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Bridging the Week by Gary DeWaal: September 17 - 21 and September 24, 2018 (Spoofing; Cryptocurrency Trading Platforms; Post-Trade Allocations)

The Commodity Futures Trading Commission filed and settled three enforcement actions for spoofing. Some of the CFTC's cases paralleled prior or concurrent exchange-resolved disciplinary actions for the same offense. One CFTC enforcement action resulted in the imposition of a fine on a trading firm for the actions of its employees when the exchanges where the spoofing occurred determined that such a penalty was not warranted. Separately, the New York Attorney General issued a report criticizing cryptocurrency trading platforms for conflicts of interest, trading oversight weaknesses, and not adequately protecting customers’ positions. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • CFTC and Exchanges Layer on Multiple Spoofing Cases (includes My View); 
  • NY Attorney General Says Investors Risk Abusive Trading and More on Crypto Platforms (includes My View1 and My View2); 
  • Introducing Broker and Principal Sanctioned by CFTC for Not Overseeing Unlawful Post-Trade Allocations of CTA Client (includes Compliance Weeds); and more.            

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  • CFTC and Exchanges Layer on Multiple Spoofing Cases: The Commodity Futures Trading Commission filed three actions against companies and one action against an individual for engaging in spoofing in violation of law. (Click here to access Commodity Exchange Act § 4c(a)(5)(C), 7 US Code § 6c(a)(5)(C).) Some CFTC actions appeared to parallel or at least draw-on, at least in part, concurrent or past exchanges' disciplinary proceedings.

Victory Asset, Michael Franko

In the enforcement action resulting in the largest fines, the CFTC claimed that, from May 2013 to July 2014, Victory Asset, Inc. engaged in spoofing on the Commodity Exchange, Inc. and the New York Mercantile Exchange, as well as cross-market spoofing on COMEX and the London Metal Exchange through Michael Franko, its Director of Commodities Trading at the relevant time. 

The CFTC said when Mr. Franko engaged in spoofing solely on domestic markets, he would place a small order on one side of a particular futures market, and then place a larger order on the other side of the same market to create or augment order book imbalances. Mr. Franko purportedly would cancel his large order as soon as his small order was executed. When Mr. Franko engaged in cross-market spoofing, he would allegedly place an order to buy or sell copper futures on either the COMEX or LME market, and attempt to effectuate the order’s execution by non-bona fide trading activity on the other market. Again, after his desired execution, Mr. Franko would cancel his spoofing order.

According to the CFTC, Mr. Franko engaged in his purported spoofing activity “frequently, on almost [a] daily basis.”

Both Victory Asset and Mr. Franko were charged with violating prohibitions against spoofing and engaging in a manipulative scheme. (Click here to access CEA § 6(c)(1), 7 U.S.C § 9(1) and here for CFTC Rule 180.1.)Victory Asset was charged with being liable for Mr. Franko’s wrongful conduct as he was its agent. (Click here to access CEA § 2(a)(1)(B), 7 U.S.C. § 2(a)(1)(B).)

To resolve this matter Victory Asset agreed to pay a fine of US $1.8 million, while Mr. Franko consented to a penalty of US $500,000 as well as a six-month trading prohibition on all US futures markets. In August 2015, Mr. Franko settled a disciplinary action in connection with alleged spoofing activity involving COMEX copper futures contracts during the same relevant time period by payment of a US $100,00o fine and a 15-business-day all CME Group exchanges’ trading prohibition. (Click here for background in the article “CME Group Files Disciplinary Actions for Trading Ahead of Block Trades and Failure to Supervise an Employee Engaging in Disruptive Trading Activities” in the August 23, 2015 edition of Bridging the Week.)

Geneva Trading

Geneva Trading USA, LLC agreed to pay a fine of US $1.5 million to the CFTC for alleged spoofing trading by three of its employees in various CME Group exchanges’ futures contracts from January 1, through December 31, 2013, and from June 1, 2015, through October 21, 2016. According to the CFTC, each of the traders’ spoofing activity entailed placing a smaller order on one side of a market, and larger orders on the other side to induce execution. Purportedly, the larger orders were often modified to avoid execution and ultimately canceled.

In accepting Geneva Trading’s offer of settlement, the CFTC acknowledged the firm’s cooperation throughout staff’s investigation and proactive conduct to enhance its compliance systems and policies regarding manipulative trading and spoofing. Geneva was charged with spoofing under applicable law and was held liable for the actions of its employees.

The three employees were: Garrett Connery, Robert Kimmons, and Krzysztof Marzec.

In parallel actions, Chicago Board of Trade and Chicago Mercantile Exchange business conduct committees also resolved disciplinary actions against Geneva Trading for alleged spoofing activity from September 1, 2015, through May 23, 2016, by Mr. Connery. Geneva Trading agreed to disgorge total profits of US $12,035, but was not required to pay a fine. Mr. Connery was also subject to disciplinary actions by the two BCCs and resolved his matters by agreeing to pay an aggregate fine of US $75,000 and to be banned from trading on all CME Group markets for six weeks.

In October 2016, Geneva Trading, Mr. Kimmons and Mr. Marzec resolved COMEX and NYMEX disciplinary actions for purported spoofing activities from March through July 2013. In connection with this matter, Geneva Trading also agreed solely to disgorge profits but was assessed no fine. (Click here for background in the article “CME Group Settles With Trading Firm for Spoofing-Type Offenses, Holding It Strictly Liable for Acts of Agents; Orders Disgorgement of Profits” in the October 9, 2016 edition of Bridging the Week.)

Mizuho Bank

Mizuho Bank also agreed to settle allegations of spoofing brought by the CFTC. The Commission alleged that, from May 2016 through May 2017, one of the firm’s traders placed spoofing orders on the CBOT to test the market in anticipation of placing hedging orders at a later time. However, said the CFTC, the trader had no intention for the test orders to be executed.

Mizuho resolved the CFTC enforcement’s action by agreeing to pay a fine of US $250,000.

The CFTC noted that Mizuho suspended the trader promptly after being made aware of its trader’s purported misconduct. The Commission said Mizuho additionally conducted its own investigation into its trader’s activities, provided Commission staff with regular updates, and enhanced its systems and controls to detect and prevent similar misconduct.

ICE Futures U.S.

Also last week, a BCC of ICE Futures U.S. settled a disciplinary action against Traditum Group LLC for spoofing trading by one of the firm’s employees on multiple occasions from September 2016 through March 2017. The exchange charged Traditum with failing to supervise the employee. Traditum agreed to pay a fine of US $90,000. In a parallel disciplinary action, the relevant employee, Shay Caherly, agreed to pay a fine of US $25,000 and be banned from trading on IFUS for two weeks.

My View: Was the glass half full or half empty?

In 2016 and last week, when CME Group exchanges brought and settled disciplinary actions against Geneva Trading for purported spoofing by three of its employees, it solely required the firm to disgorge profits. Geneva Trading was not charged with failure to supervise and it was not assessed a fine. By these actions, the CME Group exchanges implied that the firm implemented and enforced reasonable policies and procedures regarding spoofing, but, notwithstanding, wrongful conduct occurred. 

Last week in settling with Geneva Trading, the CFTC also implicitly acknowledged that, at the time of the alleged spoofing by its employees, the firm had compliance systems and procedures related to manipulative trading and spoofing. However, following the conduct, it “proactively worked to remediate and enhance” these systems and procedures and updated its training.

Notwithstanding, the CFTC assessed a fine of US $1.5 million on Geneva Trading to resolve its enforcement action.

Unfortunately, despite reasonable policies, procedures, and systems, firms cannot detect and prevent all instances of wrongful conduct by their employees. Although the CFTC said it afforded Geneva Trading a “reduced civil monetary penalty” for its early resolution of the enforcement action, it is not clear that even this reduced penalty is fair under the circumstances, let alone proportionate with trading conduct that resulted in US $105,000 of total profits to the firm – all of which was required to be disgorged by CME Group exchanges.

A civil penalty against an employer is not warranted in connection with every circumstance where employees or agents allegedly violate applicable requirements, particularly where a firm has taken reasonable measures to deter the wrongful employee conduct. As a result, the CME Group’s approach to handling this matter seems more reasonable. It appears the CME Group saw the glass as half full, while the CFTC viewed it as half empty.

  • NY Attorney General Says Investors Risk Abusive Trading and More on Crypto Platforms: The New York Attorney General issued a report claiming that trading platforms for cryptocurrencies often (1) engage in several lines of business that may pose conflicts of interest; (2) have not implemented “serious efforts to impede abusive trading activity”; and (3) have “limited or illusory” protection for customer positions. Moreover, the report alleged that three cryptocurrency platforms may be operating unlawfully in New York and referred these platforms to the NY Department of Financial Services for possible further action. The three platforms are Binance, Gate.io and Kraken. 

The AG’s report followed a voluntary request for information sent to 13 cryptocurrency platforms earlier this year (Click here for background in the article “New York Attorney General Seeks Information From 13 Cryptocurrency Exchanges Even If No State Connection” in the April 22, 2018 edition of Bridging the Week.)

Among specific findings, the NY AG claimed that few trading platforms restrict or even monitor “bots” or algorithmic trading on their systems. Moreover, many venues offer special pricing and other features, including preferential trading access, to professional traders. These circumstances could negatively hurt retail investors, said the NY AG.

The NY AG also raised potential conflict of interest concerns at cryptocurrency trading platforms. The NY AG said it is unclear why trading platforms list certain cryptocurrencies, suggesting that sometimes payments to a platform may drive listings. The NY AG also said that the owners and investors in several trading platforms are large holders of cryptocurrencies trading on their platform, and trading platforms themselves, as well as their employees, are often investors in virtual assets and trade against customers.

Kraken, which chose not to participate with the NY AG’s inquiry, was harsh in its criticism of the NY AG’s report. According to a Twitter post by Kraken, “[w]e must… object to the highly unprofessional/malicious implication that because we did not respond to the voluntary information request, we ‘might’ be operating illegally. We told you we don’t operate in NY. AG trying cases in court of public opinion now?” (Click here for further comments by Kraken.) 

Coinbase, a trading platform that voluntarily responded to the NY AG’s information request, disputed the report’s finding that 20 percent of executed trades on its trading platform was attributable to its own trading. According to a Coinbase press release, “Coinbase does not trade for the benefit of the company on a proprietary basis… When Coinbase executes [trades], it does so on behalf of Coinbase Consumer customers, not itself.” (Click here to access Coinbase’s press release.)

In other developments regarding crypto assets:

  • UK – Center for Crypto Asset Activity?: The House of Commons of the UK Parliament issued an overview of the crypto-asset landscape, identifying both advantages and limitations of blockchain technology. Among the advantages noted is that blockchain technology “allows us to validate, store, and synchronise information across many different parties more securely and efficiently than we have been before.” However, the House of Commons noted that “scalability and reliability of blockchain [is] a significant challenge.” The report concluded that if the United Kingdom could develop “an appropriate and proportionate regulatory environment for crypto assets” the country could become a “global centre” for crypto-asset activity. 
  • VanEck SolidX Bitcoin Trust: The Securities and Exchange Commission formally instituted proceedings to determine whether to approve a proposed rule change by Cboe BZX Exchange, Inc. to list and trade shares of SolidX Bitcoin Shares issued by VanEck SolidX Bitcoin Trust. As proposed, each share in the trust would represent a fractional interest in bitcoin holdings by the trust. To date, the SEC has already received over 1400 comment letters on Cboe BZX's proposal after soliciting comments on April 7. The SEC will accept additional comments on Cboe BZX’s proposed rule change through 21 days after publication of the SEC’s announcement regarding its proceedings in the Federal Register; rebuttal comments must be submitted within 35 days. 

Last month, the SEC by its staff declined to approve rule amendments proposed by NYSE Arca, Inc. and Cboe BZX Exchange, Inc. to authorize the listing and trading of shares of nine exchange-traded products that planned to seek exposure to some or all of the bitcoin futures contracts traded on the Chicago Mercantile Exchange, Cboe Futures Exchange and/or any other US exchange that subsequently traded such contracts. Subsequently, the Commission stayed staff’s denial and indicated it would review the delegated action. (Click here for details in the article “SEC Declines to Approve Two Exchanges' Rules Authorizing Nine Bitcoin Futures ETPs” in the August 26, 2018 edition of Bridging the Week.)

  • Bitcoin and Ether Tracker One Notes: The SEC’s Division of Trading and Markets provided further insight into why the SEC suspended offerings of the Bitcoin Tracker One and Ether Tracker One notes in the United States earlier this month. According to staff, the suspension was warranted because of confusion among market participants regarding the nature of the notes (e.g., were they exchange-traded notes, exchange-traded funds or equity-linked certificates?). Staff indicated that the SEC and Commodity Futures Trading Commission are currently consulting regarding “regulatory considerations” applicable to the notes. (Click here for further background on the SEC’s suspension of these notes in the article “SEC Suspends Trading of Two Cryptocurrency Notes” in the September 9, 2018 edition of Bridging the Week.) 

My View1: The NY AG’s report’s most valuable contributions are identifying useful questions for investors to ask a cryptocurrency trading platform prior to signing up and providing a comparison among cryptocurrency exchanges of certain important features. 

However, the value of the NY AG’s report is tarnished by what seems like petty retaliation against three entities that declined to participate in what was alleged to be a “voluntary” survey and, apparently, as a result, were publicly identified by name for possibly violating NY law by doing business with NY persons. 

It may be, as alleged, that the NY AG has incriminating evidence on the three entities. If that is the case, the better course would have been for the NY AG to make its referral to the NY DFS privately, and then let NY DFS follow its own processes to investigate and take appropriate action if warranted. Public shaming outside of judicial process is not appropriate by government officials or agencies under any circumstance and raises due process concerns.

My View2: SEC Commissioner Hester Peirce’s speech two weeks ago before the Cato Institute’s FinTech Unbound Conference was a humorous and insightful commentary on the SEC’s approach to cryptocurrencies and how it could be improved -- particularly in the context of the Commission's recent consideration for approval of exchange-traded products based on bitcoin. (Click here for background in the article, "SEC Says 'No' to Winklevoss Bitcoin Trust While NFA Says 'Yes' to Intermediaries’ Crypto Businesses but Requires Disclosures" in the August 5, 2018 edition of Bridging the Week.) In response to her recent designation as “CryptoMom” by some in the blockchain community, Ms. Pierce discussed the differences between helicopter moms – who hover over their kids’ every activity – and free-range moms – who let their kids take limited risk under limited supervision. 

Ms. Peirce likened the SEC’s current approach to cryptocurrencies as being like that of a helicopter mom: instead of allowing investors to make their own choices regarding potential investments in bitcoin-related exchange-traded funds, the SEC is simply precluding such investments because of its concerns regarding the underlying risks of bitcoin trading. Ms. Peirce argued this is the wrong approach. She said that the SEC should not require that crypto markets be subject to comprehensive regulation like securities markets “as a precondition to allowing products linked to those markets to be traded in markets that we regulate.” According to Ms. Peirce, regulators should not be restricting investors from taking risks and realizing losses.

Ms. Peirce’s arguments are very compelling although a bit extreme. The SEC or any government law enforcement agency should not stand on the sidelines and allow a known fraudster to seduce retail customers to part with their money on the principle of investor choice. However, concerns about new technologies and financial instruments can be addressed through enhanced disclosures of potential risks. Banning investments is not the answer. In Ms. Peirce’s words, “the losses of prohibiting risk-taking are… real. Even when we cannot readily measure them or even because we often cannot measure them, these losses are potentially very threatening to investor welfare.”

Once again, mom has it fundamentally right. (Click here to access Ms. Peirce’s full speech.)

  • Introducing Broker and Principal Sanctioned by CFTC for Not Overseeing Unlawful Post-Trade Allocations of CTA Client: Global Access Advisors, LLC, an introducing broker, was subject to enforcement actions by both the Commodity Futures Trading Commission and the National Futures Association over its handling of a commodity trading advisor and commodity pool operator – Newport Private Capital LLC – that unlawfully allocated bunched orders to proprietary accounts, harming customers. The firm was also charged with permitting payments to be made to the wife of the principal of Newport Private – Jonathan Hansen – in a new account opened after such time that the NFA issued an order (a so-called “Member Responsibility Action”) expressly prohibiting such payments. 

Glenn Swanson, an associated person and a principal of GAA, was also subject to enforcement actions by the CFTC and NFA related to his handling of the Newport Private relationship. Kenneth Packard, another principal of GAA and its chief marketing and sales officer, was also named in the same NFA enforcement action, while John Schwaebe, the sole AP in a branch office of GAA was named in separate NFA enforcement action. NFA implied that Mr. Schwaebe was the principal facilitator at GAA of Mr. Hansen's allegedly fraudulent allocations and the opening of the account for Mr. Hansen's wife.

The CFTC said that GAA and Mr. Swanson did not conduct sufficient inquiry after questionable activity regarding Newport Private and its principal was brought to their attention, including the CTA’s late allocations, the NFA’s order against the CTA and the opening of the spouse account after the order.

GAA and Mr. Swanson settled both the CFTC and NFA actions by agreeing to pay, jointly and severally, a fine of US $300,00 to the CFTC and US $200,000 to NFA. Mr. Packard agreed to remit a separate fine of US $35,000 to resolve his legal proceeding with NFA, while Mr. Schwaebe resolved his NFA proceeding by agreeing not to re-apply as an NFA member for seven years and not to become a principal of an NFA member for 9 years. GAA withdrew Mr. Schwaebe's AP registration in May 2014.

Two futures commission merchants previously resolved CFTC enforcement actions related to this matter.(For background, click here to access the article “CFTC and NFA Sanction FCM for Handling of Post-Trade Allocations by Trading Manager” in the August 5, 2018 edition of Bridging the Week.)

Compliance Weeds: Typically, upon receipt, futures commission merchants, introducing brokers and members of contract markets must immediately prepare a record that identifies the specific customer placing an order and the time the order is received, among other information, if the order cannot immediately be entered into an exchange's trade matching engine. (Click here to access CFTC Rule 1.35(b)(1).)

However, an exception to this requirement exists for qualified bunched orders. Among other things, the person placing the order for post-execution allocation must have been granted written discretion by the customer and the order placer must be an eligible account manager (e.g., CTAs, Securities and Exchange Commission-registered investment advisers, and futures commission merchants; click here to access the definition of EAM in CFTC Rule 1.35(b)(5)). Allocations must be made as soon as practicable after an entire transaction is executed but by no later than the end of the trading session for futures; allocations must be fair and equitable; and the allocation methodology must be sufficiently objective to allow for independent verification of the fairness of the methodology by regulators and outside auditors. Certain recordkeeping requirements also apply. 

FCMs processing customers’ allocated trades for an EAM have an additional express, affirmative obligation to take “appropriate action” if they have actual or constructive knowledge that allocations for its customers are fraudulent.(Click here for further background in Interpretive Guidance by the National Futures Association.)

As of October 1, 2018, CME Group will impose new requirements on suspense accounts maintained by FCMs to facilitate the post-trade allocation of bunched trades and other reasons. (Click here for background in the article, ”No Suspense Anymore – CME Group Clarifies Suspense Account Requirements in New Guidance” in the December 17, 2017 edition of Bridging the Week.) 

More Briefly:

  • ICE Futures U.S. Sanctions Introducing Broker for Not Complying With Block Trades Recordkeeping Obligations: ICE Futures U.S. fined GFI Securities LLC US $42,500 for not complying with its recordkeeping requirements for block trades. According to an IFUS business conduct committee, the firm may have failed to record and maintain all written and oral communications that led to the execution of block trades, and to report block trades correctly and timely. Moreover, said the BCC, one of the firm’s brokers may have impermissibly disclosed the identity of a customer who engaged in block trades. The firm was also charged with failure to supervise. GFI voluntarily consented to the settlement without admitting or denying any rule violations.  

Separately, Step Consulting, LLC agreed to remit a fine of US $22,500 to IFUS for using the same trade identification for automated and manually placed orders, in violation of exchange rules. IFUS claimed the trades entered automatically were placed to test connectivity and not for the purpose of execution. 

Finally, CACEIS Bank agreed to a fine of US $7,500 to IFUS for engaging in a wash sale transaction between accounts owned and controlled by a client after first notice day for cotton futures contracts. Positions were moved in this manner, said IFUS, because the transaction occurred after first notice day in the relevant futures contract and no transfer trades were permitted at such time.

  • Two Firms Agreed to Fines Imposed by CFTC for Attempting to Manipulate ISDAFIX Benchmark: Two more firms consented to fines by the Commodity Futures Trading Commission for their roles in attempted manipulation of the ISDAFIX benchmark. ICAP Capital Markets agreed to pay a fine of US $50 million for its role in aiding and abetting attempted manipulation of the ISDAFIX benchmark from January 2007 through December 2012, while Bank of America, NA consented to a fine of US $30 million for its attempted manipulation and false reporting of the ISDAFIX benchmark during the same time period. Earlier this month, BNP Paribas Securities Corp. agreed to pay a fine of US $90 million to resolve allegations that, on multiple occasions from approximately May 2007 through at least August 2017, it also attempted to manipulate the USD ISDAFIX. (Click here for details regarding this matter in the article “US-Based Subsidiary of Foreign Bank Agrees to Pay US $90 Million to Resolve Charges of Attempting to Manipulate ISDAFIX Benchmark” in the September 9, 2018 edition of  Bridging the Week.) 
  • ISDA Calls for Swap Dealer Choice in Complying With SEC or CFTC Swaps Rules: ISDA and the Center for Capital Markets Competitiveness called for the SEC and CFTC to use their exemptive authorities to authorize swap participants to use compliance with one agency’s regulations regarding dealer registration, regulatory and real-time reporting, business conduct standards and chief compliance officer requirements to comply with the other agency’s comparable regulations. This approach is warranted, said the two industry organizations, because there are material differences between the CFTC’s final swaps rules and the SEC’s final and proposed rules. Under the proposed approach, the SEC and CFTC could retain their respective enforcement, anti-manipulation and anti-fraud authorities, said the two organizations. 
  • FINRA Reminds Members of Obligations When Relying on Third-Party Recordkeeping Services: The Financial Industry Regulatory Authority issued guidance paralleling recent guidance issued by staff of the Securities and Exchange Commission that third-party recordkeeping services must grant access to a registrant’s required books and records, even if the registrant does not pay required fees. Any inapposite provision in a contract is prohibited. A recordkeeper that violates this could be subject to secondary liability for causing a registrant to violate its recordkeeping obligations. (Click here for background on the SEC’s guidance in the article “SEC Confirms Third-Party Recordkeeping Retention Agreements That Provide for Deletion or Discarding Documents in Case of Broker-Dealer Non-Payment Are Not Permitted” in the April 15, 2018 edition of Bridging the Week.) 
©2022 Katten Muchin Rosenman LLPNational Law Review, Volume VIII, Number 267

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...