Bridging the Week by Gary DeWaal: July 13-17 and 20, 2015 (Disruptive Trading Redux; Penalties; Treasury Flash Crash; CCOs )

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Published Date: July 19, 2015

This week, United States banks are required to cease certain proprietary trading activities under the so-called Volker rule. Last week, one more US exchange amended its rules to enact new disruptive practices prohibitions. In addition, a federal appeals court told the Securities and Exchange Commission it cannot apply new Dodd-Frank sanctions retroactively. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Video Version:

Article Version:

Et tu, CFE? CBOE Futures Proposes Amended Disruptive Practices Rules and New Related Policies and Procedures:

CBOE Futures Exchange became the latest designated contract market to propose specific rules to ban disruptive trading practices. The exchange previously prohibited disruptive trading practices solely by copying almost verbatim the relevant provisions of federal law into one of its own rules.

CFE now proposes to continue including the federal law provisions and to additionally include other provisions that mostly copy rules of CME Group prohibiting disruptive practices. The exchange also proposes to adopt policies and procedures related to its amended rule that provide guidance. The policies and procedures mostly track the Frequently Asked Questions published by CME Group late last year related to its disruptive practices prohibition.

(Click here to access CME MRAN RA1405-5R, which includes the text of the relevant provisions of federal law, and CME Rule 575 as well as FAQs. Click here to access background on the CME Group’s rule and FAQs prohibiting disruptive practices in the article “CME Group Issues New Rule Regarding Disruptive Trading Practices” in the September 4, 2014 edition of Between Bridges.)

Generally, CFE prohibits seven trading practices some of which appear to overlap:

As at the CME Group, on CFE:

[a]ll Orders must be entered for the purpose of executing bona fide transactions. Additionally, all non-actionable messages must be entered in good faith for legitimate purposes.

Likewise, as at the CME Group, CFE provides a list of factors it may consider in assessing whether conduct violates its disruptive trading prohibitions. These include whether a trader’s intent was to “affect a price rather than to change [his/her] position,” or whether the trader’s intent was to “create misleading market conditions,” among many other considerations.

Unlike CME Group, within its disruptive trading prohibitions, CFE imposes a duty on market participants, particularly algorithmic traders, to take steps to mitigate the impact of any errors (e.g., fat finger errors); and has different language to discuss prohibited pre-open activity and the use of user-defined spreads that reflects differences between CFE and CME Group practices.

CME Group’s and CFE’s rules and guidance related to market practices are similar (but not identical) to equivalent rules and guidance of the three ICE futures exchanges: ICE Futures Canada, Europe and U.S. (Click here for background in the article “ICE Futures U.S. and Canada Amend Rules to Expressly Prohibit Disruptive Trading Practices” in the January 4, 2015 edition of Bridging the Week. Click here for additional background in the article “ICE Futures Europe to Adopt Another Variation of Disruptive Trading Practices Rule” in the January 11, 2015 edition of Bridging the Week.)

CFE self-certified its proposed amended rule (i.e., the provision is not subject to public comment) to the CFTC claiming that it was “not aware of any substantive opposing views” to its rule changes. CFE’s new amended rule regarding disruptive trading practices is intended to be effective July 30.

My View: Like CME Group and other exchanges, CFE has tried valiantly to explain what constitutes disruptive trading practices. Unfortunately, like the federal law and other exchanges’ prohibitions, CFE’s amended prohibitions and policies do not provide the industry with sufficient practical guidance to avoid running afoul of restrictions. In the end, every potential offense is subject to a post facto facts and circumstances assessment. Until regulators can provide quantitative criteria that traders can use in advance to avoid unpleasant regulatory interactions, and that firms can use to program surveillance tools to help self-detect and mitigate potentially problematic conduct, traders risk exchange, CFTC and criminal enforcement actions for engaging in conduct that – to paraphrase the federal prohibition against “spoofing” – may be, may be of the character of, or may be commonly known to the trade as, smart trading practices.


My View: In response to the five-agency report on events of October 15, Luis Aguilar, an SEC commissioner, quickly made numerous recommendations to “revisit” the oversight of the US Treasury market. Among other things, he recommended considering revising Regulation Alternative Trading Systems (Reg ATS) and Regulation Systems compliance and Integrity (Reg SCI) to include alternative trading systems that trade US Treasury instruments exclusively. However, it is likely premature to consider any recommendations to a one-off situation that, despite the dedication of substantial government resources, is still not well understood if understood at all. Regulation by crisis is not effective and, as we learned through the implementation of Dodd-Frank, often leads to many unintended consequences. There may be valuable lessons learned from the events on October 15, 2014, but for now, let any enhancements to best practices evolve naturally rather than be forced upon industry participants. This is particularly important when unintended consequences in US Treasury markets may detrimentally impact liquidity and have grave consequences for the US government to fund itself.

My View: Just a few weeks ago, the Securities and Exchange Commission brought an enforcement action against Eugene Mason, the chief compliance officer of SFX Financial Management Enterprises, after the firm’s former president, Brian Ourand, was discovered allegedly to have stolen client funds from 2006 to 2011. The SEC acknowledged that Mr. Mason discovered Mr. Ourand’s activities as a result of a client complaint and, in response, SFX and Mr. Mason investigated Mr. Ourand’s conduct, SFX fired Mr. Ourand and SFX reported Mr. Ourand’s theft to criminal authorities. Notwithstanding, the SEC brought suit against Mr. Mason claiming that he was responsible for the implementation of SFX’s policies and procedures that “were not reasonably designed, and were not effectively implemented, to prevent the misappropriation of client funds.” This type of enforcement activity appears to involve precisely the type of second-guessing of CCOs that SEC Chairperson Mary Jo White says the SEC should not be engaging in. Indeed, this Monday-morning quarterbacking appears particularly egregious in this instance where the relevant rule appears, on its face, to impose the burden to draft satisfactory policies in the first place on the firm, not the CCO – as pointed out by SEC commissioner David Gallagher in a separate written statement. Unless the evidence and relevant rule(s) clearly points to the liability of a CCO, regulatory agencies should refrain from prosecuting such persons unless they wish to discourage qualified persons from taking such positions in the first place. (Click here for more details regarding the SEC’s enforcement action against SFX and Mr. Mason in the article “Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally” in the June 21, 2015 edition of Bridging the Week.)

And more briefly:

For more information, see:

Australia Securities and Futures Regulator Announces How It Will Conduct Self-Evaluations:

CFTC Environmental Markets Advisory Committee to Meet July 29:

CFTC Formally Issues Proposed Rule on Margin on Uncleared Swaps in Cross-Border Transactions:

CFTC Commissioners and Industry Participants Argue in Favor of Changes to Made Available to Trade Process at Agency Roundtable:

Statement of Commissioner J. Christopher Giancarlo:
Statement of Commissioner Mark Wetjen:

Et tu, CFE? CBOE Futures Proposes Amended Disruptive Practices Rules and New Related Policies and Procedures:

Nasdaq Futures Set to Launch July 24:

NFA Requires CPOs Consolidating Financial Reporting Pursuant to CFTC Relief to Notify It Too:

Regulators’ Study Finds No Single Cause Behind October 15, 2014 US Treasuries’ Flash Crash:

See also:
Statement of SEC Commissioner Aguilar:

SEC Can’t Retroactively Apply Dodd-Frank Sanctions Says US Court of Appeals:$file/14-1134-1562387.pdf

SEC Chairperson Says CCOs Not Targets of Enforcement Program:

SEC Settles Charges Against Middleman Who Ate Napkins and Post-it Notes at NYC’s Grand Central Terminal to Facilitate Insider Trading:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 18, 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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