Two non-US residents settled a civil enforcement action by the Commodity Futures Trading Commission alleging that they engaged in spoofing activity by agreement to pay an aggregate fine of US $2.69 million, while a third individual’s recent criminal conviction for spoofing was not set aside by the relevant court, despite his motion for such relief. Separately, staff of the CFTC once again delayed effective dates for obligatory electronic filings under its new Ownership and Control requirements; clarified definitions of owner and controller; and provided some interim relief on the effective dates of certain other specific requirements of reporting entities. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- CFTC Again Extends Deadlines for New OCR Compliance; Puts Pressure on FCM Clients Who Will Not Provide Adequate Information Regarding Trading Control;
- Federal Court Declines to Set Aside Coscia Spoofing Conviction (includes Legal Weeds);
- Two Non-US Residents Consent to CFTC Settlement for Alleged Spoofing Activity;
- Subject of IFUS Sanction for Alleged Non-Bona Fide EFPs Also Penalized by CFTC for Same Conduct (includes Compliance Weeds and My View);
- Basel Committee Consults on Revised Leverage Ratio Framework and Seeks Data to Consider Offsets for Initial Margin;
- CME Group Member Resolves Disciplinary Action for Automated Trading System Errant Purchases That Purportedly Drove Up Crude Oil Spread Prices (includes My View);
- US Court Says FSOC Deviated From Its Own Standards in Designating MetLife as Systemically Important and Wrongfully Failed to Consider Costs;
- ESMA Proposes One-Day Margin Period for CCP Client Accounts; and more.
CFTC Again Extends Deadlines for New OCR Compliance; Puts Pressure on FCM Clients Who Will Not Provide Adequate Information Regarding Trading Control
Late last week, staff of the Division of Market Oversight of the Commodity Futures Trading Commission again delayed the roll-out of certain new large trader reporting requirements that initially were adopted during November 2013 and, most recently, scheduled to go into effect later this month. Under these new Ownership and Control Data Reporting Requirements, the CFTC expanded upon its previous large trader reporting regime and required the electronic submission of certain large traders’ and position holders’ data regarding their futures and swaps holdings on updated forms:
- new Form 102A to identify holders of large positions;
- new Form 102B to identify traders that exceed a stated volume of transactions (50 contracts/day on a notional value basis; “volume threshold accounts”) during a single trading day (regardless of end-of-day positions);
- new Form 102S to identify holders of certain swaps positions;
- new Form 40/40S to collect information from reporting traders; and
- new Form 71 to collect information on omnibus volume threshold accounts.
Under the revised schedule, new requirements related to the electronic reporting of:
- Forms 102A, 102B (for Designated Contract Market volume trading threshold accounts) and 102S go into effect on September 29, 2016;
- Forms 40, 40S and new Form 71 go into effect on November 18, 2016; and
- Form 102B (for Swap Execution Facility volume threshold trading accounts) goes into effect on August 30, 2018.
In the interim period, recordkeeping requirements that became effective on August 14, 2014, and legacy non-automated reporting and certain other requirements remain in effect. Entities required to file the relevant forms (Reporting Parties) are also expected to cooperate with CFTC staff to test and implement relevant information technology standards and systems.
As part of its no-action relief and OCR guidance, DMO staff also agreed to extend the time period by which certain other specific OCR requirements would apply. For example, Reporting Parties obligated to file new Form 102A beginning September 29, 2016, will not be required to include certain information regarding trading account controllers (e.g., phone number, name of employer, employer National Futures Association identification, employer legal entity identifier) until August 30, 2018. Staff also increased the reporting trigger for volume threshold accounts under new Form 102B to 250 or more contracts per day from September 29, 2016, until September 28, 2017, and to 100 contracts per day from September 29, 2017, to August 29, 2018. The threshold level would revert to 50 contracts per day beginning August 30, 2018.
DMO staff also clarified who would be considered owners and controllers of reportable accounts under its OCR rules, as well as provided a mechanism for Reporting Parties to identify to the CFTC a client that does not provide it with adequate information to identify a trading account controller on a Form 102A or 102B. From September 29, 2016, to September 28, 2017, DMO staff will not recommend an enforcement action be taken against any Reporting Party that does not properly report a trading account controller provided it specially discloses to the CFTC the non-cooperation of the relevant client; this is typically a problem experienced by reporting future commission merchants and foreign brokers.
(Click here for a brief summary of the CFTC’s initial November 2013 OCR rules in the article, “CFTC Adopts Final Rules for Ownership and Control Reports” in the November 1, 2013 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)
- Federal Court Declines to Set Aside Coscia Spoofing Conviction: Last week, the judge that recently oversaw the trial of Michael Coscia in a US federal court in Chicago declined to grant Mr. Coscia’s motion for acquittal or a new trial. In November 2015, Mr. Coscia was convicted of six counts of commodities fraud and six counts of spoofing in connection with his trading activities on CME Group exchanges and ICE Futures Europe from August through October 2011. Mr. Coscia subsequently filed his motion, claiming, among other things, that the prosecution misapplied the relevant standard for proving commodities fraud and that the law prohibiting spoofing is void for vagueness. The court rejected both arguments. Although Mr. Coscia argued that, to find commodities fraud, the prosecution had to show his actual orders were false or deceptive, the court held this was not the case. Instead, said the Court, the prosecution only had to show there was a fraudulent intent, a scheme or artifice to defraud, and a nexus to the commodities markets. According to the court, “[i]n the indictment and throughout the trial, the Government alleged that Coscia engaged in a scheme to defraud by intentionally misleading market participants about price and volume information in the commodities markets through sham quote orders. That theory fits the requirements of the statute.” The court also rejected Mr. Coscia’s claim that the law prohibiting spoofing is void for vagueness, claiming that Mr. Coscia had “fair notice” of what constituted unlawful spoofing at the time of his alleged wrongful conduct. The court claimed that spoofing only occurs “when there is intent to defraud by placing illusory offers (or put another way, by placing offers with the intent to cancel them before execution).” The court further said that spoofing is a type of market manipulation, and “statutory prohibitions against specific forms of market manipulation are nothing new.” The court also rejected claims by Mr. Coscia that instructions given to the jury were faulty and that certain testimony given by the prosecution’s witnesses was false and prejudicial. (Click here for a further discussion of Mr. Coscia’s criminal conviction in the article, “Jury Convicts Michael Coscia of Commodities Fraud and Spoofing” in the November 8, 2015 edition of Bridging the Week.)
Legal Weeds: The relevant provision of law under which Mr. Coscia was prosecuted prohibits trading activity that “is, is of the character of, or is commonly known to the trade as, 'spoofing' (bidding or offering with the intent to cancel the bid or offer before execution).” It may be clear what is prohibited by this provision, as the court has written, but by its broad sweep, the provision technically makes illegal relatively ordinary trading conduct that no one – not even the Commodity Futures Trading Commission or any exchange – would likely consider nefarious.
For example, when a trader places a stop loss order, he or she does not intend for the order to be executed, because, presumably that would mean the market is trending in a direction opposite his or her expectation. However, he or she will accept a trade execution if the conditions of the stop loss order are realized.
The CFTC, in its May 28, 2013 Antidisruptive Practices Authority guidance (click here to access), seems to acknowledge this dichotomy. According to the CFTC, “a spoofing violation will not occur when the person’s intent when cancelling a bid or offer before execution was to cancel such bid or offer as part of a legitimate, good-faith attempt to consummate a trade. Thus the Commission interprets the statute to mean that a legitimate, good-faith cancellation or modification of orders (e.g., partially filled orders or properly placed stop-loss orders) would not violate [the relevant statutory provision].”
CME Group, in a market advisory addressing disruptive trading (click here to access) also provides a number of other examples where the intent of a trader is not necessarily to have all his or her orders executed at the time of order placement, but the consequence is not deemed impermissible spoofing — e.g., placing a quantity larger than a market participant expects to trade in electronic markets subject to a pro rata matching algorithm and placing orders at various price levels throughout an order book solely to gain queue position, and subsequently cancelling those orders as markets change.
Unfortunately, the statute prohibiting spoofing simply has it wrong. There is nothing automatically problematic about all spoofing as now defined under applicable law. Deception, to some except, is part of smart trading. No trader knowingly reveals all his or her strategy or intent as part of an order placement (consider, for example, exchange-sanctioned iceberg orders). As CME Group wrote in a comment letter to the CFTC about what should be deemed illegal spoofing, it is not the intent to cancel orders before execution that is necessarily problematic, it is “the intent to enter non bona fide orders for the purpose of misleading market participants and exploiting that deception for the spoofing entity’s benefit” (emphasis added; click here to access CME letter to CFTC dated January 3, 2011). Spoofing is simply the big circle in the applicable Venn diagram; what should be prohibited is solely a smaller circle within the larger one – a subset.
The jury hearing Mr. Coscia’s prosecution clearly believed there was sufficient evidence to find the defendant had engaged in spoofing, and the judge overseeing the trial has now ruled twice that Mr. Coscia was on sufficient notice that his specific trading activity constituted spoofing.
However, until the anti-spoofing law is further clarified to reflect what truly is problematic, it will embrace both legitimate and illegitimate activity; potentially scare away bona fide trading and have a deleterious impact on market liquidity; and potentially cause some market participants to run afoul of the law for ordinary order placement activity. This is not right or fair, even if, as the court ruled in Mr. Coscia’s case, traders have “fair notice.”
- Two Non-US Residents Consent to CFTC Settlement for Alleged Spoofing Activity: Heet Khara and Nasim Salim, residents of the United Arab Emirates, agreed to settle charges brought against them for alleged spoofing activity from January 29, 2015, through March 13, 2015, involving gold and silver futures contracts traded on the Commodity Exchange, Inc. The defendants were initially sued by the CFTC for this activity on May 5, 2015, in a federal court in New York, after CME Group on April 30, 2015, summarily barred Mr. Khara and Mr. Salim without a hearing from trading on any CME Group exchange for 60 days. In its complaint, the CFTC alleged that Mr. Khara initially, alone, on numerous occasions, placed layered orders on one side of the market with intent to cancel the orders before execution, to induce a run up or run down of relevant market prices. At the same time, he placed one or more smaller orders on the opposite side of the market to be executed when the market increased or decreased in price. Later on, Mr. Khara and Mr. Salim worked together to place layering orders and orders to be executed, claimed the CFTC. To resolve the CFTC charges, Mr. Khara agreed to pay a fine of US $1.38 million, while Mr. Salim agreed to pay a fine of US $1.31 million. Both individuals also agreed to never again trade on a CFTC-registered execution facility, among other sanctions. (Click here for details regarding the CFTC’s complaint in the article, “Two Traders Subject of CME Summary Suspension for Alleged Spoofing Sued by CFTC Too” in the May 10, 2015 edition of Bridging the Week.)
- Subject of IFUS Sanction for Alleged Non-Bona Fide EFPs Also Penalized by CFTC for Same Conduct: Michael Pucciarelli and Badge Trading LLC, a company wholly owned by Mr. Pucciarelli, agreed to pay a fine of US $280,000 and be barred from trading on any CFTC-supervised execution facility for four years as a result of engaging in “numerous” non-bona fide exchange for physical transactions from January 2010 to August 2012. Previously, in July 2014, Mr. Pucciarelli also agreed to settle charges by ICE Futures U.S. related to the same alleged wrongdoing by agreeing to disgorged profits of approximately US $514,018 and being subject to a two-year trading ban on all IFUS-operated markets. (Click here to access details of Mr. Pucciarelli’s prior IFUS settlement.) According to the CFTC and IFUS, during the relevant time, Mr. Pucciarelli was employed as a director of purchasing for an unnamed coffee roasting business. He purportedly engaged in 106 transactions where he entered into EFP transactions for Badge Trading, but in fact split the EFPs so that Badge would sell Coffee “C” futures, while the roasting company purchased the corresponding amount of physical coffee. (Under applicable IFUS rules, one party must be both the buyer of the related position and the seller of the futures contract, or the seller of the related position and the buyer of the futures contract. Split EFPs are not permitted.) Mr. Pucciarelli also purchased for Badge, in the open market, an identical quantity of Coffee “C” futures. Apparently, the short futures positions obtained by Badge through the EFPs were executed at higher prices than corresponding futures positions Mr. Pucciarelli purchased for Badge in the open market, thereby assuring him a profit when he offset the positions. The CFTC charged that Mr. Pucciarelli’s split EFP transactions constituted fictitious sales and resulted in non-bona fide prices being reported.
Compliance Weeds: The risk of executing any non-competitive trade is that, unless it is executed precisely in accordance with exchange rules, it is likely a violation of rules of the Commodity Futures Trading Commission. This is because the CFTC requires all futures transactions to be executed openly and competitively except for trades “executed non-competitively in accordance with written rules of the contract market which have been submitted to and approved by the Commission, specifically providing for the non-competitive execution of such transactions.” (Click here to access the full text of CFTC Rule 1.38.) Unfortunately, not all exchange rules addressing the same non-competitive transactions are identical – even on different markets of the same exchange group (Click here for examples of such different rules in the article, “CME Group Updates Its Pre-Execution Communication Rule to Reflect New Committed Crosses” in the January 31, 2016 edition of Bridging the Week.) Thus care must be taken to ensure that traders are aware of each exchange’s specific requirements and that they are followed faithfully.
My View: It always leaves the Commodity Futures Trading Commission open to second guessing when it brings a “me-too” enforcement action that alleges the same violation addressed in a prior self-regulatory organization’s disciplinary action (particularly when its enforcement action is filed almost two years later as in the instant matter). Unfortunately, the CFTC does not explain its thinking when it files such an action, particularly when there is a settlement. On the one hand, critics can fairly question whether a “me-too” action represents an appropriate expenditure of scarce agency resources. On the other hand, the CFTC can argue that the SRO action levied a sanction that was not sufficient given the severity of the alleged wrongful conduct. In the instant matter, IFUS was only able to ban Mr. Pucciarelli from trading on its markets. The CFTC could have reasonably determined that trading on all markets was a more appropriate penalty for conduct it considered egregious. Who knows – other than CFTC Division of Enforcement staff? At a minimum, the CFTC should ordinarily not file “me-too” actions except where there are particularly egregious circumstances.
- Basel Committee Consults on Revised Leverage Ratio Framework and Seeks Data to Consider Offsets for Initial Margin: The Basel Committee on Banking Supervision proposed changes to banks’ leverage-ratio calculations to better differentiate between margined and non-margined derivatives trades. (The leverage ratio refers to the amount of shareholder equity and disclosed reserves a bank maintains divided by its total exposures. Under Basel III, banks are expected to maintain a leverage ratio of 3 percent while the Board of Governors of the Federal Reserve System expects most insured bank holding companies to maintain a leverage ratio of 5 percent and systematically important financial institutions 8 percent.) However, the Basel Committee did not at this time propose to amend such calculations to better account for initial margin posted by clients in connection with cleared derivatives transactions. Currently, under banks’ leverage-ratio calculations, a measure of potential futures exposure in connection with derivatives transactions is not reduced by the amount of initial margin posted by a client. As a result, banks must maintain a greater amount of capital in connection with cleared derivatives business than if offsets were permitted. Industry organizations have argued that this is unfair and is inconsistent with the objectives of the G-20 to promote the clearing of derivatives transactions. (Click here for details of this argument in the article, “Industry Organizations Request Basel Committee Reconsider Proposed Treatment of Segregated Customer Margin” in the November 23, 2014 edition of Bridging the Week.) However, the Basel Committee agreed to collect further evidence and data to “assess the effects of the Basel III leverage ratio on the client clearing business model and the need for banks to have adequate capital to support their clearing activities.” The Basel Committee will accept comments on its proposals through July 6, 2016.
- CME Group Member Resolves Disciplinary Action for Automated Trading System Errant Purchases That Purportedly Drove Up Crude Oil Spread Prices: CME Group resolved a disciplinary action against TradeForecaster Global Markets over the alleged failure of one of TradeForecaster’s employees that caused the firm’s automated trading system to malfunction on January 20, 2015, and purportedly cause an artificial spike in the price of the June 15 – December 15 Crude Oil futures spread traded on the New York Mercantile Exchange. According to CME Group, on the relevant date, the employee allegedly failed to disengage one ATS that used an auto-spreader strategy prior to engaging a second ATS that was not designed to run at the same time. As a result, said CME Group, the two ATSs improperly interacted with each other causing continuous purchases by the auto-spreader program. TradeForecaster agreed to pay a fine of US $115,000 to resolve this matter.
My View: The comment period for proposed Regulation Automated Trading by the Commodity Futures Trading Commission has now closed, and staff is in the process of evaluating the many divergent views that were submitted and likely developing one or more final rules, potentially by as soon as year-end. Proposed Regulation AT has many prescriptive requirements (CME Group calculates 87) for persons within its scope, including rules related to utilizing mandatory pre-trade risk filters; the development, testing and monitoring of so-called algorithmic trading systems; the retention and production of source code; and the filing with designated contract markets of annual certified reports. (Click here for a detailed oversight of the requirements of proposed Regulation AT in the article, “CFTC’s Proposed New Algorithmic Trading Rules Augur Potential Increased Obligations and Costs, and a New Registration Requirement” in the November 29, 2015 edition of Between Bridges) However, nothing in the proposed rules would likely have prevented the type of alleged error at issue in the instant matter – plain old human mistake. Somewhat ironic!
- US Court Says FSOC Deviated From Its Own Standards in Designating MetLife as Systemically Important and Wrongfully Failed to Consider Costs: A US federal court in the District of Columbia held that the Financial Stability Oversight Council did not follow two of its own requirements or properly consider costs in designating MetLife, Inc. as subject to special oversight by the Board of Governors of the Federal Reserve System even though it is not a banking organization. According to the court, under the Dodd-Frank Wall Street Reform and Consumer Protection Act, FSOC has the authority to designate a non-bank financial institution for enhanced prudential oversight when “material financial distress” at the company “could pose a threat to the financial stability of the United States.” However, according to the court, FSOC did not apply its own rules and guidance in evaluating MetLife’s potential vulnerability to financial distress and how it might threaten US financial stability prior to designating the firm as systemically important. “Indeed,” said the court, FSOC’s final determination “hardly adhered to any standard when it came to assessing MetLife’s threat to U.S. financial stability” (emphasis added). In addition, although Dodd-Frank does not have an express requirement that FSOC consider the cost to MetLife in evaluating the benefit of subjecting it to enhanced prudential oversight, a requirement to consider cost is implicit in the statute, claimed the court. Specifically, the court held that the requirement under relevant law that FSOC consider appropriate “risk-related” factors “plainly subsumes consideration of cost.” The US Department of Treasury has announced the government will appeal the court’s decision.
- ESMA Proposes One-Day Margin Period for CCP Client Accounts: The European Securities and Markets Authority has issued proposed final rules – so-called “regulatory technical standards – permitting European-regulated clearinghouses (CCPs) to calculate margin requirements for clients of their members utilizing a potential liquidation horizon of one business day, subject to various circumstances. These conditions include that the CCP knows the identity of all ultimate clients and maintains separate records of the positions of each clients as of at least the end of each day, does not include proprietary positions among client accounts and calculates margin requirements “on a near to real-time basis at least every hour during the day;” and ordinarily calls for new margin within one hour on existing positions where margin requirements are higher than 110 percent of existing collateral. If a CCP does not satisfy the enumerated conditions to calculate margin requirements based on a one-day liquidation horizon, it must utilize a two business day horizon, as is currently required. This new approach was adopted following the European Commission’s recent issuance of a formal determination that the Commodity Futures Trading Commission has equivalent requirements as the European Union in overseeing clearinghouses. In approving this new approach ESMA recognized that “clearing members might lose incentives to offer client clearing services if they lose the benefit of netting efficiency that result from opposite positions of different clients.” However, ESMA considered, among other things, that not adopting this approach might make EU qualified CCPs less competitive with non-EU clearinghouses. (Click here for further details on the EC’s recent equivalency determination in the article, ”CFTC Approves Substituted Compliance Framework for EU Based DCOs; EC Formally Recognizes US CCPs as Subject to Equivalent Regulation” in the March 20, 2016 edition of Bridging the Week.)
And more briefly:
- SEC Approves FINRA Rule Mandating Registration of Algo System Designers: The Securities and Exchange Commission approved a rule proposal by the Financial Industry Regulatory Authority to require the registration of personnel at member firms who are principally responsible for the design, development or material amendment of algorithmic trading strategies, or who are responsible for supervising or directing such activity. Such persons would have to register as securities traders, a new category of registration — albeit similar in concept to the current equity trader registration category, although this distinct category would be eliminated under FINRA’s proposal. FINRA is now obligated to publish its final rule by June 6, 2016. The effective date of the final rule would be no sooner than 180 days after the publication. (Click here for details of FINRA’s new rule proposal in the March 22, 2015 edition of Bridging the Week.)
- Rollout of MiFID II One Step Closer to Formal One-Year Delay: The European Parliament formally agreed to delay the rollout of the Markets in Financial Instruments Directive II for one year, until January 3, 2018, according to published reports. The European Commission had recommended such action in February 2016 (Click here for details in the article, “EC Formally Proposes Delaying MiFID II Rollout for One Year” in the February 14, 2016 edition of Bridging the Week.)
- FinCEN Proposes to Include Funding Portals in Definition of Broker or Dealer to Apply Bank Secrecy Act Provisions: The Financial Crimes Enforcement Network, a bureau of the US Department of Treasury, proposed to amend its regulations under the Bank Secrecy Act to include funding portals within the definition of broker-dealer. This amendment, claimed FinCEn, is necessary because of provisions of the Jumpstart Our Business Startups Act that was adopted in 2012 that permit sales of certain new securities through a funding portal, bypassing traditional broker-dealers. Under the proposed amendments, funding portals would be required to implement certain anti-money laundering policies and procedures, including the filing of reports of suspicious activities. (Click here for details regarding crowdfunding securities offerings in the article, “SEC to Permit Capital Raising Through Crowdfunding” in the November 1, 2015 edition of Bridging the Week.)
- IOSCO Issues Overview of Different International Regulators’ Approaches to Cybersecurity: The International Organization of Securities Commissions published a comprehensive report setting forth regulatory issues and challenges related to cybersecurity confronted by various segments of the securities industry, including reporting issuers, trading venues, market infrastructures, intermediaries and asset managers, and examples of approaches to such matters. The report also addresses issues regarding information sharing among market participants and regulators.
- Peaking Supply Contracts Involving Electricity and Natural Gas Not Swaps Says CFTC in Proposed Guidance: The Commodity Futures Trading Commission proposed guidance to make clear certain agreements by commercial end users for the potential receipt of electricity and natural gas are not swaps contracts and thus do not subject users to swaps reporting and other obligations. These contracts are typically known as capacity contracts in electricity power markets and peaking supply contracts for natural gas contracts utilized by electric utilities.
For more information, see:
Basel Committee Consults on Revised Leverage Ratio Framework and Seeks Data to Consider Offsets for Initial Margin:
See also, ISDA Views:
CME Group Member Resolves Disciplinary Action for Automated Trading System Errant Purchases That Purportedly Drove Up Crude Oil Spread Prices:
ESMA Proposes One-Day Margin Period for CCP Client Accounts:
Federal Court Declines to Set Aside Coscia Spoofing Conviction:
FinCEN Proposes to Include Funding Portals in Definition of Broker or Dealer to Apply Bank Secrecy Act Provisions:
IOSCO Issues Overview of Different International Regulators’ Approaches to Cybersecurity:
Peaking Supply Contracts Involving Electricity and Natural Gas Not Swaps Say CFTC in Proposed Guidance:
Rollout of MiFID II One Step Closer to Formal One-Year Delay:
Sample Public Report (Pensions&Investments):
SEC Approves FINRA Rule Mandating Registration of Algo System Designers:
Subject of IFUS Sanction for Alleged Non-Bona Fide EFPs Also Penalized by CFTC for Same Conduct:
Two Non-US Residents Consent to CFTC Settlement for Alleged Spoofing Activity:
US Court Says FSOC Deviated From Its Own Standards in Designating MetLife as Systemically Important and Wrongfully Failed to Consider Costs:
See also Statement of US Department of Treasury:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 9, 2016. 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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