Bridging the Week by Gary DeWaal: April 10 to 14 and 17, 2017 (Theft of Trade Secrets; No Spoofing; Third-Party Payments; Fake News)

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Published Date: April 16, 2017

Two employees of unrelated trading firms were criminally charged in a federal court in New York City with stealing or trying to steal the source code of their employers’ proprietary trading platforms – one individual last week and the other on April 7. Separately, a broker-dealer and its chief executive officer accused last month by the Securities and Exchange Commission of aiding and abetting a client’s purported ongoing manipulative trading activities vehemently disputed such allegations, and said that its customer’s trading represented ordinary market activity. Additionally, the SEC sued 27 firms and individuals for their role in issuing fake news related to certain companies. Fake news? I’ve heard that somewhere before! As a result, the following matters are covered in this week’s edition of Bridging the Week:

Video Version:

Article Version


My View: When Regulation Automated Trading was first proposed by the Commodity Futures Trading Commission in November 2015, one of the greatest objections was that persons likely subject to the regulation would have to provide to the Commodity Futures Trading Commission and the Department of Justice, upon request and without subpoena, proprietary source code related to their trading systems. The CFTC endeavored to make this requirement more palatable in a November 2016 supplemental proposal by subjecting any request for source code by the CFTC to a heightened process of review. (Click here for background on Regulation AT and the supplemental proposal in the article “Proposed Regulation AT Amended by CFTC; Attempts to Reduce Universe of Most Affected to No More Than 120 Persons” in the November 6, 2016 edition of Bridging the Week.) However, even the revised proposal was widely criticized as inadequate. As current Acting Chairman of the CFTC, J. Christopher Giancarlo said at the time, “The Supplemental Notice before us today … would strip owners of intellectual property of due process of law” by not requiring production of source code solely by a subpoena. “Abrogating the legal rights of property owners is not assuaged by imposing a few additional procedural burdens on the government agency seizing their property.” Even if the defendants in the two criminal actions filed last week are ultimately exonerated, the criminal charges against them provide a fresh reminder of how surreptitiously source code can be stolen, and why it is so important that owners of source code have a say before an objective tribunal in how it might be produced to the government when required by law.

Legal Weeds: The Securities and Exchange Commission’s enforcement action against LEK, Mr. Lek and Avalon principally charged violations of a general anti-fraud provision of law and a related SEC regulation (Click here to access Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5). Securities law and SEC regulations have no express prohibition against trading conduct sometimes referred to as “spoofing” or “layering.” This contrasts with derivatives law, where the Commodity Futures Trading Commission was provided with both an express anti-spoofing and general anti-fraud law in the Dodd-Frank Wall Street Reform and Consumer Protection Act, and afterwards enacted a regulation to parallel the general anti-fraud provision. (Click here to access Section 4c(a)(5) (7 US Code § 6c(a)(5)) and here for Section 6(c)(1) (7 US Code § 9(1)) of the Commodity Exchange Act, and here to access CFTC Rule 180.1.) The CFTC has referenced both provisions in enforcement actions that allege spoofing. (Click here for an example in the article “London-Based Futures Trader Arrested, Sued by CFTC and Criminally Charged With Contributing to the May 2010 “Flash Crash” Through Spoofing” in April 22, 2015 edition of Between Bridges.) Currently, a federal appeals court in Chicago is deciding whether the CEA’s anti-spoofing provision is unconstitutionally vague following a criminal action brought against Michael Coscia and his subsequent conviction and imprisonment. (Click here for background in the article “Federal District Court Approves Flash Crash Spoofer’s US $38 Million Settlement; Federal Appeals Court Appears Sympathetic to Michael Coscia’s Claim That Spoofing Prohibition Is Too Vague” in the November 20, 2016 edition of Bridging the Week.)

Compliance Weeds: These unrelated enforcement actions on different sides of the Pacific Ocean remind me how important it is for regulated institutions to maintain something equivalent to a ledger of all problems of any kind that can be readily reviewed to better detect multiple red flags associated with any customer or other person. Too often firms operate in disparate pillars, where problems seen by one division are not associated with problems seen by another, or regulatory issues considered by one control group (e.g., Anti-Money Laundering) are not considered by another control group (e.g., Compliance) for independent regulatory implications. Additionally, sometimes a firm’s monitoring systems are designed to look at multiple problems by single clients, but are not set up to review common problems by multiple clients associated with a single third party or other person (e.g., an internal employee). Enhancements may be in order! (Click here for my related Compliance Weeds associated with the article “Clearing Firm’s Failure to File Suspicious Activity Reports in Response to Red Flags Charged as Violation of FINRA Requirements” in the March 26, 2017 edition of Bridging the Week.)

More Briefly:

Legal Weeds: The relief granted by the DSIO to the US FCM was in the form of a no-action letter. According to the CFTC, a no action letter “binds only the staff of the Division that issued it or the Office of the General Counsel with respect to the specific fact situation and persons addressed by the letter.”

Helpful to Getting the Business Done: The FCA discussion paper is quite thoughtful and provides an excellent primer for those trying to understand what DLT is. It will be interesting to see whether DLT would qualify as an approved storage medium under the Commodity Futures Trading Commission’s proposed revisions to its record-retention rules. (Click here for background on these proposed new rules in the article “New Records Retention Regime for 21st Century Proposed by CFTC” in the January 16, 2017 edition of Bridging the Week.)

And finally:

For further information:

CFTC Staff Gives OK for US FCM to Post Customer Securities to a UK Individual Segregated Account:

Defendants Named in SEC Spoofing Claim Vehemently Dispute Customer’s Trading Violated Law:

Employees Criminally Charged With Theft of Trade Secrets From Two Financial Services Trading Firms:

ESMA Clarifies Which Products May Be Eligible for Portfolio Margin:

Financial Conduct Authority Seeks Comments on Proposed Distributed Ledger Technology Regulation:

FinCEN Updates Advisory Regarding Problematic Jurisdictions:

FINRA Resolves Charges Against Broker-Dealer for Inadequate Controls for Third-Party Payments from Customer Accounts; Hong Kong Regulator Sanctions Yet Another Broker for Similar Offense:

FINRA Seeks Comments on New Rules for Capital Formation:

LME Proposes Accountability Levels Regime for Precious Metals Contracts:

Sanction Guidelines Updated by FINRA:

SEC Sues 27 Firms and Individuals Over Fake News to Mislead Investors:

Representative cases:

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