May 26, 2022

Volume XII, Number 146


May 26, 2022

Subscribe to Latest Legal News and Analysis

May 25, 2022

Subscribe to Latest Legal News and Analysis

May 24, 2022

Subscribe to Latest Legal News and Analysis

Better Culture; Accountants; London Whale; Asset-Backed Securities; Collusive Activity; Cybersecurity - Bridging the Week: October 20-27, 2014 [VIDEO]

Promoting stronger cultures at financial industry firms was the theme of a workshop held at the Federal Reserve Bank of New York this past week. Also last week, the Inspector General of the Federal Reserve System acknowledged the FRB NY’s own supervisory weaknesses that caused it not to review trading activity early on in the Chief Investment Office at JPMorgan Chase that ultimately led to losses of over US $6 billion by the end of 2012—the so-called London Whale incident.

As a result, the following matters are covered in this week’s Bridging the Week:

  • Senior Fed Officials Encourage Financial Industry Firms to Improve Compliance Culture (includes Culture and Ethics);

  • CFTC Proposes More Specific Standards to Bar Accountants From Practicing Before It; 

  • Federal Reserve Inspector General Finds Deficiencies in Regulatory Oversight of London Whale Risks;

  • Six Federal Agencies Adopt Final Rules Regarding Skin in the Game for Sponsors of Certain Asset-Backed Securities;

  • European Commission Settles With Multiple Banks for Collusive Activity;

  • CFTC Staff Says It’s Ok for FCMs to Credit Margin Payments of Certain Clients When Sent, Rather Than When Received; Also Provides Guidance on Certain Residual Interest Matters (includes Compliance Weeds);

  • Buy- and Sell-Side Industry Organizations Propose Form of Template for Broker-Dealer Minimum Disclosure of Order Routing and Execution Quality Information;

  • CEO of Member Firm Charged by FINRA With Failing to Update Personal Registration Information to Disclose Tax Liens (includes Compliance Weeds);

  • Merrill Lynch Sanctioned by FINRA for Not Monitoring Non-US Dollar-Denominated Customer Securities Transactions for Wash Sales;

  • SEC Issues Investor Bulletin Regarding Enforcement Investigations (includes My View);

  • SIFMA Proposes Cybersecurity Regulatory Guidance; and more.

Video Version:

Senior Fed Officials Encourage Financial Industry Firms to Improve Compliance Culture

Enhancing culture was the theme at a workshop on “Reforming Culture and Behavior in the Financial Services Industry” held at the Federal Reserve Bank in New York City last week.

In two presentations, William Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York and Daniel Tarullo, Governor of the Board of Governors of the Federal Reserve System, urged financial institutions to modify compensation arrangements to help promote more desirable employee conduct.

Mr. Dudley specifically argued that more compensation should be deferred and for longer periods, and suggested that re-structuring long-term deferred compensation as debt might better align senior managers’ focus with their firms’ “long-term enterprise value.”

Likewise, Mr. Tarullo claimed that “[t]here is still considerable work to be done in developing and implementing incentive compensation arrangements that truly give appropriate incentives to employees.” However, he also argued that, sometimes, poorly conceived or implemented regulations can contribute to a “mere compliance mentality” as opposed to a more meaningful culture.

In his remarks, Mr. Dudley opined that “[c]ulture relates to the implicit norms that guide behavior in the absence of regulations or compliance rules—and sometimes despite those explicit restraints.” He pointed to a number of factors that, in his view, contributed to “cultural failures” that resulted in a number of recent widely reported large sanctions against financial services institutions: the “sheer size, complexity and global scope” of some firms that may have left them “too big to manage;” the trend away from client-focused commercial and investment activities to trading; and large pay packages tied to short-term profits coupled with a “flexible and fluid job market” that has caused employees to have less firm loyalty.

Mr. Dudley argued that a respect for law must be a “core element” of firms’ mission and culture. This, he said, requires a culture of self-policing and self reporting:

If audit uncovers an instance of fraud in one unit, the firm’s leadership should ask, “Where else could this behavior occur?” If the press reports fraud at a competitor in a particular business line, the same self-assessment should apply. “Could this happen to us, could we have a similar problem here?” When fraud is detected, boards and senior leaders must ensure that they are informed promptly, and that a thorough inquiry is undertaken at once. The senior leaders of financial firms, and those who report to them, must also be proactive in reporting illegal or unethical activity. Early self-reporting sends a powerful message to employees and to regulators about a firm’s respect for law.

To better align the broader interests of a firm with employees’ interests, Mr. Dudley argued that at least some employees should have a component of their compensation deferred with vesting occurring over an additional time frame (he gave as an example a five-year deferral period with vesting then occurring over an additional five years).

Mr. Dudley suggested that, for senior managers, the vesting portion of compensation should be paid as debt and used as a “performance bond.” Whereas now, he said, shareholders typically pay for any large sanctions imposed by regulators, going forward, the aggregate total of senior managers’ performance bonds should be first used to pay such fines. According to Mr. Dudley,

[t]his would increase the financial incentive of those individuals who are best placed to identify bad activities at an early stage, or prevent them from occurring in the first place.

Without being as specific, Mr. Tarullo also argued that firms need to amend their incentive arrangements to dissuade them from adopting a culture solely of “mere compliance,” as opposed to “internalize[ing] the aims of the risk-management processes and systems that we expect of them,” which he termed “good compliance.”

Mr. Tarullo noted, however, that sometimes regulators unintentionally “can reinforce … a mere compliance mentality.” He said that this can happen when regulators impose requirements that are generally opposed, even if those inside a firm generally support the requirements’ objectives:

[I]n cases where those inside a firm would stipulate the stated objective of the regulation and still find a regulation badly conceived or implemented, there will be less possibility of internalization or integration into a broader set of firm norms and expectations. This is an outcome that regulators can avoid, and something with which the regulated firms themselves can assist by pointing out what they would regard as more sensible methods for achieving stated regulatory purposes.

Both Mr. Dudley and Mr. Tarullo also argued for more public disclosure when employees are dismissed for misconduct, with Mr. Dudley specifically calling for the creation of a central financial services industry-wide registry that would include information on the hiring and firing of all traders and other financial professionals (modeled after the BrokerCheck system of the Financial Industry Regulatory Authority for securities professionals).

Culture and Ethics: Maintaining a strong compliance culture is essential for each firm in the financial services industry, and balancing incentives to promote culture, no doubt, plays an important part. This means not only interjecting an element of deferral into compensation, but ensuring that compensation appropriately rewards those that control risks as well as those who take risks. However, as Mr. Dudley astutely points out, regulators must be careful not to overwhelm companies with requirements that are too numerous and of questionable utility. Otherwise firms will be too busy fixing these matters of questionable worth and not addressing core values—the difference between “mere compliance” and “good compliance.” In the end, however, it’s all about ensuring that every employee applies the grandmother test to every action he or she takes: do not engage in conduct that you would not be proud to defend to your grandmother when she inquires after reading about it in the morning tabloid (especially if that tabloid is the New York Post)!

CFTC Proposes More Specific Standards to Bar Accountants From Practicing Before It

The Commodity Futures Trading Commission proposes to amend one of its rules (Rule 14.8) to provide more guidance regarding the circumstances when accountants may be barred from practicing before the Commission.

The relevant rule currently has imprecise standards regarding unprofessional conduct that could lead to either attorneys or accountants being prohibited from practicing before the Commission: mainly that such persons: (1) lack requisite qualifications to represent others; (2) lack character or integrity; or (3) have engaged in unethical or improper professional conduct in connection with certain enumerated formal Commission interactions “or otherwise.”

Going forward, unethical and improper professional conduct for accountants is proposed to be defined as: (1) “[i]ntentional or knowing conduct, including reckless conduct, that results in a violation of applicable professional principles or standards;” (2) “[a] single instance of highly unreasonable conduct that results in a violation of applicable professional principles or standards” where the “accountant knows or should know heightened scrutiny is warranted;” or (3) “[r]epeated instances of unreasonable conduct, each resulting in a violation of applicable professional principles or standards, which indicates a lack of competence to practice before the Commission.”

The proposed amendment materially tracks an equivalent rule of the Securities and Exchange Commission (Rule 102(e)). (Click here for further details regarding this rule proposal in the article “CFTC Proposes New Rule Amendments Setting Standards to Bar Accountants” in the October 23 edition of Building Bridges.)

This proposal follows the CFTC filing and settling an enforcement action in August 2013 against Jeannie Veraja-Snelling, the external certified public accountant responsible for auditing Peregrine Financial Group’s year-end financial statements from 2001 through 2011. Peregrine, previously registered with the CFTC as a futures commission merchant, filed for bankruptcy in July 2012 after Russell Wasendorf, its owner and chief executive officer admitted to fraud in stealing customer funds.

As part of these audits, Ms. Veraja-Snelling each year issued (1) unqualified opinions stating that Peregrine’s financial statements were free from material misstatement, and (2) reports on Peregrine’s internal accounting controls concluding that the firm had no material inadequacies, as well as adequate practices and procedures for safeguarding customer funds.

According to the CFTC, Peregrine’s 2011 certified financial statement indicated that the firm was holding in excess of US$ 548 million in customer segregated and secured assets. However, that amount was exaggerated by more than US$ 200 million because of Mr. Wasendorf’s theft of customer funds for personal purposes for at least two decades.

(Click here for details on this CFTC litigation in the article “CFTC Sues Peregrine Financial Group External CPA: Says Her Audits Were Not Up To Professional Standards and She Missed Signs of Problems” in the August 26, 2013 edition of what is now known as Between Bridges.)

The CFTC’s litigation against Ms. Veraja-Snelling did not mark the first time the CFTC has filed an action against an accounting firm for failure to identify material inadequacies of a registrant to the Commission as a result of an audit.

In September 1986, the CFTC filed and settled an enforcement action involving Arthur Andersen & Co. related to its failure to report to the Commission certain material inadequacies in the internal controls of ContiCommodity Services, Inc., at the time one of the largest FCMs (click here for details regarding this action).

And briefly:

  • Federal Reserve Inspector General Finds Deficiencies in Regulatory Oversight of London Whale Risks: The Office of Inspector General of the Federal Reserve System identified various supervisory breakdowns at the Federal Reserve Bank of New York that caused the FRB NY not to investigate trading activities by JPMorgan Chase & Company that ultimately caused the firm to sustain over US $6 billion in losses by the end of 2012. This trading occurred in the Chief Investment Office of JPMC’s London branch—the so-called “London Whale” incident. During the relevant time, the Board of Governors of the Federal Reserve System was the lead banking regulator for JPMC. According to the Inspector General, the FRB NY had identified risks associated with the CIO’s trading activities as part of its ongoing monitoring of JPMC, and planned two limited reviews of the CIO’s activities in 2008 and 2010, as well as recommended a full-scope examination in 2009. However, said the Inspector General, the FRB NY never conducted these reviews because of “many supervisory demands and a lack of supervisory resources;” weaknesses in controls involving the supervisory planning process; and a 2011 reorganization of a supervisory team at JPMC that had “institutional knowledge” regarding the CIO on whom the FRB NY’s JPMC supervisory was unduly dependent. The FRB NY also never consulted or coordinated with another banking regulator, the Office of the Comptroller of the Currency, who had oversight over one of JPMC’s subsidiaries, regarding its JPMC CIO observations. The Inspector General noted that it could not say whether completing any of the missed examinations “would have resulted in an examination team detecting the specific control weaknesses that contributed to the CIO losses.” The Inspector General made 10 recommendations to enhance the Federal Reserve’s overall supervisory process. (Click here for more information on the London Whale incident in the article “US CFTC Files and Settles Charges against JP Morgan Chase Bank Employing Its New Anti-Manipulation Authority Related to Certain of the Bank's London Whale Trading” in the October 14 to 18 and 21, 2013 edition of Bridging the Week.)

  • Six Federal Agencies Adopt Final Rules Regarding Skin in the Game for Sponsors of Certain Asset-Backed Securities: Six federal agencies adopted final rules imposing risk retention requirements on originators of certain asset-backed securities, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. As its core provision, sponsors of such securities will be required to retain at least a 5% percent economic interest in the credit risk of the assets underlying such issues. Moreover, the sponsors are not permitted to offset such risk by dividing the credit risk among other parties. There is an exemption from the retention requirement for asset-backed securities securitized by certain enumerated residential mortgages (known as qualified residential mortgages). The definition of a qualified residential mortgage will rely on the definition of the term currently and in the future used by the Consumer Financial Protection Bureau under another federal law (the Truth in Lending Act). Because of concern by the six agencies to rely on the sole actions of one agency, the rules require a periodic review of the Consumer Bureau’s definition—after four years initially and then every five years thereafter. The agencies issuing the final rules are the Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency and the Securities and Exchange Commission. The rules are effective one year after publication in the Federal Register for residential-mortgage-backed securities and two years for all other types. Two months ago, the SEC separately adopted new disclosure, reporting, and offering process requirements for asset-backed securities (click here for details).

  • European Commission Settles With Multiple Banks For Collusive Activity: JP Morgan was fined in two separate matters brought by the European Commission related to alleged violations of EU antitrust rules. In one matter, the firm was fined €61.6 million for its role in a claimed bilateral cartel with the Royal Bank of Scotland whose purpose was supposedly to influence the Swiss franc London interbank offered benchmark rate between March 2008 and 2009. RBS paid no fine in connection with this matter for disclosing the existence of the cartel to the European Commission. In the second action, JP Morgan was fined €10.53 million, UBS €12.65 million and Credit Suisse €9.17 million for their alleged role in operating a cartel whereby they quoted among themselves narrower bid ask spreads of Swiss franc interest rate derivatives between May and September 2007, while at the same time quoting wider spreads to others. RBS also was alleged to have participated in this cartel, but again paid no fine because it disclosed the existence of the cartel to the European Commission. All the banks voluntarily settled their actions.

  • CFTC Staff Says It’s Ok for FCMs to Credit Margin Payments of Certain Clients When Sent, Rather Than When Received; Also Provides Guidance on Certain Residual Interest Matters: Commodity Futures Trading Commission staff issued guidance authorizing a futures commission merchant to credit a customer’s account for a margin payment as soon as it initiates a withdrawal from the customer’s bank account using the Automated Clearing House transaction system. The customer must previously have authorized in writing the proposed transaction. This is an important development for FCMs to avoid having to take a capital charge for certain unmet customer margin calls, among other reasons. Apparently, according to the Commission’s staff, many non-institutional customers, including farmers and ranchers, use the ACH system to make margin payments. Staff also provided guidance regarding the relevant date by when an FCM must infuse its own funds (residual interest) into each category of customer account origin to cover the total value of its under margined customer amounts because of a banking holiday in the US or abroad (new CFTC requirements regarding residual interest are effective November 14; see Compliance Weeds below). The three types of customer accounts are segregated 1.22 accounts in connection with domestically traded futures and related options; secured 30.7 accounts in connection with foreign-traded futures and related options; and 22.2 cleared swaps accounts. (Click here for more detailed information about this interpretive guidance in the article “CFTC Issues Interpretation Regarding Accounting for Customer Margin Payments Using Automated Clearing House Payment Processing,” in the October 24 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)


Compliance Weeds: As of November 14, new CFTC rules will require FCMs by 6 pm each business day to maintain in each of their customer segregated 1.22 and secured 30.7 accounts sufficient residual interest to cover the aggregate of all customer undermargined amounts for the prior trade date. An equivalent requirement already exists for  customer segregated 22.2 cleared swaps accounts. (Click here for details regarding these new rules in the article "CFTC Adopts More Stringent Customer Funds' Protection Rules" in the October 30, 2013 edition of what is now Between Bridges.) Now is a good time for FCMs to double check their policies and procedures to ensure they are fully compliant with the CFTC's new requirements and that staff is fully trained.


  • Buy- and Sell-Side Industry Organizations Propose Form of Template for Broker-Dealer Minimum Disclosure of Order Routing and Execution Quality Information: Buy- and sell-side industry organizations have developed and provided to the Securities and Exchange Commission for its consideration a proposed standardized order routing disclosure template that they claim, if used, would augment order routing and execution quality information that institutional investors would obtain from their broker-dealers. The organizations are the Investment Company Institute, the Managed Futures Association and the Securities Industry and Financial Markets Association. Among other things, the template provides for the disclosure by each broker-dealer of specific statistical data related to the number of shares executed at each trading venue it used that provided liquidity (i.e., not immediately executed) as opposed to the total number of shares that were executed and the number of shares that removed liquidity at each venue (i.e., immediately executed), also as opposed to the total number of shares executed. Information related to rebates paid to broker-dealers for adding and taking liquidity in connection with each venue would also be provided in the proposed template.

  • CEO of Member Firm Charged by FINRA With Failing to Update Personal Registration Information to Disclose Tax Liens: The Financial Industry Regulatory Authority filed a disciplinary action against Robert Eide for failing to update his personal registration records to reflect numerous tax liens totaling over US $1.1 million lodged against him at various times between August 2002 and May 2011. FINRA claims that, during this time, Mr. Eide filed nine updates to his registration records, but always answered “no” to the question “[d]o you have any unsatisfied judgments or liens against you?” FINRA alleged that Mr. Eide founded Aegis Capital Corp., a FINRA-member firm, in 1981 and since then has served as its president, chairman, chief executive officer and chief legal officer. Mr. Eide is specifically charged with failing to update his personal registration information within 30 days after learning of facts that require an amendment.



Compliance Weeds: Firms should have explicit policies requiring employees to notify them immediately of information requiring updates to their personal information on their registration data on file with FINRA and/or the National Futures Association. Employees should be obligated regularly to review their personal registration information and notify their employer of any errors. It should be made clear that it is the employee’s duty to update registration information, even if the employer physically processes such information on the employee’s behalf.


  • Merrill Lynch Sanctioned by FINRA for Not Monitoring Non-US Dollar-Denominated Customer Securities Transactions for Wash Sales: Merrill Lynch, Pierce, Fenner & Smith Incorporated agreed to pay a fine of US $250,000 to the Financial Industry Regulatory Authority related to charges that it failed adequately to monitor for wash trades in certain client accounts from August 2009 through March 2011. According to FINRA, during the relevant time, the firm’s systems did not detect and review trades in securities in 83 customer accounts that did not have a US dollar value in the currency indicator field. The Letter of Acceptance, Waiver and Consent published by FINRA in connection with this matter did not specify the number of wash transactions that occurred that were not detected by the firm.

  • SEC Issues Investor Bulletin Regarding Enforcement Investigations: The Securities and Exchange Commission published an Investor Bulletin providing a general overview of its Division of Enforcement’s investigation process. According to the SEC, “Enforcement decides whether to initiate an investigation based on many factors, including the magnitude and nature of the possible violations, the number of victims affected by the misconduct, the amount of potential or actual harm to investors from the misconduct, and whether misstated or omitted facts would have impacted investors’ investment decisions.” The SEC also describes in the bulletin the process by which it may determine to bring a legal proceeding against a respondent.


My View: I looked up and down in the SEC’s Investor Bulletin to find any statement that subjects of an SEC investigation are not accused of any wrongdoing until a formal legal action is commenced and, even then, may only be found to have violated a provision of law or SEC rule after a formal adjudicatory process or voluntary settlement. Since the SEC found it useful at this time to publish this bulletin, it would have been helpful to disclose these other important caveats too!

  • SIFMA Proposes Cybersecurity Regulatory Guidance: The Securities Industry and Financial Markets Association proposed 10 principles to help encourage a partnership between financial regulators and the financial services industry to better protect the financial sector’s data security and infrastructure from cyber-based attacks. As part of its rollout of these principles, SIFMA argued that coordination between regulators and industry is critical to ensure the “harmonization of regulatory guidance.” According to SIFMA, “[t]he proliferation of different government and private sector security standards creates confusion and fosters an environment in which noncompliance is at risk.” Among the principles is (1) an acknowledgment that the US government has a key role and responsibility in protecting the business community; (2) a recommendation that all US regulators, including self-regulatory organizations, should take a “consistent and coordinated” approach to cybersecurity to avoid overlapping activities; and (3) a recommendation that regulatory guidance should reflect the different nature of risks, and the different sizes and resources of firms. SIFMA also points out that no matter how good cybersecurity programs may be, they may be compromised. As a result it is important that regulators and firms work together to prepare for a response to a cyber-attack. Finally, SIFMA urges regulators to increase their involvement with systemically important third parties relied on by the financial services industry that may be unregulated but may not have robust cybersecurity protections.

And even more briefly:

  • HKFE and LME Offer Reciprocal Membership Arrangement: The Hong Kong Futures Exchange and the London Metal Exchange announced a reciprocal membership arrangement. Subject to approval of this plan by the HK Securities and Futures Commission, a member at one exchange would not have to pay application charges or their first year’s annual subscription fees to become a member of the other exchange. This arrangement is being adopted to encourage participation by existing LME members in new Asia commodities being offered by HKFE beginning December 1.

  • SIFMA Asks for Further Delay in Trade Execution Requirement for Package Transactions: The Asset Management Group of the Securities Industry and Financial Markets Association has requested the Commodity Futures Trading Commission to extend the expiration date for the last phase of previously granted relief from the requirement to mandatorily execute certain package transactions on swap execution facilities or designated contract markets. This relief initially was granted on May 1 and is scheduled to expire on November 15. Package transactions are transactions between two counterparties quoted with one price that have at least one leg involving a swap trade subject to mandatory execution under CFTC rules.

©2022 Katten Muchin Rosenman LLPNational Law Review, Volume IV, Number 301

About this Author

Gary DeWaal, Securities Attorney, Katten Law Firm, New York
Special Counsel

Gary DeWaal focuses his practice on financial services regulatory matters. He counsels clients on the application of evolving regulatory requirements to existing businesses and structuring more effective compliance programs, as well as assists in defending and resolving regulatory disciplinary actions and enforcement matters. Gary also advises buy-side and sell-side clients, as well as trading facilities and clearing houses, on the developing laws and regulations related to cryptocurrencies and digital tokens.

Previously, Gary was a senior...