Bridging the Week by Gary DeWaal: May 8 to 12 and May 15, 2017 (Block Trades; EFRPs; Delivery Reports; Wash Trades; Government Employee Lied)

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Published Date: May 14, 2017

Last week, ICE Futures U.S. settled disciplinary actions against three persons for violating its block trade rule for a combined fine of US $325,000. The violations included allegedly trading on nonpublic information regarding block trades; purportedly receiving allocations of block trades without expressly requesting such transactions; and possibly executing block trades without being an eligible contract participant. Separately, CME Group resolved disciplinary actions involving purported violations of its rules regarding exchange for related positions, reporting of long positions eligible for delivery and wash trades. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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ICE Futures U.S. Settles Disciplinary Actions Against Three Respondents For Alleged Block Trade Violations For US $325,000 Combined Fine

ICE Futures U.S. settled two related disciplinary actions against three persons for alleged violations of its block trading and other rules for an aggregate fine of $325,000. However, both disciplinary actions referenced the central actions of an unnamed introducing broker that was not named in either matter or in a separate matter; presumably a disciplinary action against such IB may be pending.

In one disciplinary action, Calgary, Canada-based AC Power Financial Corporation and Jason Vaccaro, the firm’s president, agreed to pay a combined fine of US $225,000 and to each serve 30-day suspensions from trading all IFUS energy markets products for purported violations of the exchange’s block trading rule. According to IFUS, at various times from August 2013 through July 2014, “Vaccaro received from his Introducing Broker and may have used nonpublic information concerning the identity or trade activity of the Introducing Broker’s customers” in connection with various of the customers’ block trades. However, said IFUS, this sharing of information appeared unrelated to any negotiation of a block trade between Vaccaro and such customers and thus was prohibited by IFUS requirements (click here to access IFUS Block Trade FAQ, Question/Answer 22). Moreover, when it executed block trades, alleged IFUS, AC Power may not have been an eligible contract participant as required (click here to access IFUS Rule 4.07(a)(i)).

Separately, Susquehanna Energy Partners ("SEP") agreed to pay a fine of US $100,000 and disgorgement of approximately US $49,000 for purportedly placing a verbal standing order with the same unnamed introducing broker that resulted in block trades being allocated to SEP after the fact, rather than placing individual orders for each block trade. This, charged IFUS, potentially violated its requirement that every order underlying a block trade explicitly state that it is or may be executed by a block trade (click here to access IFUS Rule 4.07(a)(ii)(A)). According to IFUS, SEP’s allegedly wrongful conduct occurred from August 2013 through July 2014.

SEP was also charged with failing to diligently supervise its employee who caused the firm’s purported violations.

AC Power, Mr. Vaccaro and SEP all agreed to resolve their IFUS charges without admitting or denying any rule violation.

In December 2014, Mr. Vaccaro consented to settle an enforcement action against him by the Federal Energy Regulatory Commission related to trading on behalf of his then employer, Twin Cities Power – Canada Unlimited ("TCP"). FERC alleged that TCP, TCP's parent company during the relevant time, Mr. Vaccaro and two other TCP traders scheduled and traded physical electric power flows out of certain markets in ways to benefit related swap positions based on such markets’ real-time prices. Mr. Vaccaro agreed to resolve his FERC action, without admitting or denying any violations, by payment of a fine of US $400,000 and a five-year ban on scheduling or trading physical electric power at wholesale in interstate commerce. (Click here for details regarding the FERC disciplinary action.)

Unrelatedly, the Chicago Board of Trade resolved separate disciplinary actions against three persons for alleged violations of its rules regarding exchange for related positions, reporting of long positions eligible for delivery and wash trades.

In one action, Li Jia Ning, a nonmember, agreed to a six-month trading prohibition of all CME Group products for entering into multiple matching buy and sell orders for a single account owned by his employer from January 2015 and May 2015 involving Soybean Futures contracts. This activity resulted in self-match of 21,434 Soybean Futures contracts.

Moreover, charged CBOT, Mr. Ning allegedly utilized another trader’s Tag 50 identification to enter orders onto Globex, as opposed to his own.

In another action, Cunningham Commodities Ltd, a CBOT member firm, consented to pay a fine of US $50,000. CBOT claimed that, on three occasions in November 2015, Cunningham failed to accurately report its long position for delivery in the expiring month Rough Rice futures contract. This failure, said CBOT, resulted in incorrect delivery assignments in the relevant futures contract.

And in the third action, GAM International Management Limited, also a CBOT member, agreed to pay a fine of US $25,000 for engaging in two EFRP transactions involving 10-Year US Treasury Note Futures that were purportedly impermissibly contingent on each other for the purpose of offsetting the related position without incurring “material market risk.” Moreover, said CBOT, the quantity of the related position was not approximately equal to the futures component of the EFRP.

Compliance Weeds: Block trades are an approved limited exception to the Commodity Futures Trading Commission’s requirement that all futures contracts be executed openly and competitively unless they are executed noncompetitively “in accordance with the written rules of [a] contract market that have been submitted to and approved by the Commission, specifically providing for the noncompetitive execution of such transactions.” (Click here to access CFTC Rule 1.38.) As a result, to avoid violation of this CFTC rule, persons engaging in block trades must strictly comply with relevant exchange requirements.

The IFUS rule that authorizes block trades has strict requirements. Among them are that (1) the parties are so-called “eligible contract participants” as defined under applicable law (click here to access the Commodity Exchange Act, §1a(12); (2) each buy and sell order state “explicitly” that it is to be, or may be, executed through a block trade; and (3) block trades must be: at least for the applicable minimum quantity (with special rules for investment managers); privately negotiated; executed at a fair and reasonable price in light of the quantity; and reported within such time and in such manner as required by the exchange.

Information regarding a block trade constitutes proprietary, nonpublic information. As a result, it is prohibited for any person to front-run a block trade when acting on such information regarding an impending transaction by another person acquired through a confidential employer/employee relationship, a broker/customer relationship or in breach of some other preexisting duty.

To effectuate a block trade, a broker may disclose to a potential counterparty a customer’s identity and other material information but only with the customer’s consent. A broker may not, however, ever disclose the terms of a completed or pending block trade to a non-involved party prior to the consummated block trade being publicly reported.

Pre-hedging or anticipatory hedging of block trades is now permitted by persons who are not intermediaries taking the opposite side of a customer order, subject to strict conditions. (Click here for background in the article “Pre-Hedging by Principals Authorized in Block Trade Clarification Implemented by IFUS and Adopted by CME Group” in the October 30, 2016 edition of Bridging the Week. Click here for further background in a publication associated with a November 21, 2016 FIA webinar entitled “Exchange Amendments to Block Trade Pre-Hedging Rules.”)

Other designated contract markets have equivalent rules but there may be discrete differences. (Click here, for example, to access CME Group Rule 526.)


On the same day, Mr. Humphrey also agreed to settle civil charges brought by the SEC related to the same matter. He consented to pay the SEC a fine of US $51,917 and disgorge profits of the same amount plus interest.

According to the SEC, during the relevant time, Mr. Humphrey was subject to numerous ethics rules that, among other things, prohibited SEC employees from (1) purchasing or holding securities of companies directly regulated by the Commission; (2) engaging in transactions in financial instruments that are derivatives of securities; (3) not confirming with the SEC before entering into a securities transaction that the transaction was authorized; and (4) not holding securities for a minimum of six months after trade date. The SEC claimed that, during the relevant time, Mr. Humphrey engaged in securities and options on securities transactions without preclearance; filed false forms with the SEC Ethics Office that did not disclose his prohibited transactions; falsely denied to the SEC Office of Inspector General that he engaged in prohibited transactions; and various other offenses.

According to the SEC, Mr. Humphrey engaged in false transactions for his own accounts, for his mother and for a friend. Mr. Humphrey principally conducted his illicit activities “using his SEC computer during business hours,” said the SEC.

Sentencing for Mr. Humphrey is scheduled for August 8, while his SEC settlement is subject to court approval.

My View: Under Regulation Automated Trading as initially proposed, the Commodity Futures Trading Commission would have been permitted to obtain proprietary source code of so-called “AT Persons” pursuant to its general inspection authority. Subsequently, the CFTC modified its proposal to limit such access to requests made pursuant to enhanced special call procedures, but did not restrict such access to requests through subpoena only. The industry vehemently criticized both proposals, as did then commissioner and now Acting Chairman, J. Christopher Giancarlo. (Click here for background regarding Reg AT 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.)

Last week’s criminal prosecution and civil action against a 16-year SEC veteran, for illicitly trading securities and options on securities and then lying about his actions to his employer, concretely evidences one of many concerns of critics fearful of turning over proprietary source code to staff of the CFTC or Department of Justice other than pursuant to lawful subpoena. Although Mr. Humphrey’s alleged wrongful conduct likely represents only the rarest of behavior by otherwise ordinarily and overwhelmingly very honest and ethical government employees, it illustrates how, over a relatively long period of time, a rogue government employee could disregard important safeguards to routinely and flagrantly engage in illicit activity right under the nose of his/her employer – including potentially misappropriating confidential information such as source code provided by a private entity. Only in connection with the issuance of a lawful subpoena can a private entity have an effective opportunity to address in federal court concerns about confidentiality and attempt to tailor government access to proprietary source code subject to reasonable conditions.

Moreover, President Trump’s issuance of an executive order last week requiring federal agencies to enhance their cybersecurity by implementing risk management measures developed by the National Institute of Standards and Technology is a reminder that, today, federal agencies are not obligated to maintain standards of protection as high as those adopted by many private companies. Accordingly, government agencies may be at greater risk of cyber-attack and theft than many companies such agencies regulate. (Click here to access last week’s executive order regarding government agencies’ cybersecurity; click here to access background on NIST and its recommendations for enhancing critical infrastructure cybersecurity.)

The source code provisions of Reg AT are not expected to survive the next rendition (if any) of any revised Reg AT proposal, but hopefully last week’s developments will eliminate any lingering support the source code provisions may continue to have.

Mr. Giancarlo also bemoaned the supplemental leverage ratio imposed by banking regulators that requires banks to set aside additional capital for cash held by their affiliated derivatives clearing brokers for their customers. This has reduced the profitability of such clearing brokers and consequently reduced the willingness of banks to be in the futures commission merchant business, said Mr. Giancarlo. However, “[a] consolidated FCM industry could pose difficulties in transferring customer positions and margin to other FCMs in times of stress or an FCM default,” warned the Acting Chairman.

In his presentation, Mr. Giancarlo encouraged making cross-border regulatory comity work in order to enhance market certainty and expressed reservations about US swaps trading rules that he believes have heightened market fragmentation.

Mr. Giancarlo’s nomination as Chairman of the CFTC was formally passed by the White House to the Senate last week for the Committee on Agriculture, Nutrition & Forestry to begin processing (click here for background). Mr. Giancarlo noted during his speech before ISDA that he looked forward to restating during his nomination process his “long-standing support for swaps market reform and some of the current and long-term challenges facing trading markets.”

Separately, The White House announced its intent to nominate Brian D. Quintenz as a CFTC commissioner (click here for details). Mr. Quintenz served as founder, managing partner and chief investment officer of Saeculum Capital Management LLC from 2013 through 2016. He previously was nominated for a commissioner position by President Barack Obama (click here for details).

More briefly:


Duet Group specializes in niche investment strategies involving complex and added-value transactions. It takes advantage of cross-fertilization among its various asset classes, from long-only equity, debt funds, hedge funds, private equity and real estate, to create above average returns for its sophisticated, institutional investor base.

Duet Asset Management (DAM) failed to appreciate the extent to which NFA rules prohibit related parties transactions, even when done on commercially reasonable terms. These types of related parties transactions would ordinarily be allowed by other regulatory bodies as long as they are properly disclosed to investors. The transactions in question were generally disclosed in our fund annual reports or elsewhere.

DAM believes these transactions should not be characterized as a misuse of the pools’ assets, were done for the pools’ benefit, and in almost every instance resulted in market, or above-market returns for the pools. Investor funds were not harmed in any way.

DAM fully cooperated with the NFA and has decided to settle, without admitting or denying the violations. Since January 2016, DAM has already undertaken remedial measures to prevent any future violation of NFA rules, including the creation of an internal policy prohibiting all related parties transactions falling under the NFA’s jurisdiction.

For further information:

Acting CFTC Chairman Giancarlo Gives Rehearsal Speech to ISDA Prior to Senate Committee Confirmation Hearing:

Ex-SEC Employee Pleads Guilty to Lying About Trading Securities:

FIA Stuffs Christmas Stocking With Wish List of Proposed Regulatory Reforms – in May:

HK Regulator Seeks View on Proposals to Reduce Hacking Risk for Internet Trading:

ICE Futures US Settles Disciplinary Actions Against Three Respondents For Alleged Block Trade Violations For US $325,000 Combined Fine:

CME Group:

ICE Futures U.S.:

Investment Bank Agrees to Pay US $97 Million to Resolve Claim It Overcharged Advisory Fees and Mutual Fund Sales Charges:

US Attorney General Toughens Charging and Sentencing Policy:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 13, 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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