Bridging the Week by Gary DeWaal: April 20 to 24 and 27, 2015 (CFTC-SEC Merger, Spoofing, LIBOR Manipulation, Bitcoin, Exchange Non-Member Cooperation)

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Published Date: April 26, 2015

The most publicized news last week involving financial services were the legal actions on April 21 by the US Department of Justice and Commodity Futures Trading Commission against a UK-based trader for alleged spoofing that the agencies claim contributed to the so-called “Flash Crash” in May 2010. But a day before that news broke, a think tank headed by Paul Volcker, the former chairman of the Federal Reserve, called for a major overhaul of the US financial regulatory system, including merging the CFTC and the Securities and Exchange Commission. As a result, the following matters are covered in this week’s Bridging the Week:

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Volcker Alliance Calls for CFTC and SEC Merger Among Other Financial Oversight Agencies’ Reform

A not-for-profit think tank headed by Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has called for a substantial overhaul of the federal regulatory system that oversees US financial services, including merging the Commodity Futures Trading Commission and the Securities and Exchange Commission.

Claiming that the oversight of US financial institutions “is highly fragmented, outdated, and ineffective,” the Volcker Alliance issued a report last week that recommended the creation of a so-called “twin-peaks” model of regulation. This paradigm would consolidate prudential oversight currently administered by a number of banking and financial regulators into one new independent federal agency—a prudential supervisory authority—and collapse the CFTC and the SEC’s investor protection and capital markets oversight functions into another new independent body.

Under the Volcker Alliance’s proposal, both the Federal Reserve and the Financial Stability Oversight Council would retain many of their current functions. However, the FSOC would establish a new Systemic Issues Committee (SIC) that would have the authority to designate systemically important financial institutions (SIFIs) and require adequate standards and safeguards to avoid threats to systemic stability even if arising from sources not currently under prudential supervision (e.g., so-called “shadow banking” activities)

The SIC would be composed of the heads of the Federal Reserve, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Consumer Financial Protection Board and the head of the new merged CFTC-SEC. The SIC would also include the director of the Office of Financial Research (which would be broken away from the Department of Treasury and become an independent agency), and one state insurance commissioner chosen by all state insurance commissioners.

The new PSA would take over prudential supervisory functions currently performed by the Federal Reserve, the Office of the Comptroller of the Currency (which would be eliminated entirely), and the FDIC related to most banks and SIFIs, and by the CFTC and SEC regarding broker-dealers, futures commission merchants and other financial entities currently under the supervision of the two regulators.

To the Volcker Alliance, the need for this reorganization is “unambiguously clear.” This is because a “regulatory framework developed in a piecemeal fashion over the past 150 years” is not sufficient to meet the challenges of today’s marketplace. According to the Volcker Alliance,

A fundamental weakness of the regulatory apparatus is that [the currently financial regulatory oversight system] allocates responsibilities among agencies based in significant part on rigid “functional” business lines, such as banking, insurance, securities and derivatives. However, the lines of separation between these markets have blurred as large, complex, and globally active firms have emerged to provide most of the broad array of products and services that cross these previously clear lines. In addition, the regulatory system has struggled to keep up with the market for non-bank credit intermediation, or shadow-banking market, which has become a bigger part of the financial system but operates largely outside the sphere of prudential regulation. The current system also has been outpaced by the rapidly evolving, increasingly complex, and sometimes opaque financial products that continue to emerge and transform the system, and that often migrate to less-regulated or unregulated yet critically important parts of the financial system.

While acknowledging many prior failed proposals to merge the CFTC and SEC, the Volcker Alliance suggests that a combination would be more palatable if the newly merged agency was placed under the jurisdiction of the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services with concurrent oversight by the Senate and House Agriculture committees. The Volcker Alliance proposes that the merged agency be funded solely through fees and assessments, including fines and penalties. No funding would come through congressional appropriations.

A separate 107 page memorandum published by the Volcker Alliance provides a comprehensive overiview of the history and functions of both the CFTC and SEC, and the principal laws under which they operate.

My View: For sure, the alphabet soup of federal agencies with oversight over financial firms, products and markets needs to be rationalized, and the CFTC and the SEC should long ago have been merged. To me, it is solely a naming convention to label financial products as either futures or securities (and now swaps too), and a terrible mistake to base regulatory structure on the titles of products rather than their essential characteristics and purposes. That being said, the Volcker Alliance report, albeit very thoughtful, is remarkable for its absence of any meaningful discussion of non-regulatory reasons for its proposed financial regulatory system overhaul. For example, perhaps some overhaul could help reduce duplicative regulatory requirements and costs, and promote more responsible lending, robust and sound markets, and financial structuration to help end users and other companies meet their ordinary capital raising, hedging and financing needs. Alas, for the Volcker Alliance, it appears that regulations exist solely to make banks and other financial intermediaries safe and sound. This is critically important—few would disagree. But it is also important that financial institutions are not excessively handicapped in performing their critical functions to help the economy. The financial regulatory system needs to be overhauled, but it must be structured in a way to address safety and soundness concerns, as well as to promote a robust financial services industry and liquid markets, and to save costs.


My View (new): Since publication of this article originally on April 22, Mr. Sarao has opposed the Department of Justice’s efforts to extradite him from the United Kingdom. The nucleus of Mr. Sarao’s defense to both the Department of Justice’s and the CFTC is likely previewed in a May 29, 2014, email he wrote to the UK Financial Conduct Authority in response to questions they submitted to him (this email is included in the Appendix to the CFTC’s Complaint). There, Mr. Sarao portrayed himself as the victim of manipulative conduct by high-frequency traders (“I don’t like the HFT arena and have complained to the exchange numerous times about their manipulative practices, please BAN IT”), and appeared to justify his layering activity as a defensive effort to facilitate the execution of orders he truly desired filled (“I asked [the company] specifically to help try and hide my orders from these people … I decided that the only way I could mask my orders, was to place them as the market changed price so that they may not be seen in the ‘chaos’ of a price change”). Just a few weeks ago, Michael Coscia failed in his effort to have a federal court in Illinois dismiss his indictment for spoofing on the grounds that the relevant law was void for vagueness and prohibited legitimate market conduct. (Click here for more details in the article, “Alleged Spoofer Fails to Convince Court to Dismiss Indictment” in the April 19, 2015 edition of Bridging the Week.) It appears we will soon see whether other tribunals—including one in the UK—might be more sympathetic to this argument. Also – expect more allegations at least by the CFTC in connection with this matter. In a footnote in its complaint against the defendants, the Commission indicated that the layering examples it has publicized so far “are referenced for illustrative purposes only.” It anticipates supplementing these “as additional information is obtained and analyzed.”

Compliance Weeds: By trading on CME Group, even a non-member submits to the jurisdiction of the exchange “and agrees to be bound by and comply with [all its rules], including, but not limited to, rules requiring cooperation and participation in investigatory and disciplinary procedures. (Click here to access CME Group Rule 418.) Other futures exchanges have similar rules. (Click here to access, e.g., ICE Futures U.S. Rule 4.00.)

My View: Although many are skeptical of cryptocurrencies, Bitcoin and other virtual currencies are receiving more and more attention by investors—both as investments in themselves as well as a commodity around which a nascent support industry is developing. Currently, for example, the Commodity Futures Trading Commission is considering the designation of LedgerX both as a swap execution facility and a derivatives clearing organization in connection with options on Bitcoin. (Click here for details in the article, “LedgerX Seeks CFTC Designation as a Clearinghouse and Swap Execution Facility for Bitcoin Options” in the December 21, 2014 edition of Bridging the Week.) Bitcoins (like other cryptocurrencies) represent either a currency or a medium of money transfer (sometimes referred to as small “b” Bitcoin) and are facilitated by the creation of a public ledger (blockchain) of all transactions for all time on the Bitcoin network (the technology behind the distribution and publication of Bitcoin is sometimes referred to as big “B” Bitcoin). At some point, it appears likely that the technology behind Bitcoin can be utilized to help marry lending with unprecedented securitization (e.g., an individual whom is lent Bitcoin to purchase a car may not be able to start his/her car if he/she misses too many repayments). ESMA’s approach of seeking more information before proposing any regulation is commended.

And even more briefly:

For more information, see:

Deutsche Bank Fined US $2.5 Billion by Four Regulators for LIBOR and FX Manipulation:

CFTC Order:
FCA Final Notice:
NYS Consent Order:
US Department of Justice Deferred Prosecution Agreement:

ESMA Seeks Industry Input on Investments Using Cryptocurrencies and Distributed Ledger Technology:

Global Derivatives Markets Continue to Fragment Post-SEF Introduction Says ISDA Study:

ICE Clear U.S. Plans Major System Changes on August 20:

London-Based Futures Trader Arrested, Sued by CFTC and Criminally Charged With Contributing to the May 2010 “Flash Crash” Through Spoofing:

CFTC Complaint:
Appendix to CFTC Complaint:

Criminal Complaint and Affidavit:

Non-Member Barred for Five Years From Trading on CME Group Exchanges for Not Cooperating With NYMEX Disciplinary Processes:

OCIE Issues Additional Guidance Regarding Examinations of Never-Before-Examined Investment Companies:

SEC Awards Over US $1 Million to Compliance Officer Whistleblower Who Turns In Own Company:

SEFs Provided Guidance by CFTC Staff on Projecting Operating Costs; SEFs and DCMs Given Relief Regarding the Handling of Erroneous Swaps Trades; and SEFs, for Swaps Trade Confirmations Too:

Guidance on Operating Costs for SEFs:
Relief re: Erroneous Trades:
Relief re: Trade Confirmations:

UK FCA Fines Merrill Lynch Almost US $20 Million for Transaction Reporting Delinquencies:

Volcker Alliance Calls for CFTC and SEC Merger Among Other Financial Oversight Agencies’ Reform:

Memo Concerning CFTC and SEC:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 24, 2015. 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.

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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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