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Bridging the Week by Gary DeWaal: August 12 - 16, and August 19, 2019 (Manipulation Settlement; CFTC Gag Agreement; Digital Securities Offering)

Two food giants agreed to resolve charges brought by the Commodity Futures Trading Commission that they manipulated or attempted to manipulate prices of the Chicago Board of Trade’s December 2011 wheat futures contract and spot wheat by consenting to pay a US $16 million fine and agreeing never to violate certain provisions of law in the future. Very unusually, the CFTC did not include any findings of fact or conclusions of law in the consent order, and separately agreed not to discuss this case publicly. However, concurrently with publicizing the consent order, the CFTC published a press release and certain statements that the food giants promptly challenged as violating the terms of the order. Separately, the Securities and Exchange Commission resolved an enforcement action against a healthcare industry blockchain company over a purported unregistered digital securities offering. As a result, the following matters are covered in this week’s edition of Bridging the Week

  • Mum’s the Word – Maybe: CFTC Officially Agrees to Keep Quiet About Settlement of Manipulation Complaint That Nets US $16 Million Penalty; Unofficially?

  • Unregistered ICO by Blockchain Company for Healthcare Providers Results in No Fine Despite SEC Enforcement Proceeding ; and more. 

Briefly:

  • Mum’s the Word – Maybe: CFTC Officially Agrees to Keep Quiet About Settlement of Manipulation Complaint That Nets US $16 Million Penalty; Unofficially?: Kraft Foods Group, Inc. and Mondelez Global LLC agreed to settle the 2015 complaint by the Commodity Futures Trading Commission charging the firms with manipulating or attempting to manipulate the price of the December 2011 wheat futures contract traded on the Chicago Board of Trade and cash wheat by payment of a US $16 million fine. The CFTC also charged the firms with using or attempting to use a manipulative or deceptive device or contrivance in connection with the same futures contract; exceeding applicable speculative position limits in connection with their holding of December 2011 wheat futures; and engaging in wash sales in connection with trading both sides of exchange for physical transactions at various times from 2009 through 2014.

In agreeing to the settlement, the CFTC and the defendants acquiesced not to make any public statements about this case other than referencing the settlement agreement between the parties and public documents filed in the enforcement action. This agreement was formally codified in a consent order. However, the consent order, unlike other typical CFTC consent orders, also did not contain any factual findings or conclusions of law.

Concurrently with its announcement of the settlement, the CFTC issued a press release summarizing its complaint against the defendants including a statement that “[t]he $16 million penalty is approximately three times defendants’ alleged gain" and a comment by new Chairman Heath Tarbert regarding the harm of market manipulation to farmers (click here to access). The CFTC also released a “Statement of the Commission” (click here to access) and a joint statement by Commissioners Dan Berkovitz and Rostin Behnam (click here to access).

Subsequently, the defendants requested an “emergency status” hearing before the judge presiding over the matter – the Hon. John Robert Blakey of the US District Court for the Northern District of Illinois – alleging that the CFTC violated the terms of the consent order and should be held in contempt and/or subject to sanctions. The judge scheduled a hearing on these allegations for this morning (August 19). 

According to the 2015 complaint filed by the CFTC in a federal court in Illinois, by November 29, 2011, the defendants purchased 3,150 long CBOT December 2011 wheat futures contracts, which was equivalent to 15.75 million bushels or approximately US $93.5 million worth of wheat (November 29 was the first day of the delivery period for the December 2011 wheat futures contract). The companies did this, said the CFTC, with the intent to depress the price of wheat in the cash market.

Although the companies used wheat for their commercial purposes, acknowledged the CFTC complaint, they could not have used the quantity of wheat they potentially controlled at the time of the companies’ long futures purchase without incurring exorbitant costs, said the Commission. This is because they allegedly did not have sufficient storage facilities of their own.

Ultimately, the defendants’ actions caused the price of cash wheat to decline and the December wheat futures contract to increase, alleged the CFTC. According to the Commission, as a result of their activities, the companies realized US $5.4 million in profits. (Click here for additional background on all the CFTC’s allegations in the article “Manipulation Is Not Hedging Says CFTC in Federal Court Lawsuit Against Kraft Foods Group and Mondelez Global” in the April 5, 2015 edition of Bridging the Week.) In addition to agreeing to a monetary settlement, the defendants consented to entry of an injunction prohibiting them from future violations of the relevant provisions of law charged in the complaint. According to its terms, the consent agreement does not constitute “an agreement or a legal determination that [d]efendants have or have not violated any provision [of applicable law.”

In June 2015 defendants moved the federal court hearing this matter to dismiss the manipulation and use of a manipulative device or contrivances charges in the CFTC’s complaint. The federal court denied defendants’ motion in December 2015. (Click here for details in the article “Global Food Merchants’ Motion to Dismiss CFTC’s Enforcement Action for Alleged Manipulation Denied” in the December 20, 2015 edition of Bridging the Week.)

The terms of the settlement were initially agreed by the parties in March 2019; however, the parties have apparently been working on the precise language since that time with multiple delays in reaching a final accord. (Click here for background in the article “Where’s the CFTC v. Agricultural Food Giants’ Purported Manipulation Settlement?” in the June 9, 2019 edition of Bridging the Week.”)

During the period covered by the CFTC’s complaint, Kraft Foods Inc. was the parent of Kraft Food Group, Inc. and its affiliate Mondelez Global LLC, the defendants in the CFTC’s enforcement action. In October 2012, the companies engaged in a corporate restructuring that resulted in Kraft Foods Group being one corporation owned by public shareholders and Kraft Foods Inc., its former parent, being a separate publicly traded company and renamed Mondelez International Inc. which owns Mondelez Global. Under the consent order, the US $16 million fine is to be paid by Mondelez Global, but both defendants are jointly and severally liable for the payment.

Legal Weeds: One of the charges included in the CFTC’s original complaint was that the defendants’ purported manipulation or attempted manipulation of the December 2011 wheat futures contract also constituted the defendants’ intentional or reckless use, or attempted use of “a manipulative device or artifice to defraud” in violation of the CFTC’s fraud-based anti-manipulation authority granted it under the Dodd-Frank Wall Street Reform and Consumer Protection Act. (Click here to access Commodity Exchange Act § 6(c)(1), 7 U.S.C. § 9(1) and here to access CFTC Rule 180.1.)

The CFTC charged that the defendants violated this provision because they “intended to affect or acted recklessly with regards to affecting the prices of the December 2011 wheat futures contract and engaged in overt acts in furtherance of [their] intent.” However, this allegation was conclusory and did not note who specifically was defrauded by defendants’ purported conduct (other than the “market” generally) and how. 

Defendants raised this point in their motion to dismiss. According to the court:

Defendants argue that the CFTC must allege “something suggesting that the market allegedly received a message from Kraft, in some particularly identified form, that was different from Kraft’s alleged true intent,” and that the “mere fact that Kraft established a large long position in December 2011 wheat futures cannot, in and of itself, be the method by which Kraft allegedly misled the market.”

In response, the CFTC claimed that the defendants acquired an extraordinarily large futures position in order to “create the false appearance of demand for wheat from the December 2011 futures contract”:

Thus, [the defendants] through its activities in the market, conveyed a false sense of demand, and the resulting prices in the market (both of cash wheat and of wheat futures) were based not solely on the actual supply and demand in the market, but rather were influenced by [the defendants’] false signals of demand. 

Defendants argued that their very large long position “could have signaled many things” and therefore their trading could not be seen as necessarily deceptive or manipulative. However, the court concluded that, for purposes of considering a motion to dismiss, it is “confined at this stage to the Complaint itself.” As a result, the complaint adequately alleged that defendants’ conduct was meant to fraudulently “signal” the market and declined to grant defendants’ motion to dismiss.

Because of this settlement, it will be another day before the Commission’s view of what it must demonstrate to prove fraud under this still relatively new law provision will be impartially evaluated.

My View: The decision of the CFTC to acquiesce to a gag order applied to both defendants as well as itself and its agreement not to include express findings of fact and conclusions of law in the consent order is highly unusual. Although the amount of the fine and the injunction against future violations incurred by the defendants is onerous and sends a loud warning to the industry, the Commission’s agreement not to provide insight into its thinking either in the consent order or through official, public comments is counterproductive and undercuts any intended message.

The Commission explained its agreement by saying that the limitation on the Commission making certain public statements applied only to the CFTC itself and not individual commissioners “speaking in their personal capacities.” However, this view seems a stretch and clouds the significance of any potential comments. 

Moreover, while it is not uncommon for CFTC staff when speaking at public forums to make clear they are speaking in their individual capacities, none of the CFTC press release, “Statement of the Commission,” or joint statement by Commissioners Berkovitz and Behnam noted that these statements were in any commissioner’s personal capacity. Absent such a disclaimer, it would appear that when the CFTC publishes statements it does so on behalf of the Commission. Indeed, companies, as well as government agencies, only speak through their leaders and staff, absent some carve-out. Thus, depending on the outcome of today’s hearing, it is not clear that even individual CFTC commissioners or officers may provide insight into the Commission’s thinking going forward. 

Very, very strange.

  • Unregistered ICO by Blockchain Company for Healthcare Providers Results in No Fine Despite SEC Enforcement Proceeding: SimplyVital Health Inc. was assessed no fine by the Securities and Exchange Commission to settle an enforcement action alleging that it engaged in an unlawful securities offering without registering the securities when it offered and sold digital tokens to raise funds for a new venture in 2017 and 2018. The firm consented to a cease-and-desist order and agreed never to violate any US securities registration requirement again.

According to the SEC, during the relevant time, SimplyVital sought to develop a blockchain-based system – Health Nexus – through which healthcare providers could share patient data. To accomplish this, it organized a sale of a proposed new digital token know as Health Cash or HLTH – which ultimately would be used as the currency on Health Nexus. Although SimplyVital planned for a pre-sale of HLTH solely to so-called “accredited investors” relying on an exemption from registration (click here to access information regarding Regulation D), the company did not take “reasonable steps” to verify that purchasers were appropriately qualified, claimed the SEC. Moreover, the SEC said that SimplyVital expressly solicited investors through general solicitations “including through internet postings and direct communications with US persons”.

However, after being contacted by SEC staff, SimplyVital determined not to generate any HLTH tokens and returned “substantially” all funds claimed by investors as a result of their initial investment. The SEC said this represented “substantially” all of SimplyVital’s assets.

In other legal and regulatory developments involving cryptoassets:

  • Major Cryptocurrency Exchange Cited for Misleading Ads by UK Overseer of Advertising Standards: The Advertising Standards Association – the UK’s independent regulator of advertising – upheld complaints against HDR Global Trading Ltd. (BitMEX) for allegedly running a newspaper advertisement that it concluded was misleading. The regulator said that the advertisement overstated the profit potential of bitcoin without referencing the risks of investing in the digital asset. ASA stated that the advertisement – which appeared on January 3, 2019 – could not run again in its same form and that, going forward, financial information included in advertisements by BitMEX must be understandable and adequately address risks. No fine was assessed. BitMEX claimed that the advertisement was not a promotion for investing in bitcoin, but instead was published as a commemoration of the 10th anniversary of the mining of the first bitcoin block.

  • NYDFS Designates Bakkt as Limited Liability Trust Company; ICE Futures U.S. Schedules Physically Deliverable Bitcoin Futures Launch to Begin September 23: Bakkt Trust Company LLC was granted a charter to operate as a New York State limited liability trust company. In connection with this authority, Bakkt will be authorized to provide custody services for bitcoin in connection with the launch of potentially physically settled bitcoin futures contracts listed on ICE Futures U.S. and cleared through ICE Clear U.S., both Bakkt affiliates. According to NYDFS, Bakkt will service institutional customers. Separately, IFUS announced it will launch trading in its Bakkt Bitcoin Monthly and Daily futures contracts beginning September 23, 2019.

Previously, the Commodity Futures Trading Commission approved LedgerX as a designated contract market, enabling it to offer physically settled bitcoin swaps to retail persons. (Click here for details in the article “LedgerX Authorized to Offer Physically Settled Bitcoin Swaps to Retail Persons by CFTC Order” in the June 30, 2019 edition of Bridging the Week.) Additionally, Eris Clearing LLC was recently approved by the CFTC as the first derivatives clearing organization authorized to clear fully collateralized virtual currency futures contracts; it intends to offer the clearing of bitcoin futures contracts traded on its affiliate Eris Exchange LLC (together, branded as ErisX) beginning later in 2019. (Click here for further background in the article “CFTC Approves New Clearing House as First Derivatives Clearing Organization for Fully Collateralized, Deliverable Virtual Currency Futures” in the July 7, 2019 version of Bridging the Week.)

Legal Weeds: To date, the SEC has treated gingerly firms that engaged in what it considered unregistered digital securities offerings, provided no fraud was involved, and the entities returned raised funds to investors among other remedial measures.

In addition to its settlement with SimplyVital Health, earlier this year, the SEC settled charges again Gladius NetworkLLC alleging that the firm’s initial coin offering of GLA tokens intended to be used as the currency for a blockchain-enabled cybersecurity service constituted an offering of unregistered securities in violation of applicable law. Although Gladius’s Terms and Conditions of Token Sale expressly noted that GLA tokens were “not being structured or sold as securities or any other form of investment product,” the SEC said that the firm’s principals and agents discussed the prospects for investment returns from GLA tokens on various social media; Gladius took steps to have GLA tokens traded on significant digital asset trading venues; and Gladius pronounced after the ICO that it entered into a “partnership” to list GLA tokens on “one of the top cryptocurrency exchanges in the world.” 

As a result, said the SEC, purchasers of GLA tokens “would have reasonably expected that they could obtain a future profit from GLA [t]okens if the entrepreneurial and managerial efforts of Gladius’s founders, employees and agents succeeded” regardless of whether they ever used the Gladius service. The SEC did not charge that Gladius committed any fraud in connection with its ICO.

To resolve the SEC’s allegations, Gladius agreed to register GLA tokens as a class of security and compensate investors, among other undertakings. However, the SEC imposed no fine on Gladius because of the firm’s remedial steps, including its self-reporting of a possible securities law violation and cooperation with SEC staff. (Click here to access the Gladius settlement order.)

In November 2018, the SEC filed and settled two enforcement actions against issuers of ICOs – Carrier EQ Inc. d/b/a/ AirFox and Paragon Coin, Inc. – for violating securities registration requirements. These cases represented the first time the SEC assessed fines in connection with a non-fraudulent ICO.

At the same time it published the AirFox and Paragon settlement orders, the SEC’s Divisions of Corporation Finance, Investment Management and Trading and Markets issued a “Statement of Digital Asset Securities Issuance and Trading” that, among other things, noted that the two settlements provided an express “path to compliance” for prior issuers of unregistered or not lawfully exempt cryptosecurities. (Click here for background regarding the SEC’s Divisions’ statement as well as the Air Fox and Paragon settlements in the article “SEC Assesses Penalties for Non-Fraudulent Initial Coin Offerings and Requires Registration; Issues Advisory on Issuance and Trading of Cryptosecurities” in the November 18, 2018 edition of Bridging the Week.)

More Briefly:

  • Purported Misuse of Customer Block Trade Information Results in Fines to Two Individuals and FCM: The Chicago Mercantile Exchange settled disciplinary actions against two individuals – Hicham Boularbah and Hamza Slaoui, brokers at an unnamed non-US firm – for acting on nonpublic order information from a customer without the customer’s consent to direct a broker at R.J. O’Brien & Associates, their United States clearing firm, to execute trades on Globex in Euro FX options strategies on various dates in June 2016. The individuals then used the average prices of the fills to price block trades for their customer and allowed their non-US firm to “secure a portion of riskless profit.” After being contacted by CME, the individuals’ firm returned the relevant profits. Mr. Boularbah agreed to resolve his disciplinary action by paying a fine of US $60,000, while Mr. Slaoui consented to pay a penalty of US $40,000. Both individuals also agreed to serve a one-month all CME Group exchanges’ access prohibition. Relatedly, RJO agreed to pay a fine of US $80,000 and disgorge profits of US $110,050 for pre-hedging a block trade prior to consummation of the transaction and for not reporting two block trades within times required by CME.

Unrelatedly, Marex Financial Limited agreed to pay a fine of US $50,000 to ICE Futures U.S. for transmitting electronic orders to the exchange on behalf of a non-US futures broker without including the unique IDs assigned to the registered operators. Apparently, this was caused by a software error that caused the overriding of all unique IDs assigned to traders at the non-US futures broker with a single non-unique ID. IFUS acknowledged that Marex identified and fixed the software glitch after being advised by the exchange.

Additionally, Mark Lindop consented to pay a fine of US $50,000 and serve a one-week access suspension at IFUS for entering orders without the intent to execute them on various occasion during January 2017, April 2017, March 2019 and May 2019. Mr. Lindop allegedly entered and cancelled orders during pre-open periods of various markets to determine market depth and the effect the orders might have on the indicative opening price. 

  • FINRA Sanctions Member for Allegedly Not Detecting Potentially Manipulative Transactions: Lime Brokerage LLC, a registered broker-dealer, agreed to pay a fine of US $US $625,000 to resolve allegations by the Financial Industry Regulatory Authority and multiple securities exchanges that from September 1, 2012, through August 3, 2016, it failed to maintain a supervisory system and written supervisory procedures “reasonably designed” to detect and respond to potential manipulative trading by its direct market access customers. According to FINRA, beginning in December 2014 thorough the end of the relevant period, Lime employed only one individual to manually review its surveillance system’s alerts, but never provided the analyst “with any written guidance or explanations of the factors to consider reviewing the alerts and determining alert categories or dispositions.” Moreover, during the relevant time, the firm failed to respond to red flags of potential manipulative trading, including spoofing and layering, said FINRA.

Follow-Up:

  • ICE Futures U.S. Amended Pre-Execution Rule Effective August 23: ICE Futures U.S. will implement amendments to a rule and guidance to permit certain participants to an options cross trade to hedge their proposed transactions after agreeing to a cross trade, but prior to any execution, beginning on August 23, 2019. Currently, no trader may hedge any proposed futures or options transaction agreed during pre-execution discussions until after execution. (Click here for background regarding IFUS’s amended rule and guidance in the article “ICE Futures U.S. Proposes No Delay in Hedging Trades Related to Pre-Execution Negotiated Options Cross Trades” in the August 11, 2019 edition of Bridging the Week.)

For further information

FINRA Sanctions Member for Allegedly Not Detecting Potentially Manipulative Transactions:
/ckfinder/userfiles/files/Lime%20Brokerage%20LLC.pdf

ICE Futures U.S. Amended Pre-Execution Rule Effective August 23:
https://www.theice.com/publicdocs/futures_us/exchange_notices/Amendments_to_Rule_4.02_and_pre-execution_Communication_FAQ_20190813.pdf

Major Cryptocurrency Exchange Cited for Misleading Ads by UK Overseer of Advertising Standards:
https://www.asa.org.uk/rulings/hdr-global-trading-ltd.html

Mum’s the Word – Maybe: CFTC Officially Agrees to Keep Quiet About Settlement of Manipulation Complaint That Nets US $16 Million Penalty; Unofficially?:
https://www.cftc.gov/media/2336/enfkraftfoodsgroupincdelezgloballlcconsentorder81419/download

NYDFS Designates BAKKT as Limited Liability Trust Company; ICE Futures U.S. Schedules Physically Deliverable Bitcoin Futures Launch to Begin September 23:

Purported Misuse of Customer Block Trade Information Results in Fines to Two Individuals and FCM:

  • CME:

Hicham Boularbah:
https://www.cmegroup.com/notices/disciplinary/2019/08/CME-16-0539-BC-3-HICHAM-BOULARBAH.html
Hamza Slaoui:
https://www.cmegroup.com/notices/disciplinary/2019/08/CME-16-0539-BC-2-HAMZA-SLAOUI.html
R.J. O’Brien:
https://www.cmegroup.com/notices/disciplinary/2019/08/CME-16-0539-BC-RJ-OBRIEN.html

  • ICE Futures U.S.:

Mark Lindop:
https://www.theice.com/publicdocs/futures_us/disciplinary_notices/ICE_Futures_US_Mark_Lindop_20190814.pdf
Marex:
https://www.theice.com/publicdocs/futures_us/disciplinary_notices/ICE_Futures_US_Marex_Financial_Limited_20190814.pdf

Unregistered ICO by Blockchain Company for Healthcare Providers Results in No Fine Despite SEC Enforcement Proceeding:
https://www.sec.gov/litigation/admin/2019/33-10671.pdf

 

©2019 Katten Muchin Rosenman LLP

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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...

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