges’ own rules, or for not having certain rules at all. Also not celebrating were respondents who were charged with violating speculative position limits, as well as EFRP and block trade requirements, and sanctioned by the Chicago Mercantile Exchange, and in one case, the Commodity Futures Trading Commission too.

As a result, the following matters are covered in this week’s Bridging the Week:

Video version:

Article version:

SEC Charges and Settles with the New York Stock Exchange and Two Affiliates for Acting Contrary to Their Own Rules or Without Rules at All; Affiliated Broker Dealer Also Charged

In a sweeping criticism of the New York Stock Exchange’s and two affiliates’ course of conduct from 2008 to 2012, the Securities and Exchange Commission brought an administrative proceeding against the exchange and its affiliates for failing to comply with their own rules, or for not having certain required rules in the first place, on numerous occasions.  This resulted in the organizations’ failure to comply with their obligations as self-regulatory organizations under law, says the Commission.

Also sued was the NYSE’s affiliated broker dealer, Archipelago Securities, LLC (ArcaSec). ArcaSec was charged with failing to meet SEC regulatory capital requirements on two days in 2010, and not having required policies and procedures regarding the handling of non-public information. The two NYSE-affiliated exchanges involved in this matter are NYSE Arca, Inc. and NYSE MKT LLC (formerly NYSE Amex; Amex).

To settle this matter, NYSE, its affiliated exchanges, and ArcaSec agreed to pay a fine of US $4.5 million and to retain an independent consultant to review their rule compliance programs. Last year, NYSE, Arca, Amex and ArcaSec were all acquired by the IntercontinentalExchange, Inc. Previously, NYSE’s parent was NYSE Euronext.

Among the specific violations found by the SEC was that,

In its complaint, the SEC also took issue with NYSE’s handling of certain block trades of securities through the New York Block Exchange, a joint venture involving NYSE and an unaffiliated entity, as well as its offer of a continuous electronic feed of closing order imbalance information to floor brokers earlier each day than the SEC had approved.

NYSE, Arca, Amex and ArcaSec settled this SEC complaint without admitting or denying any of the findings. NYSE previously was subject to three SEC enforcement actions, including in 2012 when the Commission found that the exchange failed to provide market data information to market participants on a manner that was “fair and reasonable” and “not unreasonably discriminatory.” Arca was subject to an SEC enforcement action in 2000, while Amex was sued twice by the Agency prior to being acquired by NYSE Euronext in 2008.

Compliance Weeds: Maintaining strong internal controls is important for all registrants, whether they are brokers, traders, fund managers, or even exchanges and clearing houses. Under current rules of the Commodity Futures Trading Commission, certain registrants are now formally required on at least an annual basis to itemize all relevant regulatory requirements and to assess how they meet such requirements through adequate policies and procedures. In fact, this exercise is a valuable drill for all registrants whether required or not. Certainly, when a regulator points out a potential deficiency in following a requirement, a registrant should timely assess whether the regulator’s assessment is correct, and if it is, then address that deficiency promptly.

CFTC and CME Bring and Settle Actions for Speculative Position Limit Violations; One CME Action Is for an Intra-day Violation

The Commodity Futures Trading Commission and the Chicago Mercantile Exchange brought and settled enforcement proceedings last week related to quite a few respondents’ failures to comply with speculative position limits. In most instances, including the CFTC matter, the offense involved a violation of speculative limits calculated at the end of a day; however, in one CME matter, the offense involved a violation of a speculative position limit intraday.

In the CFTC action, James Yadgir agreed to pay $130,000 for violating CME position limits in live cattle futures contracts on one day in 2011 and feeder cattle futures contracts on two days in 2012. The amounts of the excess over position limits were 70 futures equivalent contracts for the live cattle futures contracts, and approximately 82 futures equivalent contracts on one day and less than one futures equivalent contract on the other day for the feeder cattle futures contracts.

(A futures equivalent contract involves the conversion of options positions to futures contracts using the prior day’s risk factor provided by the relevant exchange. This allows futures and options positions to be aggregated to assess speculative position limit compliance, among other reasons.)

Separately, DRW Commodities, following a full evidentiary hearing before a CME (NYMEX) business conduct committee panel, was found to have violated CME position limits on June 20, 2011, in the July 2011 crude oil futures contract when it maintained an intraday long position of 3,734 lots, including 2,973 positions executed as trading at settlement (TAS) transactions and 761 non-TAS positions; the combined position exceeded NYMEX position limits by 734 lots. According to NYMEX,

“…the Panel found that market participants had fair notice that their positions established via TAS were included in the same underlying contract for purposes of determining compliance with the Exchange’s position limits.”

The panel ordered DRW to pay a fine of US $10,000 and to disgorge profits in excess of US $20,000 related to this matter.

(TAS trading is a means of trading intraday with the price of any position assigned as of the end of the day either using the actual settlement price or a price derived from a pre-agreed increment from the settlement price.)

Likewise, D.E. Shaw & Co and certain affiliates were alleged by CME (NYMEX) to have provided investment management services to certain funds that had approximately 1,478 open positions in the December 2012 Henry Hub natural gas look-alike last day financial futures contract (financial nat gas) on November 27, 2012, while at the same time holding 750 positions in the related December 2012 Henry Hub natural gas futures contract (physical nat gas). During the last three trading days, a trader can hold up to 5,000 financial nat gas futures contracts provided it does not hold any physical nat gas futures contracts. D.E. Shaw settled this matter by paying a US $25,000 fine. D.E. Shaw also agreed to pay a fine of US $75,000 to settle another matter involving alleged violations of position limits in the November 2013 financial nat gas futures contracts one one day in October 2013.

D.E. Shaw is not a member of CME, but the exchange exercised jurisdiction over it in these matters because affiliates of the company were CME members. (In fact, the CME regards any person who trades any of its products to have submitted to the exchange's jurisdiction for investigations and disciplinary matters; see CME rule 418 by clicking Here.)

Finally, last week the Ontario Teachers Pension Plan also settled with the CME for a position limit violation involving lean hog futures contracts on March 5, 2013. The Ontario Plan paid a fine of US $15,000 for this incident and disgorged profits in excess of US $17,500.

Compliance Weeds: With the impending re-issue of CFTC position limit rules, these cases are a reminder of the need for traders to maintain robust monitoring systems to compare open positions against position limits not only at the end of each day but intraday too. Positions must also be converted to futures equivalent contracts. Even a violation of less than one lot apparently might warrant CFTC attention, while violations of positions that are not priced until the end of day (e.g., TAS trades) can also cause regulatory issues. (For a discussion of the CFTC’s proposed new position limits, see the article in Bridging the Week entitled “CFTC Proposes New Position Limit Rules,” published November 11, 2013, by clicking Here.)

CME Initiates and Resolves Still More Disciplinary Proceedings for EFRP and Block Trade Violations:

A number of firms and one individual settled disciplinary proceedings in the CME’s seemingly ongoing crackdown related to violations of its exchange of futures for related positions and block trade requirements (for more, see the February 24, 2014, article on this website entitled “CME Publicizes a Plethora of EFRP Fines Involving Incomplete Documentation, Late Submissions and Improper Parties," by clicking Here).

In seemingly the most serious matter, the CME and Blake Strohofer agreed to his 10-year ban from trading CME products, as well as from being a CME member, as a result of Mr. Strohofer's misallocation of certain natural gas futures trades for one of his customers on June 28 and July 28, 2010, to an account of a former CFTC registrant. Mr. Strohofer subsequently used block trades to offset these transactions for the CFTC registrant against Mr. Strohofer’s customer, to the customer’s detriment.

In addition, the CME fined Republic Metals Corporation US $85,000 because the company, apparently on numerous occasions between February and August 2013, used EFRP transactions to transfer futures positions from one Republic account to another, and did not maintain documentation of corresponding cash positions. These transfers constituted wash sales, said the CME, and were non bona-fide EFRPs.

Separately, CME fined ING Bank NV US $25,000 for two transactions, and Somitekno Ltd. US $15,000 for one transaction, where the companies failed to have documentation of the related swap transaction in connection with executed EFRPs. Nomura Securities International was fined US $30,000 and PVM  Futures, Inc. was sanctioned a total of US $100,000, for failing to report timely and to have accurate records regarding certain block trade transactions.

Compliance Weeds: Typically, under CFTC rules, all futures transactions must be competitively executed on a regulated exchange (designated contract market; DCM). However, there are exceptions for EFRPs and block trades provided the transactions are undertaken precisely in accordance with CFTC-approved DCM rules. If the transactions are not handled accordingly, they are technically unlawful non-competitive transactions. Accordingly, futures commission merchants and their clients, should augment or implement internal compliance programs to ensure that all EFRP and block trade transactions they execute and post comply with all applicable requirements, including those related to authorized parties, documentation and the timing of information submitted to an exchange regarding a transaction. Sales and operations staff that physically handles such transactions should be alerted to indicia that may indicate potential issues with EFRPs or block trades and set up a process for consultation with the firm’s compliance department in such circumstances. Periodically, firms' compliance or internal audit departments should review the firm’s adherence to relevant CFTC and contract market rules related to EFRPs and block trades. Just a few weeks ago, the CME issued a revised frequently asked questions regarding EFRPs (for details, see article on this website entitled “Lord Voldemort Hovers over the Futures Industry: CME Prohibits All Transitory Exchange of Futures for Related Positions by Name” by clicking Here).

CFTC Announces Phased Roll-in of Mandatory Trading Requirement for “Package Transactions” That Starts May 16:

The Commodity Futures Trading Commission announced last week a schedule when all so-called package transactions that include at least one swap subject to a made available to trade (MAT) mandate, must begin to trade on, or subject to the rules of, a swap execution facility or designated contract market.

Previously, the CFTC temporarily had exempted such transactions from mandatory execution on such facilities through at least May 15, 2014.

(A package transaction involves two or more instruments executed between two or more counterparties that have one leg subject to the Commission’s requirement for mandatory execution on or subject to the rules of a SEF or DCM, and where the execution of one leg is dependent on the execution of all legs.) 

Under its new requirements, package transactions must begin trading on or subject to the rules of a SEF or DCM:

  1. where all legs are subject to the MAT requirement, beginning May 16, 2014;
  2. where one leg is a swap subject to MAT, and all the other legs are swaps subject to the CFTC’s mandatory clearing requirement, beginning June 2, 2014;
  3. where one leg is subject to MAT and the other legs are US Treasury securities, beginning June 16, 2014; and
  4. beginning November 16, 2014, where one leg is subject to the MAT requirement and at least one leg is under the CFTC’s exclusive jurisdiction but not subject to a clearing requirement; is not under the CFTC’s exclusive jurisdiction; or is not a swap (e.g., a futures contract or a security). 

At the same time, the Commission also granted certain relief through September 30, 2014, to accommodate the clearing of package transactions. This additional relief is necessitated because of the possibility that an individual leg of a package transaction could be rejected for clearing for risk reasons, while the overall risk in aggregate of all the legs of the transaction is not problematic.

(For further details on this matter, review an article in last Friday’s Katten Muchin Rosenman LLP Corporate and Financial Weekly Digest, “CFTC Provides Relief Regarding Package Transactions,” by clicking Here.)

And briefly:

“Mr. Hughes did not consider the [account] to be honest and knew that the Firm would not have authorized its use. Mr. Hughes conduct in relation to the [account] was dishonest and demonstrates that he is not a fit and proper person to perform functions in relation to any regulated activity carried on by an authorized or exempt person.”

And even more briefly:

For more information, see:

CFTC Requires Certain Package Transactions to Trade on SEFs or DCMs Beginning May 16:

CFTC v. Tunney & Associates et al.:

CFTC v. James C. Yadgir:

CFTC Technical Guidance Regarding OCRs:

CME Disciplinary Actions:

D.E. Shaw (NYMEX):

DRW Commodities (NYMEX):


Nomura Securities (CBOT):

Ontario Teachers Pension Plan:


Republic Metals Corporation (NYMEX):

Somitekno (NYMEX):

Blake Strohofer (NYMEX):

FCA Final Notice re: John Hughes:

ICE Clear Europe Proposal to Have Clearing Members Cover Certain Investment Losses:

PFG Forex and OTC Metals Claimants:

SEC v. New York Stock Exchange et al.:

UK SFO Issues Criminal Proceeding Against Three More Ex-Barclays Employees Related to Their Role in the Alleged LIBOR Manipulation:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 3, 2014.  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 and/or Gary DeWaal may represent one or more entities mentioned in this article. 

Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained in this article is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.


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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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