Bridging the Week by Gary DeWaal: October 10 to 14 and October 17, 2016 (Coming to the US; Cross-Border; Liquidity Management; Insider Trading Supervision)

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Published Date: October 16, 2016

Navinder Sarao will likely soon be headed to the United States to stand trial in connection with criminal charges against him for his alleged role in the May 201o “Flash Crash” after losing his last effort to avoid extradition from his home in the United Kingdom. In addition, non-US consolidated subsidiaries of US entities might more readily have to register as swap dealers under proposed new cross-border rules by the Commodity Futures Trading Commission, while the Securities and Exchange Commission issued final rules to purportedly strengthen the liquidity risk management of open-end investment funds. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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Article Version


Legal Weeds: Earlier this year Michael Coscia was sentenced to three years’ imprisonment for illicit futures trading he engaged in during three months in 2011. Like Mr. Sarao currently, Mr. Coscia had been criminally charged for violating the law prohibiting spoofing that was enacted after the 2007-2008 financial crisis. (Click here to access Commodity Exchange Act Section 4c(a)(5)(C), 7 US Code § 6c(a)(5)(C).) Previously, Mr. Coscia had settled civil actions related to the same conduct with the CFTC, the Financial Conduct Authority and the CME Group by payments of aggregate fines of approximately US $3.1 million; disgorgement of profits; and a one-year trading suspension. (Click here for details in the article, “CFTC, UK FCA and CME File Charges and Settle with Proprietary Trading Company and Principal for Spoofing” in the July 22, 2013 edition of Between Bridges.) Mr. Coscia was convicted of six counts of commodities fraud and six counts of spoofing for his prohibited trading activities in November 2015. (Click here for details of Mr. Coscia's conviction in the article, “Jury Convicts Michael Coscia of Commodities Fraud and Spoofing” in the November 8, 2015 edition of Bridging the Week.)

My View: The CFTC’s proposed cross-border rules regarding application of certain of its swap requirements contains at least one potentially deleterious expansion and one potential improvement over its 2013 Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations. (Click here for details of the CFTC’s 2013 guidance in the article, “CFTC Enacts Interpretive Guidance and Passes Exemptive Order regarding Cross Border Swaps Transactions” in the July 16, 2013 edition of Between Bridges.) The bad provision is the proposal that all FCSs – even if non-guaranteed or bankruptcy remote from their ultimate parent company – must count all swaps with US and non-US persons in determining their potential registration requirement as a swap dealer. Moreover, a non-US person would have to include a bilateral swap opposite an FCS in its own threshold calculation to assess its own potential registration requirement. This could dissuade non-US persons from engaging in swaps with FCSs. On the other hand, by defining a bright light territorial test to assess whether an investment vehicle is a US person, non-US persons might be inclined to engage in more swaps with non-US-based investment vehicles since they will not have to worry about such swaps causing them potential US swap dealer registration headaches.

Legal Weeds: In September 2014, a US federal court mostly tossed out all legal challenges brought by three industry groups to the CFTC’s 2013 Interpretive Guidance. In ruling generally against the plaintiffs, the court adopted the CFTC’s principal argument, that the Dodd-Frank Wall Street Reform and Consumer Protection Act’s swaps requirements applied extraterritorially when swaps activity outside the United States had a “direct and significant connection” with US commerce without the need for any implementing regulations. As a result, the court said, “[t]he CFTC was not required to issue any guidance (let alone binding rule) regarding its intended enforcement policies. … Indeed, the CFTC’s decision to provide such a non-binding policy statement benefits market participants and cannot now, all other things being equal, be turned against it.” Notwithstanding, the court ordered the CFTC to conduct a cost-benefit analysis regarding the extraterritorial application of many of the CFTC’s rules addressed in the cross-border guidance. In response, the CFTC sought comment on its cross-border guidance in March 2015. (Click here for details in the article, “CFTC Formally Responds to Court Judgment on International Guidance; Calls for Public Comments” in the March 15, 2015 edition of Bridging the Week.) The current proposed rules incorporate the CFTC’s response to that input.

Compliance Weeds: Applicable law and rules of the Financial Crimes Enforcement Network of the US Department of Treasury require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers and SEC-registered mutual funds) to file a suspicious activities report (SAR) with FinCEN in response to transactions or patterns of transactions involving at least US $5,000 which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. In spring 2016, Albert Fried & Company, LLC, a registered broker-dealer, agreed to pay a fine of US $300,000 to resolve charges by the Securities and Exchange Commission that, from August 2010 through October 2015, it failed to file SARs by customers with FinCEN, as required by law. (Click here for details in the article, “Broker-Dealer Sanctioned by SEC for Anti-Money Laundering Breakdowns” in the June 5, 2016 edition of Bridging the Week.) Previously, FINRA fined Brown Brothers Harriman & Co. US $8 million for failing to file SARs in connection with similar activity involving penny stocks. In that matter, FINRA also fined and suspended the firm’s global anti-money laundering compliance officer for his alleged role in the firm’s alleged misconduct. (Click here for details in the article, “FINRA Says Brown Brothers Harriman Had an Unsatisfactory Anti-Money Laundering Program; Sanctions Firm and Former Global AML Compliance Officer,” in the February 10, 2014 edition of Bridging the Week.) Covered entities should continually monitor transactions they effectuate and ensure they maintain written procedures they follow to identify and evaluate red flags of suspicious activities and file required SARs with FinCEN when appropriate. (Click here for a discussion of another FINRA disciplinary action against a member for alleged widespread AML breakdowns in the article, “Two Related Broker-Dealers To Pay US $17 Million for Widespread AML Compliance Failures; Former AML Compliance Officer Also Sanctioned” in the May 22, 2016 edition of Bridging the Week.)

Culture and Ethics: Sam tried to keep it simple. And perhaps, in a former day, his method of supervision might have been more appreciated. Unfortunately, today, it is unlikely that just a few surveillance systems, an astute and observant small staff, and just calling Sam are sufficient to meet minimum regulatory expectations for reasonable supervision particularly, as in the case of Lek Securities, where the client base generated 500 trades/minutes. However, Sam tried to keep it simple, and focusing employees on a few high level objectives in addition to the myriad of rules that likely govern their business, is very important to ensuring that a strong compliance culture is ingrained within the DNA of an organization. These days, however, employees need to abide by both high level objectives and detailed rules (memorialized in robust written procedures and training), and have strong automated surveillance systems tailored to a firm's precise business for a registered entity to satisfy the minimum expectations of regulators. (Click here for a recent presentation I made to students considering careers on Wall Street on applying the "grandma test" to assess whether proposed conduct is right or wrong.)

My View: I recently reported on a rule review by the CFTC’s DMO of the CBOE Futures Exchange, LLC. (Click here to access the article, “CFTC’s Division of Market Oversight Highlights Compliance Department Resources Concern in CBOE Futures Rule Enforcement Review” in the July 10, 2016 edition of Bridging the Week.) One recommendation made by staff was that the CBOE Futures Regulation Department “should recommend and the Exchange should promptly take appropriate disciplinary action when it makes a finding that a violation of a substantive trading rule occurred.” This may sound innocuous. However, the recommendation was made in response to the issuance of warning letters by CFE to certain trading permit holders in response to their alleged placement of fictitious orders and trades. According to CFTC staff, “[w]hile a warning letter may be appropriate for certain violations of recordkeeping or audit trail rules, the Division believes that issuing a warning letter for a substantive trading violation is never appropriate.” As I have written previously, this statement appears contrary to the plain language of CFTC Rule 38.711 (click here to access) that does not limit the types of violations for which warning letters may be issued. All this provision does is limit to one time the number of occasions an exchange may issue a warning letter for any type of rule violation during a rolling one-year period. If, based on its own assessment of facts and circumstances, an exchange believes that the appropriate disciplinary action in response to a rule violation is to issue a warning letter, the CFTC should defer to the exchange’s discretion absent extraordinary circumstances. It is encouraging that CFTC staff may have backed away from its harsh and seeming misinterpretation of the relevant CFTC rule in DMO’s NYMEX and COMEX rule review.

Legal Weeds: The key phrase of Section 10(b) of the Securities Exchange Act of 1934 “manipulative or deceptive device or contrivance” is also at the heart of the relatively new parallel provision of the Commodities Exchange Act, Section 6(c)(1) enacted after the 2008/2009 financial crisis (click here to access this provision, 7 US Code § 9(1)). Pursuant to this CEA authority, the CFTC adopted Rule 180.1 (click here to access), and has used this law and rule in a wide-ranging host of enforcement actions, from its proceeding against JP Morgan in the so-called “London Whale” incident, to allegations of illegal off-exchange metals transactions, insider trading, claims of more traditional manipulation and attempted manipulation (without endeavoring to show an artificial price) and allegations of spoofing. In adopting Rule 180.1, the CFTC indicated that it would be guided “but not controlled” by the substantial body of judicial precedent applying the comparable language of SEC Rule 10b-5. (Click here to access CFTC insight on its Rule 180.1.; click here for a discussion of the CFTC’s use of its Rule 180.1 in the article, “Ex-Airline Employee Sued by CFTC for Insider Trading of Futures Based on Misappropriated Information” in the October 2, 2016 edition of Bridging the Week.)

And more briefly:

For more information, see:

Alleged Flash Crasher Navinder Sarao Loses Final Effort to Avoid US Extradition:

Representative media article:

CFTC Formally Delays Swap Dealer De Minimis Threshold Decrease:

CFTC Requires All Non-US Consolidated Subsidiaries of US Parents to Count All Swaps in De Minimis Threshold in Proposed Cross-Border Rules:

COMEX and NYMEX Should Increase Testing of Position Limits Exemptions Says CFTC in Rule Review:

Federal Court Finds No Possible Manipulation of US Treasury Markets Where No Allegation of Intent:

HK SFC Commences Review of Brokers’ Internet and Mobile Trading Systems:

Investment Adviser and Supervisor Resolve SEC Charges They Failed to Supervise Employee Who Engaged in Insider Trading:

Investment Bank Resolves SEC Charges It Failed to Safeguard Nonpublic Research Information:

Just Calling Sam Is Inadequate Substitute for Robust AML Procedures Even at Small Broker-Dealer Rules FINRA Adjudicatory Council:

Nonmember Fined US $100,000 and Access Ban by CME Group for Prearranged Trading to Transfer Equity:

SEC Applauds Itself on Most Ever Enforcement Cases in Fiscal Year 2016:

SEC Imposes Tougher Liquidity Requirements on Mutual Funds; Defers Decision on Derivatives:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of October 15, 2016. 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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