Bridging the Week by Gary DeWaal: June 19 to 23 and June 26, 2017 (Costs and Benefits Don’t Add Up; Floor Trading; LOPR; MiFID II and Direct Market Access)

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Published Date: June 25, 2017

The Office of Inspector General of the Commodity Futures Trading Commission severely criticized the agency’s cost-benefit analysis relied on in promulgating the Commission’s final rule for margin for uncleared swaps issued in December 2015. Additionally, in a rare current disciplinary action involving pit-trading, five respondents settled disciplinary actions brought by the Chicago Mercantile Exchange alleging that they engaged in prohibited conduct to avoid payment of fines mandated when members of a broker association trade opposite each other in restricted contracts for more than a designated maximum percentage of their overall volume. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Bridging the Week will not publish on July 3 because of the Independence Day holiday in the United States. The next regular publication of Bridging the Week will be July 10, 2017.

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Policy and Politics: In his recent defense of his proposed FY 2018 budget for the Commodity Futures Trading Commission before the US House Appropriations Subcommittee on Agriculture, Rural Development and Related Agencies, Acting Chairman J. Christopher Giancarlo, argued that one of justifications for increased CFTC funding was to enhance the agency’s ability to “systematically analyze large volumes of trade data and improve our understanding of the markets.” Mr. Giancarlo acknowledged that “[t]he current staff dedicated to economic analysis is inadequate to meet appropriate standards for econometric analysis required by a regulatory agency with oversight of more than 35 percent of the global derivatives markets.” (Click here for background on Mr. Giancarlo’s testimony and his FY 2018 budget request for the CFTC in the article “Acting CFTC Chairman Explains Zero‑Based Budgeting Approach to Congressional Committee in Defending Request for Increased 2018 FY Funding” in the June 11, 2017 edition of Bridging the Week.)

CBOT and CME Disciplinary Actions

In a rare current disciplinary action involving floor-trading, the Chicago Mercantile Exchange brought and settled disciplinary actions against five individuals associated with the same broker association, four of whom allegedly traded customer orders opposite each other without complying with strict exchange rules that permit such trading with severe restrictions.

According to a CME Business Conduct Committee panel, on numerous occasions between September 2015 and December 2016, four members of a single broker association traded customer orders opposite other members of the same association that were improperly verified as being at the best and only bid and offer at the time. This apparently was done to avoid volume percentage limitations members of the same broker association may trade opposite each other without being subject to mandatory fines (click here to access CME Rule 515.E).

The BCC charged that one runner and trade checker for the association, John Calarco, was responsible for improperly documenting customer orders to conform to the exchange’s requirements and on one or more occasions, along with another non-member employee, endorsed and submitted trading documents to Market Regulation with fabricated witness signatures. For this, John Calarco agreed to pay a fine of US $10,000 and be suspended from access to all CME trading venues for two years.

In addition, Frank Calarco and Philip Mansfield, principals of the association, agreed to pay fines of $47,500 and $77,5000 respectively. Each was charged with failure to supervise their association’s member and non-member employees. Moreover, Mr. Mansfield was also alleged to have executed one Eurodollar option order on September 23, 2015 against another broker in a non‑competitive fashion. To resolve the disciplinary actions against them, John Calarco also agreed to a 30-business day trading venue access suspension, while Mr. Mansfield agreed to a 40-business day time out.

Finally, Andrew Schwieters and Joseph Cosenza, other members of the association, also agreed to pay fines of US $10,000 and $15,000 respectively for their alleged role in this matter, and to serve trading suspensions of five business days and 20 business days, respectively. Mr. Cosenza was also alleged to have to have engaged in a separate non-competitive execution of a Eurodollar option order on September 23, 2015 against another broker in a non-competitive fashion.

Unrelatedly, Coastland Capital LLC agreed to pay a fine of US $15,000 for allegedly entering into a transitory exchange for a related position transaction on April 5, 2016. According to the CME BCC, as part of its EFRP transaction, Coastland bought E‑mini S&P 500 futures contracts and sold SPDR S&P exchange‑traded fund (SPY) contracts. Contemporaneously against the same counterparty, Coastland allegedly sold the SPY contract and bought other contracts. The CME BCC claimed that, as a result, Coastland did not incur market risk related to the SPY contracts. Also, Nidera US LLC consented to pay a fine of US $40,000 for violating position limits from the close of business one day through the next when it liquidated its overage in connection with a disciplinary action brought by the Chicago Board of Trade.

ICE Futures U.S. Disciplinary Actions

Separately, Arlington Commodities LLC agreed to pay a fine of US $10,000 for entering into a block trade when it was alleged it was not an eligible contract participant, as required. Additionally, ED&F Man Capital Markets, Inc. consented to pay US $100,000 for purportedly not conducting adequate due diligence to ensure that one of its customers that executed a block trade was an ECP. ED&F Man also agreed to implement procedures to verify that its customers are ECPs before permitting them to engage in block trades. Finally, Wedbush Securities Inc. consented to pay a fine of US $10,000 for not timely filing a copy of its annual certified financial statement with the exchange.

Compliance Weeds: On CME, three contracts – Eurodollar options, Eurodollar MidCurve options and S&P 500 price index futures – are subject to strict rules to accommodate members of broker associations that may trade opposite each other in trading pits. Most basically, members of a broker association cannot trade opposite each other for more than a designated volume of their trading without incurring mandatory fines. However, trades executed between members of a broker association will not be counted towards such volume thresholds if one member was the best and only bid at the time, and the other was the best and only offer. Another member or exchange official present at the time must sign the relevant member’s trading record attesting that these conditions were met, and provide the information to Market Regulation. (Click here for further details regarding trading in so-called “restricted contracts” in the applicable CME Market Regulation Advisory Notice.) CME Group closed all of its New York trading floors in 2016 and most of its Chicago trading floors in 2015 (click here for background).

Compliance Weeds: Generally, FINRA requires members to report or have reported on their behalf any options position in any account or multiple accounts where the firm or any customer, whether alone or in concert, maintains an aggregate position of 200 or more options contracts (whether long or short) of the put class and the call class on the same side of market for the same underlying security or index. All positions must be reported to LOPR by no later than close of business on the business day following the day the transaction or transactions happened that necessitated the filing. Where aggregate positions meet the 200-contract threshold, the option position of each individual account must be reported. Accounts must be aggregated when they are under common control or acting in concert. Control is presumed for all parties to a joint account who have authority to act on behalf of the account, all general partners of a partnership account, a person or entity that has a 10 percent or more ownership interest in an entity or shares 10 percent or more of an account’s profits and losses, accounts with common directors or management, or an individual or entity who has authority to execute transactions in an account. (Click here to access the May 2016 guidance by FINRA regarding member firms’ LOPR obligations.)

More briefly:

For further information:

Acting CFTC Chairman J. Christopher Giancarlo Testifies Before US Senate Ag Committee; Commissioner Sharon Bowen Reveals Intent to Leave:

Australian Brokerage Firm Fined AU $505,000 for Not Halting Suspicious Trades or Filing Suspicious Activity Report:

Broker-Dealer Settles FINRA Options Reporting Disciplinary Action by Payment of $3.25 Million Fine:

CFTC Inspector General Strongly Criticizes Cost-Benefit Analysis Underlying Commission’s Rules Establishing Margin for Uncleared Swaps:

CPO Settles NFA Charges of Facilitating Loans by Fund to Fund’s Manager:

Former Broker-Dealer Operations Head Charged with Supervisory Failure for Firm’s Improper ADR Handling:

HK SFC Suspends Broker Eight Months for Transferring Proprietary Information and Company Date from Former to New Employer:

ICE Europe Advises Clearing Members of New Obligations for Granting Clients Direct Electronic Access Following MiFID II Roll-Out:

Members of Broker Association Charged by CME With Not Complying With Strict Conditions to Trade Opposite Other Members of Same Group on Trading Floor; IFUS Charges FCM and Client for Block Trades by Non-ECP:

CME Group:

ICE Futures U.S.:

UK Financial Regulator Initiates Criminal Proceedings Against Former Bank Compliance Officer for Insider Trading:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 24, 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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