June 21, 2021

Volume XI, Number 172


June 18, 2021

Subscribe to Latest Legal News and Analysis

Bridging the Week: Financial Ratios Whistleblowing, Volcker II, Comparable Margin, Layering [VIDEO]

The National Futures Association submitted to the Commodity Futures Trading Commission for its approval a new requirement that commodity pool operators and commodity trading advisors provide to the NFA two financial ratios on a quarterly basis. However, NFA said it does not want to impose minimum ratios, but solely to monitor the two ratios to assess how CPOs and CTAs are doing financially. Separately, three banking agencies, including the Board of Governors of the Federal Reserve System, proposed additional restrictions on non-core banking activities of certain banking organizations, while the Securities and Exchange Commission awarded its second largest whistleblower payment, US $22 million. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:

  • NFA Proposes Requiring CTAs and CPOs to File Certain Financial Ratio Information;

  • Federal Reserve Recommends Repeal of Financial Holding Company’s Authority to Invest in Commodity Firms (includes My View);

  • Another Day, Another Large SEC Whistleblower Award; CFTC Proposes to Update Its Whistleblower Rules (includes Compliance Weeds);

  • CFTC Says Japan’s Uncleared Swaps Margin Rules Comparable to Its Own; Commissioner Bowen Vehemently Objects;

  • CME Group Files and Settles Disciplinary Actions Alleging Layering, Impermissible Transitory EFRPs and a Transfer Trade;

  • DCO, DCM, SEF and SDR System Safeguard Rules Approved by CFTC (includes Compliance Weeds); and more.


  • NFA Proposes Requiring CTAs and CPOs to File Certain Financial Ratio Information: The National Futures Association submitted to the Commodity Futures Trading Commission for its approval a new requirement that would mandate that registered commodity pool operators and commodity trading advisors submit two financial ratios on their quarterly reports to it on Forms PQR and PR, respectively. The required ratios would be current assets/current liabilities and total revenue/total expenses and must be calculated using the accrual method of accounting. The NFA said it seeks to obtain these ratios so that it might better monitor each CPO’s and CTA’s financial condition in order to identify firms that might be having financial troubles. CPOs and CTAs that are part of a holding company/subsidiary structure would have the option to report the ratios at the parent level, according to NFA. In addition, each CPO and CTA would be required to ensure it could demonstrate how it computed its ratios and to retain all financial records supporting its calculations. Importantly, stated NFA, it “is not establishing any minimum ratio that a firm must meet. Rather NFA will incorporate the financial information collected on Forms PQR and PR in to its oversight program and use it to identify trends that indicate that a firm may be facing financial difficulties which could impair its ability to act in the best interests of its customers.” NFA expressly noted that it would not constitute a rule violation solely because a CPO’s or CTA’s financial ratios suggested it might be experiencing financial problems. In January 2014, NFA sought comment regarding a possible new requirement that registered CPOs and CTAs maintain a minimum amount of capital, much like futures commission merchants and non-guaranteed introducing brokers currently are required. In a podcast summarizing the August 2016 NFA Board of Directors meeting, Dan Roth, NFA's chief executive officer, said that proposal proved to be a "spectacularly unpopular idea." (Click here to access this podcast.) Currently, CPOs and CTAs are not subject to any capital requirement.

  • Federal Reserve Recommends Repeal of Financial Holding Company’s Authority to Invest in Commodity Firms: The Board of Governors of the Federal Reserve System recommended a further limiting of the non-core bank activities that financial holding companies may engage in, by proposing that Congress repeal the authority of FHCs to invest in non-financial companies as part of a bona fide merchant or investment banking activity (including the authority to make investments in portfolio companies engaged in physical commodity activities) and the grandfathered authority of two FHCs to engage in physical commodity activities directly. (FHCs include certain bank holding companies and foreign banking organizations that meet heightened regulatory standards imposed by the FRB.) According to the FRB, “commercial activities conducted by portfolio companies held by FHCs under merchant banking authority may cause, or may be affected by, catastrophic and environmental events that, in turn, could pose substantial legal and environmental risks.” Although the FRB acknowledged the significant constraints it currently imposes on FHC’s that engage in merchant banking activity to mitigate the risks imposed by such activities, it said a total ban is necessary to “maintain the basic tenet of separation of banking and commerce." The FRB, along with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, also made recommendations to restrict or to study the potential restriction of other non-core banking activities of FHCs, state-chartered insured banks, national banks, federal savings associations and federal branches and agencies of foreign banks. Among other things, the OCC indicated it is studying the risks to federal banking entities potentially incurred by membership in clearinghouses, “particularly clearinghouse with rules that do not cap members’ liability.” The three banking agencies issued their recommendations in response to a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act that required them to conduct a study of activities engaged in by banking entities, including the risks of such activities, and to propose additional measures to help mitigate any risks to the “safety and soundness” of such entities. The so-called "Volcker Rule" under the Dodd-Frank law (click here to access) already imposes strict restrictions on the authority of federal banking entities to engage in proprietary trading and certain asset management activities.

My View: I don’t pretend to be a banking regulation expert, but in fact, my return to the legal side from the business side in 1995, was prompted by my role in helping Fimat USA Inc. gain FRB approval to acquire the assets of my former employer, Brody White & Company, Inc., a futures commission merchant that brokered, among other things, exchange-traded commodity derivatives (I previously served as president of BWC). It is important to note that, in the first instance, bank holding companies and foreign banking organizations must be adjudged to be well-capitalized and well-managed to qualify as an FHC. Only FHCs may engage in certain non-core banking activities including merchant banking activities. However, to engage in merchant banking activities, FHCs are subject to another host of limitations, including restrictions on the holding period of such investments and restrictions on the routine management and operations of an underlying portfolio company, as well as limitations on cross-marketing and affiliate transactions. To engage in merchant banking activities, the FRB also imposes on FHCs requirements related to policies and procedures and risk monitoring systems, among a number of other specially crafted obligations. Notwithstanding, the FRB now concludes its restrictions on such activities and its monitoring of such activities are not good enough, and the only alternative is to ban such activities entirely. This seems as much a condemnation of the merchant banking activities performed by FHCs as well as of the FRB’s own supervisory oversight. Moreover, a very important element missing in the study issued by the three banking agencies is a cost benefit analysis of the implications of banning the proposed enumerated activities by banking entities. If eliminating more permissible activities by banking entities reduces competition in certain commercial activity (thus, potentially increasing prices to consumers), or if substantially less revenue opportunities might threaten the safety and soundness of banking entities, then perhaps the three banking agencies' recommendations should not have been issued “as is.”

  • Another Day, Another Large SEC Whistleblower Award; CFTC Proposes to Update Its Whistleblower Rules: The Securities and Exchange Commission awarded more than US $22 million to a whistleblower for voluntarily providing original information that “helped the agency halt a well-hidden fraud at the company where the whistleblower worked.” This is the second largest whistleblower award every awarded by the SEC, which now has awarded over US $107 million in whistleblower awards since establishing its whistleblowing program in 2011. Separately, the Commodity Futures Trading Commission proposed to amend its whistleblower program to more closely emulate that of the SEC. Among other things, the CFTC proposed (1) new procedures to review whistleblower claims; (2) to clarify that the CFTC may bring enforcement actions against any employer that violates its anti-retaliation provisions; and (3) to prohibit any agreement or condition of employment, including a confidentiality or pre-dispute arbitration agreement, from containing a provision that might “impede” an individual from communicating a possible violation of law to CFTC staff. Comments to the CFTC’s proposed amendments will be accepted through September 29.

Compliance Weeds: Recently, the SEC has sanctioned two publicly traded companies for including in their standard severance agreements language that the Commission determined potentially impeded employees from disclosing to the SEC a possible securities law violation. (Click here for background regarding) Both the SEC and CFTC have express rules that prohibit the waiver of the right of any person to file a whistleblower complaint with the agencies and receive a monetary award. (Click here to access CFTC Rule 165.19 and here to access SEC Rule 240.21F-17.) Employees also may not be retaliated against for whistleblowing. (Click here, e.g., to access Section 23(h)(1) of the Commodity Exchange Act, 7 USC §26(h)(1) and here for Part A to Part 165 of the CFTC Rules.) The CFTC's proposed rule amendments are aimed at enhancing its current requirements and streamlining  internally the processing of whistleblower claims. SEC and CFTC registrants and SEC-regulated publicly traded companies should review their form employment and severance agreements to ensure they are consistent with regulatory requirements regarding employee and ex-employee whistleblower rights.

  • CFTC Says Japan’s Uncleared Swaps Margin Rules Comparable to Its Own; Commissioner Bowen Vehemently Objects: Over the vehement dissent of Commissioner Sharon Bowen, the Commodity Futures Trading Commission determined that the margin requirements for uncleared swaps applicable to swap dealers and major swap participants under Japanese rules are mostly comparable to those under CFTC rules. As a result, such covered swap entities (CSE) may comply with Japanese law for most margin requirements when transacting with a non-US counterparty where the transaction is subject to both US and Japanese margin rules. The only material difference, said the CFTC, are requirements related to the posting of margin for inter-affiliate transactions. Whereas a CSE entering into an uncleared swaps transaction with a consolidated affiliate under CFTC rules is required to exchange variation margin, and in certain circumstances collect initial margin, this is not the case under Japanese requirements. Accordingly, a CSE transacting an uncleared swap with a non-US person that would otherwise be subject to both US and Japanese margin rules will have to comply with the US margin rules related to inter-affiliate transactions. Similarly, under CFTC rules, all initial margin posted by or collected by a CSE must be held by an independent third-party custodian. Although this is not a requirement under Japanese rules, under Japanese requirements all initial margin must be held in a trust structure. The Commission said the Japanese structure is comparable because “property deposited to such a trust account … is legally recognized as segregated from the property of the trustor, the property of the trust bank, and other trust property in the trust account.” Commissioner Bowen dissented from this and other comparability determinations claiming that “[i]n my experience with bankruptcies, I have learned that access to customer funds largely depends on the location of those funds. Third-party custodianship is an important safeguard.” Commissioner Bowen also objected that, while under US law, variation margin for dealer-to-dealer swaps must be met in cash, less liquid instruments are permitted under Japanese law. “That means,” said Ms. Bowen, “that in a crisis, American companies in Japan could be exchanging instruments that are virtually worthless since they cannot be readily converted to cash, thereby putting them in jeopardy.”

  • CME Group Files and Settles Disciplinary Actions Alleging Layering, Impermissible Transitory EFRPs and a Transfer Trade: The Chicago Board of Trade and the Chicago Mercantile Exchange each brought and settled disciplinary actions against Fredrik Nielsen, a nonmember, claiming that between February 2013 and February 2014 he engaged in a “pattern of activity” where he would layer orders on one side of a market “without the intent to trade.” He did this to allegedly induce market participants to trade opposite smaller orders he had resting on the other side of the market. Once those smaller orders began being executed, Mr. Nielsen purportedly cancelled his remaining layered orders. Mr. Nielsen agreed to resolve these actions by paying a combined penalty of US $65,000 and being suspend from access to all CME Group markets for three weeks. Separately, both OZ Management LP and Yannix Management LP, nonmembers, agreed to resolve disciplinary actions by CME Group exchanges for allegedly engaging in exchange for related position transactions that were prohibited transitory EFRPs. CME Group claimed, in both matters, that the related position transactions “were not independent transactions exposed to market risk.” Both firms settled their unrelated disciplinary action through payment of a US $15,000 fine. Finally, Ronald Sippel, a member, resolved a disciplinary action brought by CME by agreeing to pay a fine of US $55,000 and having his access to CME Group exchanges suspended for 10 business days. Mr. Sippel was charged with executing multiple trades for accounts opposite each other, where he controlled the accounts on both sides. His intent, said the CME Group, was to transfer positions from one account to another.

  • DCO, DCM, SEF and SDR System Safeguard Rules Approved by CFTC: The Commodity Futures Trading Commission adopted final amended rules implementing enhanced cybersecurity testing and other requirements for derivative clearing organizations as well as for designated contract markets, swap execution facilities and swap data repositories. For DCOs, the CFTC indicated that cybersecurity programs must address information security; business continuity and disaster recovery planning and resources; capacity and performance planning; system operations; systems development and quality assurance; and physical security and environmental controls. All DCOs must have physical, technological and personnel resources to ensure a recovery by no later than the next business day following a disruption. The CFTC also mandated that DCOs conduct periodic vulnerability testing, external penetration testing, and internal penetration testing, among other requirements. The CFTC’s amended rules would impose similar testing requirements on DCMs, SEFs and SDRs. Although the new provisions for all market infrastructures are effective upon their publication in the Federal Register, there are different compliance dates for different provisions, stretching out to within one year following the effective date for some rules.

Compliance Weeds: All members of the National Futures Association were required by March 1 to have adopted and begun enforcing formal written policies regarding cybersecurity. These policies must be “reasonably designed by members to diligently supervise the risks of unauthorized access to or attack of their information technology systems, and to respond appropriately should unauthorized access or attack occur.”

And more briefly:

  • Energy Trader Charged by CFTC for Making False Entries in Employer’s Records: The Commodity Futures Trading Commission filed an enforcement action against Fan Wang (aka Alex Wang), in a federal court in New York City, claiming that he made “multiple” manual false entries in his employer’s computerized trading records in order to disguise the status of 587 New York Mercantile Exchange crude oil futures contracts he purchased on November 16, 2011. The CFTC seeks an injunction against Mr. Wang, as well as a fine and restitution, among other sanctions. Previously, Mr. Wang pleaded guilty to making a false report related to substantially the same facts, and was subsequently sentenced to three months imprisonment and ordered to make restitution of $2.2 million to his former employer, Bluefin Energy LLC. (Click here to access the Sealed Complaint filed against Mr. Wang by the US Attorneys Office for the Southern District of NY.)

  • Federal Reserve Bank Seeks US $1.2 Million Fine and Employment Ban Against Former Bank FX Trader for Allegedly Manipulating Benchmarks: Christopher Ashton, the former global head of the FX spot business of Barclays Bank PLC, was named in an administrative proceeding by the Board of Governors of the Federal Reserve System for his alleged role, from January 1, 2010, through November 1, 2013, in allegedly trading to manipulate foreign exchange currency benchmarks. The FRB seeks to bar Mr. Ashton from associating with any US banking institution and to fine him US $1.2 million.

  • CFTC Staff Grants Swap Dealers Temporary Relief From Holding Swaps Initial Margin With an Unaffiliated Custodian: On the same day that margin requirements for uncleared swaps kicked in for so-called “Phase I Firms” (September 1), staff of the Division of Swap Dealer and Intermediary Oversight of the Commodity Futures Trading Commission granted “no-action” relief permitting any initial margin posted to or collected from a counterparty by a swap dealer not to have to be posted with an independent third-party custodian as otherwise required by CFTC rule. This relief extends from September 1 through October 3, 2016, only and is subject to various conditions.

  • HK SFC Designates Four CCPs for OTC Clearing: The Hong Kong Securities and Futures Commission designated four clearinghouses as authorized for market participants to fulfill their mandatory clearing obligations for OTC swaps under HK law. The clearinghouses are the Chicago Mercantile Exchange, Inc.; the Japan Securities Clearing Corporation; LCH.Clearnet Limited; and OTC Clearing Hong Kong Limited. Initially, the mandatory clearing obligation in Hong Kong for OTC swaps will cover certain standardized interest rate swaps denominated in HK dollars or US Dollars, Euros, Great Britain Pounds or Japanese Yen.

  • FinCEN Updates Jurisdictions With Strategic Deficiencies; Also Issues Advisory on Email Fraud Schemes: The Financial Crimes Enforcement Network of the United States Department of Treasury updated its publication of jurisdictions that have deficiencies in anti-money laundering/combatting the financing of terrorism according to the Financial Action Task Force. Myanmar and Papua New Guinea have both been removed from FATF’s list of problematic jurisdictions. Separately, FinCen issued an advisory to financial institutions on email compromise fraud schemes, providing specific examples how compromised email accounts may be used to mislead financial institutions and their customers to send unauthorized wire transfers.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 256



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...