A shortened workweek in the United States because of President’s Day and in Asia because of the Lunar New Year seems to have induced a very light week of news impacting the financial services industry. However, during the week, CME Group sanctioned a number of firms for miscues in handling EFRPs and block trades, while FINRA brought an action against a broker-dealer for not following up on numerous AML red flags. As a result, the following matters are covered in this week’s Bridging the Week:

• CME Group Reminds Members of Regulatory Requirements for EFRPs and Block Trades Through Disciplinary Actions;

• FINRA Sanctions Broker-Dealer for Failing Adequately to Monitor Red Flags Regarding Suspicious Trading Activity;

• Broker-Dealer Fined by SEC for Acting in Dual, Conflicting Roles in Connection With CDO Liquidations;

• FCA Discusses Good and Bad Practices Asset Managers Follow to Control Risks of Insider Trading; and more.

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Briefly:

• CME Group Reminds Members of Regulatory Requirements for EFRPs and Block Trades Through Disciplinary Actions: The CME Group brought and resolved multiple disciplinary actions against various members and non-members related to their alleged failure to follow requirements of the Commodity Exchange, Inc. and the New York Mercantile Exchange in connection with exchange for related position transactions and block trades. Among the allegedly improper actions sanctioned by CME Group were the failure to maintain required documentation of the related position in connection with EFRP transactions, failure to timely report block trades, failure to report accurately the time of execution of a block trade, and misreporting exchange for swap transactions as block trades. Companies within one group, Marex Spectron, were subject to four separate disciplinary actions with sanctions ranging from US $7,500 to US $25,000. Other firms received fines within the same range and above.

Compliance Weeds: Once again CME Group has highlighted through disciplinary actions the detailed rules that must be followed in connection with EFRP and block trade transactions (similar detailed rules exist on other futures exchanges too). EFRPs have strict requirements related to recordkeeping, reporting and the nature of acceptable instruments that may qualify as the related position in an EFRP, among other requirements. Block trades also have strict requirements related to minimum size, reporting, and using information derived from potential block trades. Violation of these requirements may not only constitute a violation of CME Group’s rules, but also the rules of the CFTC prohibiting noncompetitive transactions. 

• FINRA Sanctions Broker-Dealer for Failing Adequately to Monitor Red Flags Regarding Suspicious Trading Activity: Cobra Trading, Inc., a broker-dealer, agreed to pay a fine of US $150,000 to the Financial Industry Regulatory Authority to resolve a disciplinary action brought against it. FINRA charged that Cobra failed adequately to implement anti-money laundering procedures to detect suspicious activities and failed to have an effective customer identification program for new accounts. FINRA also charged that Cobra moved customer transactions into the firm’s exempt error account so that its customers could avoid additional margin charged by Cobra’s clearing broker on individual securities. Cobra’s alleged wrongful conduct occurred from January 6, 2009, through September 3, 2013. According to FINRA, despite Cobra having written supervisory procedures that required it to follow up on various AML red flags, Cobra failed, during the relevant time, to identify and conduct additional due diligence on (1) one customer that rapidly liquidated low-priced securities at Cobra and transferred the proceeds abroad (when public articles identified the customer as being involved in a securities fraud matter that resulted in charges by the Securities and Exchange Commission in 2009); (2) one customer previously convicted of securities fraud who opened a joint account when the customer’s release conditions only authorized the opening of an individual account; and (3) wire transfers to a financial secrecy or high-risk location with no apparent business reason, among other matters.

• Broker-Dealer Fined by SEC for Acting in Dual, Conflicting Roles in Connection With CDO Liquidations: The Securities and Exchange Commission filed and settled an administrative enforcement action against VCAP Securities, LLC, a registered broker-dealer, and Brett Graham, its chief executive officer, in connection with VCAP’s conduct of five auctions to liquidate certain collateralized debt obligations in 2012. According to the SEC, while conducting these auctions as liquidation agent for various CDO trustees, VCAP and Mr. Graham secretly arranged for a third-party broker-dealer to bid for the auctioned CDOs in order to purchase them for Vertical Capital, LLC, an affiliated investment adviser of VCAP’s (Mr. Graham was also the portfolio manager and chief investment officer for Vertical). The SEC charged that Mr. Graham used confidential information VCAP was in possession of from other bidders to encourage bids placed by the third-party broker-dealer that were slightly higher than the highest bid from any other participant. After the third-party broker-dealer was successful with its bid, it would resell the relevant bond to Vertical at a slight mark-up. Vertical acquired 23 bonds through these arrangements. This practice was contrary to VCAP’s own compliance procedures and various engagement letters signed by Mr. Graham wherein VCAP agreed not to participate in bidding and not to misuse confidential information. In connection with one auction, Mr. Graham also provided one non-affiliated broker-dealer with unique, special treatment, specifically advising it to decrease its bid by one half in order to win the auction, when it had been willing to increase its bid to obtain the relevant bond. The SEC alleged VCAP’s and Mr. Graham’s conduct violated anti-fraud provisions of the relevant federal securities law and SEC rules. To resolve this complaint, VCAP agreed to pay disgorgement and prejudgment interest of almost US $1.15 million and Mr. Graham consented to pay disgorgement and prejudgment interest of US $127,733 and a penalty of US $200,000, as well as other sanctions.

• FCA Discusses Good and Bad Practices Asset Managers Follow to Control Risks of Insider Trading: The UK Financial Conduct Authority published the results of its review of asset management firms and how they control risks associated with the impermissible trading of equities based on confidential inside information, as well as improper disclosure and market manipulation. Although FCA concluded that all firms had established “some practices and procedures to control the risk of market abuse,” the measures were comprehensive in only “a small number of firms.” Accordingly, wrote FCA, “firms need to pay more attention to the possibility of receiving inside information through all aspects of the investment process and take steps to manage this risk.” Firms should also enhance their post-trade surveillance, warned FCA. As part of its publication, FCA provided specific examples of good and bad practices various asset managers have taken to control the risks associated with insider trading.

Compliance Weeds: In connection with its review of asset management firms’ practices related to controlling the risk of unauthorized and prohibited trading on inside information and manipulation, FCA listed six steps firms should take to minimize abuse: (1) minimizing the possibility that inside information might be received but not identified as such; (2) restricting access to inside information and preventing its improper disclosure; (3) utilizing pre-trade controls to help prevent insider trading and potentially manipulative trading; (4) utilizing effective post-trade surveillance; (5) maintaining and enforcing personal account policies that reduce the risk of improper trading (e.g., pre-trade checks against restricted lists and minimum holding periods); and (6) requiring ongoing training of employees. The FCA publication provides many specific examples of how firms have endeavored to implement these steps with a characterization of their efforts as effective or not. Comparison of firms’ own practices against the FCA’s analysis might prove helpful to firms seeking to enhance their own procedures.

And even more briefly:

• ICE to Launch New LBMA Gold Price, Replacing London Gold Fix, on March 20: The Intercontinental Exchange announced that it will launch its new LBMA Gold Price, to replace the historic London Gold Fix, on March 20. The LBMA Gold Price will be based on a physically settled, electronically tradable auction overseen by ICE Benchmark Administration. (Click here for further information in the article, “ICE Benchmark Administration to Administer Gold Price Benchmark” in the November 3 to 7 and 10, 2014 edition of Bridging the Week.)

• FIA Summarizes HFT Issues Under MiFID II and MiFR: The Futures Industry Association published another in a series of special analyses of the impact of the Markets in Financial Instruments Directive (MiFID II) and Regulation—this time highlighting potential issues for algorithmic and high-frequency traders. In general, under MiFID II, persons engaging in proprietary high-frequency algorithmic trading must be authorized and are subject to ongoing oversight and compliance requirements. MiFID II and MiFIR are scheduled to take effect in January 2017.

• NFA Reminds Swap Dealers and MSPs to Update Annually and Keep Current the SD-MSP Questionnaire: The National Futures Association published a reminder to registered swap dealers and major swap participants to complete the SD-MSP Questionnaire as part of their annual membership renewal process, and to amend their answers to this Questionnaire, as necessary, during the course of the year, to keep their information accurate. In connection with filing the Questionnaire, SDs and MSPs must also provide contact information for five employees, including the chief risk officer, with authority to make decisions for the firm in connection with business continuity and disaster recovery events.

• Clearinghouse Recovery and Resolution to Be Addressed by Upcoming CFTC Roundtable: The Commodity Futures Trading Commission has scheduled a public roundtable on clearinghouse recovery and resolution issues for March 5 in Washington, DC. Among matters proposed to be discussed are the pros and cons of variation margin gains haircutting, re-establishing a matched book and when and how to conduct a clearinghouse wind-down. (Click here to see commentary regarding clearinghouse recovery and resolution proposals in two articles, “CFTC Commissioner Raises Ghost of HanMag Securities to Discuss Clearinghouse Risk Management Issues…” and “…While a Clearinghouse—LCH.Clearnet—Weighs in on Clearinghouse Issues Too” in the December 1 to 5 and 8, 2014 edition of Bridging the Week).