Bridging the Week by Gary DeWaal: March 27 to 31 and April 3, 2017 (Regulation Through Enforcement; Produce Or Be Fined; Spoofing; Undisclosed Mark-Ups)

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Published Date: April 02, 2017

An international cheese and food ingredient company settled an enforcement action brought by the Commodity Futures Trading Commission that it acted as a futures commission merchant without being registered, as required under law, in connection with a risk management program it administered for its milk suppliers. However, the settlement order raised many questions, including what precisely the firm did wrong. Separately, the Financial Industry Regulatory Authority and 10 exchanges brought an enforcement action against a broker-dealer and its principal owner for aiding and abetting manipulative trading through layering, spoofing and cross-market manipulation by one of the firm’s customers. The case echoed the same themes as an enforcement action filed by the Securities and Exchange Commission against the same two respondents two weeks earlier. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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My View: Just last week in a speech before the US Chamber of Commerce, CFTC Chairman nominee J. Christopher Giancarlo said that market enforcement “will remain aggressive and assertive under the Trump Administration.” To support this, he appointed James McDonald, an assistant US Attorney based in New York City, as the next Director of the Commission’s Division of Enforcement (click here for details of Mr. Giancarlo’s most recent speech, and here for details of his appointment of Mr. McDonald).

Hopefully, however, this enforcement action by the CFTC against Davisco is not an example of the type of tough enforcement to come, which aims to make derivatives markets more liquid and investors better protected. That is because, on its face, it is not clear from the Davisco settlement order what the firm did wrong. The settlement order engenders confusion among end-users and agricultural cooperatives that today offer valuable price protection and similar types of risk management programs to our nation’s farmers and livestock growers.

It is Futures 101 that a person acting as a futures commission merchant must be registered as such with the CFTC. However, it is not clear from the CFTC’s settlement order where Davisco crossed the line, if at all.

As best a reader of the settlement order can tell, through its Milk Patron program, Davisco bought milk from its suppliers and offered them an opportunity to obtain a price that was impacted by settlement prices of the relevant CME milk futures contract. It appears that at least some milk suppliers placed orders for futures with Davisco; however, this was for Davisco’s account – although individual suppliers received debits and credits to accounts somehow related to this. Davisco “solicited and accepted funds” for this program from its suppliers – “but only as a pass-through.” Huh? Did the milk suppliers have individual accounts or not? Did they deposit with Davisco funds for margin or something else? Were there marked-to-market payments? Or was Davisco solely offering a commodity option or price protection product of some type based on the CME futures contract? Not clear!

The CFTC’s choice of words is confusing at best, and at worst sends an unclear message as to what was problematic. Was there fundamental wrongdoing with an intent to evade registration requirements? Or was there simply an inadvertent mistake in administration or marketing? If the latter, why bring the case at all? Wouldn’t it be better to privately warn the company to stop engaging in the problematic conduct and issue public guidance to the industry overall?

Aggressive and assertive enforcement is appropriate when there is real wrongdoing – not to articulate new expectations of regulators or to engage in “gotcha” with otherwise law-abiding persons who might have made a good faith mistake with no real harm to anyone – particularly when enforcement budgets are tight. In any case, at a minimum, all regulatory settlement orders should make it clear what was wrong so the industry can continue to conduct an important business for customers while structuring it to avoid a regulator’s wrath. In no case, should there ever be regulation by settlement order.

Separately, Isaiah Kingston and Alexander Perelberg were charged with unrelated instances of engaging in disruptive trading practices. According to a business conduct committee of the New York Mercantile Exchange, Mr. Kingston, a non-member, placed a series of large stops orders in the NY Harbor low sulfur heating oil futures contracts on several trade dates in June and July 2015 “in close proximity to each other.” When executed, said the BCC, the orders caused “a disruptive and rapid price movement” in the futures contract and prompted an automatic temporary suspension of trading – known as a stop logic event. To resolve this matter, Mr. Kingston agreed to pay a fine of US $100,000 and be suspended from trading any CME Group contract for six months.

Similarly, CME BCC claimed that, from December 12, 2014, through January 31, 2015, Mr. Perelberg, a CME member, “engaged in a pattern of activity” on several dates where he manually entered large orders for March 2015 E-Mini NASDAQ 100 futures contracts solely to observe the market’s response and to induce market participants to trade opposite his smaller iceberg orders on the other side of the market. After receiving fills on his iceberg orders, Mr. Perelberg allegedly cancelled his resting large orders. Mr. Perelberg resolved his CME disciplinary action by agreeing to pay US $7,329 in disgorgement and a fine of US $5,000, and to serve a three-month CME Group trading ban.

Unrelatedly, Consolidated Trading Futures agreed to pay a fine of US $40,000 for purportedly violating Chicago Board of Trade position limits on parts of two days, while Two Sigma Investments, LP consented to pay a fine of US $25,000 for also violating CBOT positions limits for parts of two days. Frere Hall Capital Management LLP agreed to pay a fine of US $25,000 for allegedly exceeding NYMEX position limits on multiple days.

Additionally, Oakley Fuels Inc. on NYMEX and Flow Traders on CBOT agreed to resolve disciplinary actions charging that they engaged in exchange for related position transactions without an exchange of a related position; while National Bank of Canada consented to paying a fine of US $75,000 for allegedly entering into a “series of trades” opposite each other for accounts the firm owned and controlled. These constituted impermissible wash trades said the NYMEX BCC.

Finally, Guosheng Li, a non-member, agreed to pay the Commodity Exchange, Inc. US $25,000 and serve a one-year CME Group trading ban for allegedly pre-arranging round-turn transactions on two days in May 2015 between an account he traded for his employer and an account over which he exercised discretion, whereby his account made US $8,350 and his employer’s account lost US $10,738. Mr. Li previously reimbursed his employee for this trading, acknowledged the Comex BCC.

Compliance Weeds: It is unusual for self-regulatory organizations to file charges claiming that a member firm failed to produce documents or cooperate during an examination or as part of a regulatory inquiry. But it happens. Just recently, two firms were barred from membership with the National Futures Association for not cooperating with an examination by staff. (Click here to access the article “CTA and Principal Barred from NFA Membership for Failing to Cooperate in Examination” in the March 12, 2017 edition of Bridging the Week and here to access the article “CTA and Principal Barred as NFA Members for Not Cooperating With NFA Examination” in the March 5, 2017 edition of Bridging the Week.) Although SRO rules typically require production of documents upon request within certain time periods (e.g., 10 days or less for CME Group; click here to access CME Group Rule 432(L)(3)), SRO staff will usually grant reasonable extensions upon advance request – absent exigent circumstances. Ordinarily, broad requests can also be narrowed down too. However, it is always best to identify the need for a delay or narrowing of scope as soon as possible after an SRO request and to ask for the delay or a more fine-tuned request prior to the deadline for the response. You don’t have to send flowers (indeed, you shouldn't), but don’t ignore regulators’ demands for documents or other information!

Legal Weeds: The Guosheng Li fact pattern resonates of two recent enforcement actions by the Commodity Futures Trading Commission charging persons with insider trading for misappropriating trading information. In the first action brought in 2015, the CFTC alleged that Arya Motazedi, a gasoline trader for an unnamed large, publicly traded corporation, similarly misappropriated trading information of his employer for his own benefit. In the second action, CFTC brought and settled charges against Jon Ruggles, a former trader for Delta Airlines, for trading accounts in his wife’s name based on his knowledge of trades he anticipated placing for his employer. Both actions were grounded in a provision of law under the Dodd-Frank Wall Street Reform and Consumer Protection Act and a CFTC rule that prohibit use of a manipulative or deceptive device or contrivance in connection with futures or swaps trading. (Click here to access Commodity Exchange Act Section 6(c)(1), US Code § 9(1), and here to access CFTC Rule 180.1. Click here for background on these CFTC enforcement actions 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 further information:

CME Settles With FCM for Failure to Timely Produce Documents; Other Exchange Disciplinary Actions Allege Disruptive Trading and Violations of Position Limits and EFRP Requirements:

ESMA Publishes Final Rules to Promote Accuracy and Integrity of Financial Benchmarks:

Following SEC Action, Broker-Dealer and CEO Also Charged by FINRA and 10 Securities Exchanges With Aiding and Abetting Client’s Layering, Spoofing and Cross-Market Manipulation:

Former FCM Traders Settle CFTC Charges They Engaged in Spoofing More Than 1,000 Times:

ICE Futures Proposes to Empower Its VP of Market Regulation to Taketh Away and Giveth Back Too:

Inter-Dealer Broker Cannot Charge Commissions and Undisclosed Mark-Ups and Mark-Downs Says SEC Enforcement:

Introducing Broker Charged by NFA With Not Conducting Annual AML Review:

LME Sanctions Member for Position Reporting Errors:

UK Regulator Issues Near Final Rules on Markets and Commodity Position Limits:

Price Protection Is Price Protection Is Price Protection – Unless It’s FCM Activity Says CFTC:

CFTC and SEC Both Look at Markets Functioning in Upcoming Advisory Meetings:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 1, 2017. 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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