Bridging the Week by Gary DeWaal: February 25 – March 1 and March 4, 2019 (Appeal Not Appealing; Purported Fraudster Indicted for Fraud)
The Commodity Futures Trading Commission determined not to appeal a decision of a federal court that a well-known proprietary trading firm and its principal did not engage in manipulation or attempted manipulation as charged by the Commission in an enforcement action because they traded in a manner that exploited a flawed futures contract. Unrelatedly, the founder and principal operator of a company that marketed a purportedly fraudulent cryptocurrency was indicted for wire fraud and unlawful monetary transactions in a US federal court in Massachusetts. As a result, the following matters are covered in this week’s edition of Bridging the Week:
CFTC Accepts Federal Court Ruling in Market Manipulation Case but Still Committed to the Cause (includes Legal Weeds and My View);
Purported Cryptocurrency Fraudster Indicted for Fraud; Previously Sued by CFTC (includes My View); and more.
CFTC Accepts Federal Court Ruling in Market Manipulation Case but Still Committed to the Cause: The Commodity Futures Trading Commission determined not to appeal the December decision of a federal court in New York, holding that the Commission failed to meet its burden of proof in an enforcement action against DRW Investments, LLC and Don Wilson, its chief executive officer, charging the defendants with manipulation and attempted manipulation of the IDEX USD Three-Month Interest Rate Swap Futures Contract from January 24 through August 12, 2011. The court ruled against the CFTC following a bench trial that concluded in December 2016.
Although the CFTC did not announce the reason for its decision, it noted that “[w]hile the agency will not move forward with this case, it will continue to vigorously enforce the Commission’s anti-manipulation provisions and prosecute cases through trial where necessary.”
In its complaint and during the trial, the CFTC claimed that the defendants engaged in their prohibited conduct by placing bids involving the relevant futures contract “that DRW knew would never be accepted” to artificially influence the settlement prices in their favor on at least 118 trading days in a “banging the close” scheme. However, the court said that it was not manipulation or attempted manipulation for defendants to take advantage of flawed exchange rules that were public information where their bids reflected their bona fide perception of fair value and were designed to induce liquidity.
(Click here for further background on the DRW decision in the article “Being Smarter Than Your Counterparties Is Not Manipulation Rules Judge in CFTC Enforcement Action” in the December 9, 2018 edition of Bridging the Week.)
Legal Weeds and My View: In its complaint against defendants, the CFTC solely relied on the traditional provisions in relevant law prohibiting manipulation and attempted manipulation. (Click here to access 7 U.S.C. § 9(3) (prior to D0dd-Frank, effectively 7 U.S.C. § 9) and here for 7 U.S.C. § 13(a)(2) – the CFTC’s traditional anti-manipulation authorities.) In order to prove manipulation, said the court, the CFTC had to show that (1) the defendants had the ability to influence market price, (2) an artificial price existed, (3) defendants caused the non-bona fide price, and (4) defendants intended to cause the non-legitimate price. The court noted that, to show attempted manipulation, the Commission did not have to prove an artificial price existed, but had to demonstrate that defendants intended to cause an artificial price. The court ruled that the CFTC did not prove that the defendants violated either provision of law.
In its DRW complaint, the CFTC did not charge the defendants with violating the fraud-based manipulation prohibition enacted under the Dodd-Frank Wall Street Reform and Consumer Protection Act. This was because defendants’ purported wrongful trading predated the effective date of this provision. Under this law and a rule promulgated by the CFTC in conjunction with this statute, it is prohibited for any person to intentionally or recklessly engage in “any manipulative device, scheme or artifice to defraud.” (Click here to access 7 U.S.C. § 9(1); click here for CFTC Rule 180.1.)
For factual situations arising on or after August 15, 2011 – the effective date of CFTC fraud-based manipulation rule –, nothing precludes the CFTC from charging a defendant with both a violation of the traditional manipulation provisions of law and with a violation of the new fraud-based manipulation prohibitions.
In determining not to appeal the DRW decision, the CFTC may very well have considered that, since it now has the authority to prosecute alleged manipulation and attempted manipulation under the lesser requirements of fraud-based manipulation, its overall enforcement program is less harmed by an adverse decision of a federal trial court grounded on a discrete fact pattern (e.g., a purportedly flawed futures contract), than a potential adverse outcome in a federal court of appeals that would have greater precedential weight.
Indeed, contemporaneously with publication of the DRW decision, CFTC Chairman J. Christopher Giancarlo issued a statement noting that the court’s decision in DRW solely involved “CFTC’s pre-Dodd-Frank legal authority.” (Click here to access the chairman’s December 3, 2018 statement.)
In any case, the Commission's decision not to appeal was correct. The bottom-line message of the trial court hearing DRW was compelling: it's not illegal to be smarter than your competitors!
Purported Cryptocurrency Fraudster Indicted for Fraud; Previously Sued by CFTC: Randall Crater, the purported founder and principal operator of My Big Coin Pay Inc. (“MBCPI”), was indicted in a federal court in Massachusetts with four counts of wire fraud and three counts of unlawful monetary transactions in connection with the marketing of an allegedly fraudulent cryptocurrency, “My Big Coin.”
In January 2018, the Commodity Futures Trading Commission filed an enforcement action against MBCPI, Mr. Crater, and Mark Gillespie for allegedly engaging in a virtual currency scheme that misappropriated approximately US $6 million from 28 or more persons. In its civil case filed in the same federal court in Massachusetts, the CFTC charged the defendants with making false or misleading statements to customers and fraud. (Click here for details in the article “CFTC Sues Unregistered Company and Promoters of Fake Virtual Coin for Alleged Fraud and Operating Purported Ponzi Scheme” in the January 28, 2018 edition of Bridging the Week.)
According to the criminal indictment, between 2014 and 2017, Mr. Crater purportedly solicited investors to purchase My Big Coins, claiming they were functioning and valuable virtual currencies backed by gold and other assets. However, alleged the indictment, My Big Coins had no value and were not backed by any precious metal or other asset. As did the CFTC, the indictment claimed that Mr. Crater misappropriated US $6 million of investor funds for personal use.
Previously, defendants in the CFTC’s civil case involving MBCPI made a motion to dismiss, claiming the CFTC had no jurisdiction to bring enforcement actions against persons engaged in purported fraudulent activities involving cryptocurrencies. In September 2018, the court held that cryptocurrencies are commodities as defined under applicable law, and that the CFTC’s authority to bring enforcement actions under its fraud-based manipulation authority extends to fraud cases that are not necessarily also grounded in illicit market conduct. (Click here for background in the article “Second Federal Court Rules That Cryptocurrencies Are Commodities and CFTC Has Anti-Fraud Jurisdiction Over Alleged Wrongdoing” in the September 30, 2018 edition of Bridging the Week.)
Other legal or regulatory matters involving cryptoassets:
OCC Once Again Tells Court That DFS Lawsuit Challenging FinTech Charter Still Before Its Time: The Office of the Comptroller of the Currency requested a federal court dismiss a challenge by the NY Department of Financial Services regarding OCC’s authority to grant special purpose national bank (“SPNB”) charters to entities that engage in financial technology businesses. NY DFS sued OCC over its authority to issue fintech charters in September 2018. (Click here for background in the article “NY DFS Sues OCC Over FinTech License; Other State Financial Regulators Say Their Legal Challenge Is Right Behind” in the September 16, 2018 edition of Bridging the Week.) OCC claimed that NY DFS’s lawsuit is premature because the agency has not granted any fintech charters let alone even received a SPNB charter application to date. Additionally, OCC asserted that, in any case, it has the authority to issue SPNBs because SPNB activities fall under the applicable law’s definition of “the business of banking.” In December 2017, a federal court in New York dismissed a prior lawsuit by NY DFS against OCC over its SPNB charter granting authority, ruling that the court lacked standing to hear the case because OCC had not yet finalized a decision to grant any SPNBs. (Click here for background regarding the prior court’s ruling against NY DFS in the article “Challenges to NY BitLicense and Potential OCC Fintech Charter Quashed” in the January 7, 2018 edition of Bridging the Week.)
My View: Both the CFTC and Securities and Exchange Commission have provided extensive guidance regarding what they believe falls within their regulatory remit related to cryptoassets. Courts are also beginning to weight in with greater frequency. However, legislators and regulators must be cognizant of the potentially inhibiting impact of government agency edict and case law arising from purportedly fraudulent conduct by nefarious persons in the development of potentially innovative and societally useful new technologies – such as distributed ledger technology.
CFTC Commissioners Continue to Spar Over Proposed SEF Rules' Revisions: CFTC Chairman J. Christopher Giancarlo and CFTC Commissioner Dan Berkovitz continued to exchange differing views on the merit of potential expanding execution requirements for swap execution facilities at the International Swaps and Derivatives Association’s DerivCon 2019. Generally, Mr. Giancarlo supported the proposed rule changes, claiming, in particular, that adding flexibility to SEF execution methods would promote innovation “to meet demand and operate trading environments that are more salutatory to the episodic nature of swaps liquidity.” Mr. Giancarlo – joined in his views by CFTC Commissioner Brian Quintenz – warned that the status quo could significantly impede liquidity “when the next crisis comes.” Mr. Berkovitz argued that “if it ain’t broke, don’t fix it", however. He claimed that current rules – including trade execution requirements – have promoted the migration of swaps trading to SEFs. Mr. Giancarlo also argued that the current CFTC interpretation that floor traders lose the ability to be excluded from the definition of swap dealer if they enter into “just one swap that is off-venue or uncleared” is inconsistent with Congressional intent. He indicated that, as a result, the CFTC’s Division of Swap Dealer and Intermediary Oversight would be “inclined to provide appropriate[e] … no-action relief” to a request for relief from this interpretation. (Click here for background on Mr. Giancarlo’s and Mr. Berkovitz’s different view on the proposed SEF rules, and the proposed rules themselves in the article “Different Roads to Travel for Swap Execution Reform Proposed by CFTC Chairman and New Commissioner” in the February 3, 2019 edition of Bridging the Week.)
Data Collection Practices of CFTC To Be Reviewed Under New Initiative: Commodity Futures Trading Commission Commissioner Dawn Stump proposed a path forward for the CFTC in handling data collected from market participants to fulfill its regulatory responsibilities in light of the potential for cyberattacks and information theft. Ms. Stump proposed that the Commission consider the necessity of receiving sensitive data when making requests for data "...and ensure that we only receive data required for our regulatory responsibilities, remove duplicative reporting streams, explore alternative mechanisms for accessing sensitive information, enhance internal controls for interacting with data, examine response procedures to cyber incidents, and update data retention best practices." Ms. Stump's call for a CFTC data collection review comes on the heels of a recent Securities and Exchange Commission enforcement action naming nine persons for participating in a scheme to benefit from the hacking of the agency's Electronic Data Gathering, Analysis, and Retrieval system used for receiving and retaining corporate filings and from trading on information illicitly acquired through cyber-theft. (Click here for background in the article, " Nine Persons Charged by SEC in EDGAR Hacking and Illicit Trading Scheme; Two Persons Additionally Named in Criminal Indictment" in the January 20, 2019 edition of Bridging the Week.)
Former Futures Trader Settles CFTC Action for Spoofing: Krishna Mohan settled an enforcement action by the Commodity Futures Trading Commission, admitting to manipulative and deceptive trading on the Chicago Mercantile Exchange and Chicago Board of Trade from at least September 2012 through March 2014. In particular, Mr. Mohan admitted that he engaged in spoofing transactions on “thousands of occasions” from November 2013 to December 2013, “intentionally sending false signals of increased supply or demand designed to trick market participants into executing against the orders he wanted to fill.” Previously, Mr. Mohan pleaded guilty in a federal court in Texas to the same prohibited trading activities. (Click here for background in the article “Three Traders Plead Guilty to Spoofing Violations” in the November 11, 2018 edition of Bridging the Week.)
US and UK Regulators Pledge No Traffic Stops in Derivative Markets No Matter What Road Brexit Takes: The Bank of England, the UK Financial Conduct Authority, and the US Commodity Futures Commission agreed to take measures to ensure that derivatives market activity between the UK and US will not be disrupted no matter what type of Brexit occurs at the end of March 2019. Among other things, the three regulators will implement measures to ensure continued supervisory cooperation, extend existing CFTC relief to European Union firms (including UK firms) and to UK firms that will not be part of the EU at the time of Brexit, and ensure that US trading venues, firms and clearinghouses are able to continue to provide services in the UK.
NFA to Members: Don’t Say We Didn’t Remind You: The National Futures Association published information on its website helpful to futures commission merchants, Forex dealing members, introducing brokers, commodity trading advisors and commodity pool operators regarding certain annual and ongoing regulatory obligations. The information also addressed obligations related to anti-money laundering obligations and requirements related to engaging in virtual currency business activity.