Bridging the Week by Gary DeWaal: August 19 – September 6, and September 9, 2019 (Clearing Organization Sanctioned; Programmer Seeks End to CFTC Enforcement Action)

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Published Date: September 09, 2019

A clearing organization for futures and securities was sanctioned US $20 million in aggregate by the Commodity Futures Trading Commission and the Securities and Exchange Commission for allegedly not having and following procedures pertaining to risk management, credit exposure and liquidity risk, and information system safeguards. Separately, the purported programmer of software used by Navinder Sarao – the Flash Crash spoofer – is scheduled to present this week a motion for summary judgment to end his civil lawsuit by the CFTC, just a few months after the judge hearing his criminal trial declared a mistrial, and the Department of Justice determined not to re-file another criminal complaint. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Video Version:

Guest video cover photograph by Dan Berkkovitz, Washingtton, D.C. (Bixby Bridge, Big Sur)

Article Version


OCC is a CFTC-registered derivatives clearing organization authorized to clear futures and options on futures contracts and is also the sole SEC-registered clearing agency for exchange-listed equity options. OCC was additionally designated as a systemically important financial market utility in 2012 by the Financial Stability Oversight Council.

According to the CFTC, at various times, OCC failed to comply with various core principles applicable to all DCOs. The CFTC said that OCC failed to have and enforce written policies and procedures reasonably designed to ensure regular review of its risk-based margin models and appropriate margin levels, monthly stress testing of its financial resources, management of its credit and liquidity risks, and security of its information systems. The SEC charged OCC with express violations of laws and rules imposing similar obligations, as well as failing to obtain the agency’s approval for a number of proposed rule changes in advance of implementing them.

In addition to agreeing to pay a fine of US $5 million to the CFTC and US $15 million to the SEC to resolve the agencies’ allegations, OCC agreed to retain a compliance auditor to help ensure its future adherence with its regulatory obligations. In settling with OCC, both the CFTC and SEC acknowledged remediation efforts taken to date, including the wholesale replacement of many senior officers at the direction of OCC’s executive chairman and board of directors.

Memory Lane: In August 1985, the CFTC brought its first enforcement action against a DCO – Comex Clearing Association Inc. – for its alleged role in the default of Volume Investors Corporation. At the time, VIC was a CFTC-registered futures commission merchant that mostly catered to floor brokers.

VIC defaulted on its aggregate margin obligations to CCA in March 1985 after three of its traders, Gerald and Valerie Westheimer and James Paruch, accumulated large short positions in gold call options traded on the Commodity Exchange, Inc., and could not meet the firm’s own margin call when gold prices rallied substantially and unexpectedly. The traders’ failure to meet VIC’s margin calls caused the firm itself to collapse because it had insufficient capital to cover the traders’ losses.

Initially VIC’s financial failure  imperiled the firm’s non-defaulting customers as VIC did not have sufficient funds to pay them in full. In part, this was because VIC used funds owed to non-defaulting customers to partially satisfy its overall margin obligation to CCA. Ultimately Comex and one of Volume’s principals provided sufficient funds to make all customers whole.

The CFTC sued CCA, claiming that the DCO knowingly permitted VIC to use funds of non-defaulting customers to partially satisfy VIC’s obligations to it caused by the three traders’ losses. The CFTC claimed that CCA aided and abetted VIC’s violation of its prohibition of using one customer’s funds to satisfy the obligation of another customer under applicable law and CFTC rules. CCA settled the CFTC’s complaint in November 1987 by paying a fine of US $30,000.

(Click here for an overview of the VIC default in the article “Maintenance Of Market Strategies In Futures Broker Insolvencies: Futures Position Transfers From Troubled Firms” by Andrea Corcoran and Susan Ervin in the Summer 1987 edition of the Washington and Lee Law Review. Click here to access an overview of the multiple CFTC enforcement actions emanating from VIC’s default. Click here for a contemporaneous article in The New York Times.)

Mr. Thakkar and his company were sued by the CFTC in January 2018. At the same time, Mr. Thakkar was also named in a criminal complaint related to the same conduct. (Click here for more details regarding the criminal and civil complaints involving Mr. Thakkar in the article “CFTC Names Four Banking Organization Companies, a Trading Software Design Company and Six Individuals in Spoofing-Related Cases; the Same Six Individuals Criminally Charged Plus Two More” in the February 4, 2018 edition of Bridging the Week.)

Subsequently, after criminal charges against Mr. Thakkar for conspiracy to commit spoofing were dismissed by the judge presiding over Mr. Thakkar’s criminal trial, the same judge declared a mistrial after the jury failed to reach a unanimous verdict on the charge of aiding and abetting spoofing. The Department of Justice declined to retry Mr. Thakkar. (Click here for background regarding Mr. Thakkar’s criminal proceedings in the article “Department Declines to Retry Alleged Programmer for Flash Crash Spoofer” in the April 29, 2019 edition of Bridging the Week.)

Following these events, the CFTC determined to proceed with its civil action against defendants. In a memorandum filed in support of their motion, defendants argued that, as established at Mr. Thakkar’s criminal trial, they “did not know Sarao would use the computer program Edge Financial developed to engage in illegal trading, and [defendants] did not intend to further Sarao’s illegal trading.” Defendants claimed that after conducting a joint investigation with the DOJ prior to Mr. Thakkar’s criminal trial, the CFTC now proposes to launch a second investigation through civil discovery; this they claim is “a waste of the Court, the government and the Defendants’ resources.”

My View: As I wrote at the time of the DoJ’s decision not to retry Mr. Thakkar, 

Although the standard of proof the CFTC would have to satisfy to gain a judgment against Mr. Thakkar in its enforcement action is less than what the DoJ required in its criminal case (a preponderance of the evidence vs. beyond reasonable doubt), the Commission should exercise its discretion and voluntarily drop its enforcement action against Mr. Thakkar. Unless the CFTC has a smoking gun it did not make available to the DoJ, it does not appear that there is compelling evidence that Mr. Thakkar was aware that software developed by his firm would be used by Mr. Sarao for illicit purposes. 

It should not be case that a software developer or provider can be held liable for the illicit use of the software absent express knowledge of the user’s illicit intent. Simply being aware that that software could potentially be used for an illegal purpose should not be enough to warrant prosecution by the CFTC let alone by the DoJ. Otherwise the potential for regulatory liability will chill if not freeze trading software development.

Nothing has transpired since April 2019 that changes my view on what should be the outcome of this CFTC action.

According to the revised market regulatory advisory notice – which is scheduled to be effective on October 1 – the time of consummation or execution of a block trade is the time the parties agree to the transaction in principle. For spreads, this is when the differential is agreed between the parties, not when the actual leg prices are determined. All block trades must be reported in accordance with CME Group requirements within five or 15 minutes of execution depending on the product.

Ordinarily, a broker involved in the negotiation of a block trade may not reveal the identity of a customer unless the customer consents. Under the revised consent, this permission must be formally reconfirmed no less than once annually and brokers should retain documentation evidencing such consent.

Finally, in 2016, CME Group authorized principals to pre-hedge block trades that they believe “in good faith” will occur. However, this authority was denied to an intermediary that takes the opposite side of its own customer’s order directly or indirectly. In such circumstances, the intermediary can only offset its position after the block trade has been consummated (but prior to reporting). (Click here for background regarding CME Group’s authorization of pre-hedging under limited circumstances for block trades 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.) 

Under CME Group’s revised MRAN, a party acting as a principal to a block trade that seeks to pre-hedge an anticipated block transaction must “ensure it is clear” to its counterparty its role in the transaction and not take any action that suggests it owes agency duties to the counterparty. According to CME Group, telling a counterparty that it would “work an order” would imply that a party is acting in an agency, not principal, capacity.

Compliance Weeds: Through its revised MRAN, CME Group appears to be trying to help clarify when it might consider a party to be acting as a principal as opposed to as an agent to a block trade transaction. This is critical, as only principals may pre-hedge a block trade prior to consummation.

CME Group suggests that a surefire way to help ensure that counterparties understand that a firm is acting as a principal is to expressly tell them – provided this is done prior to engaging in pre-hedging activity. This could be done by a header/footer disclosure in an instant message, on a recorded telephone line, or by email. However, CME Group cautions that words matter. A representation that a party is acting as a principal could be defeated by the use of words that convey that the party is acting as an agent, or where the price of the block trade is set at the party’s pre-hedge price plus a markup or basis. Under all circumstances, the price of a block trade must be a “fair and reasonable” price at the time of execution considering the size of the transaction, the prices and sizes of other transactions in the same contract at the same time, the price and sizes of transactions in other relevant markets at the same time and “the circumstances of the markets or the parties to the block trade.” (Click here for background on the CFTC’s view of what does not constitute a fair and reasonable block trade price in the article "Futures Block Trades' Prices at Midpoint of Related Swaps Bid-Ask Were Not Fair and Reasonable Says CFTC in Enforcement Action" in the September 25 2016 edition of Bridging the Week.) 

More Briefly:

Baruch Glauback agreed to pay a fine of US $45,000 and serve a two-week all CME Group exchanges’ access prohibition for purportedly engaging in layering and spoofing at various times in November 2017 on the New York Mercantile Exchange. NYMEX also alleged that Nicholas Murphy engaged in similar disruptive behavior at various times in January 2018; he agreed to pay a fine of US $65,000, disgorge profits of approximately US $41,500 and serve a three-week all CME Group exchanges’ access prohibition to settle his matter. Separately, Kunal Makhijani was fined US $45,000 and barred from access to all CME Group exchanges for five years for allegedly engaging in layering and spoofing on the Chicago Board of Trade on multiple occasions between April 2017 and February 2018, and for entering orders in various soybean futures contracts during pre-open periods that were purportedly not intended to be executed. Phillip Ferguson agreed to pay a fine of US $40,000 to IFUS and serve a one-month IFUS trading suspension for also possibly engaging in layering and spoofing trading from January through September 2017. 

Separately, Deepak Patwari was also assessed a fine of US $50,000 and barred from all CME Group exchanges’ access for one year for entering pre-opening period orders for CME Live Cattle without intending for the transactions to be executed.

Unrelatedly, Credit Suisse Securities (USA) LLC agreed to pay a fine of US $150,000 to CBOT to settle allegations related to violations of rules on calls for performance bond, recordkeeping related to net capital computations and risk management, while Cunningham Commodities, LLC agreed to pay a penalty of US $50,000 to the CBOT for alleged violation of rules related to the assessment, collection and release of funds previously collected for margin.

Finally, Cornerstone Commodities LLC agreed to pay a fine of US $60,000 to NYMEX for not timely reporting block trades it brokered, while CSC Futures (HK) Limited consented to a US $15,000 sanction by the CBOE Futures Exchange LLC for not filing required large trader reports with CFE from June through December 2018.

Did You Know?: Last month the Monetary Authority of Singapore and the Singapore Exchange published a trade surveillance practice guide that sets forth practical guiding principles in an exceptionally straightforward manner for organizing trade surveillance operations and pointers on monitoring potential market misconduct. It’s well worth checking out, as well as two prior trade SGX surveillance handbooks, each of which provides very helpful examples of spoofing of futures contracts. (Click here to access the MAS-SGX surveillance practice guide; here for SGX’s trade surveillance handbook – series one; and here for SGX’s trade surveillance handbook – series two.) 

Additionally, CTAs will have to receive or provide to each client who maintains an amount with more than the amount the client has instructed for trading decisions a written confirmation that includes a description of the trading program and the nominal size of the client’s account; this requirement currently applies solely to clients with partially funded accounts. Moreover, the requirement for written confirmation statements, going forward, will apply to all clients, including qualified eligible participants. 

Separately, NFA proposed amendments to various rules and interpretive notices to more accurately reflect current technology and practices and help ensure consistent requirements for use of hypothetical performance in promotional literature directed exclusively to QEPs. The amendments make clear, among other things, that the various rules and interpretive notices apply solely to futures commission merchants, introducing brokers, CTAs, CPOs and, in some cases, foreign exchange dealer members.

No effective date was included in the NFA’s proposed amendments to rules and interpretive notices.

The SEC alleged that, from December 2017 through July 2018, the firm – ICO Rating (the trade name for an unincorporated entity) – charged ICO issuers a fee for ratings, and then produced and published research reports on its website that it also publicized through social media. However, the entity did not disclose its receipt of compensation for ratings.

To resolve this matter, ICO Rating agreed to pay a fine of US $162,000 as well as disgorgement and prejudgment interest of US $106,998.

In other legal and regulatory developments involving cryptoassets:

For further information

Clearing Organization Cited by CFTC and SEC for Lax Risk Management and Information-Systems Security Policies and Procedures:

CME Group Clarifies 2016 Block Trading Pre-Hedging Authorization:

CBOT, CME, NYMEX and ICE Futures Sanction Traders for Disruptive Trading:

Futures SRO Group Extends CFTC Margining Relief for Separate Accounts to Foreign Futures and Options:

Bakkt Trust Company LLC Approved by NY DFS for Bitcoin Custody; ICE Futures U.S. Announces September 23 Launch of Two Physically Deliverable Bitcoin Futures Contracts:


Liquidity Provider Program (sample for daily contract):
Market Maker Program (sample for daily contract):,Rule%204.17_and_CSLOR.pdf

ICO Rating Agency Sanctioned by SEC for Not Disclosing Payments for Promoting Certain Digital Assets:

NFA Proposes Amendments to CTA/CPO Performance Reporting Requirements and Requirements for All Intermediaries Related to Presenting Hypothetical Results:

NY DFS Authorizes Gold-Backed Digital Currency:

Purported Programmer for Flash Crash Spoofer Moves for Summary Judgment in CFTC Enforcement Proceeding:


Putative Class Action Lawsuit Filed Against Major Ethanol Producer for Purported Manipulation of Key Ethanol Benchmark and Three-CME Group Exchanges-Traded Ethanol Derivatives Contracts:

SEC Sanctions ICO Rating Agency for Not Disclosing Payments for Promoting Certain Digital Assets:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of September 7, 2019. 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. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or employees.

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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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