May 13, 2021

Volume XI, Number 133

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Bridging the Week: June 19 to 23 and June 26, 2017 (Costs and Benefits Don’t Add Up; Floor Trading; LOPR; MiFID II and Direct Market Access) [VIDEO]

The Office of Inspector General of the Commodity Futures Trading Commission severely criticized the agency’s cost-benefit analysis relied on in promulgating the Commission’s final rule for margin for uncleared swaps issued in December 2015. Additionally, in a rare current disciplinary action involving pit-trading, five respondents settled disciplinary actions brought by the Chicago Mercantile Exchange alleging that they engaged in prohibited conduct to avoid payment of fines mandated when members of a broker association trade opposite each other in restricted contracts for more than a designated maximum percentage of their overall volume. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • CFTC Inspector General Strongly Criticizes Cost-Benefit Analysis Underlying Commission’s Rule Establishing Margin for Uncleared Swaps (includes Policy and Politics);

  • Members of Broker Association Charged by CME With Not Complying With Strict Conditions to Trade Opposite Other Members of Same Group on Trading Floor; IFUS Charges FCM and Client for Block Trades by Non-ECP (includes Compliance Weeds);

  • Broker-Dealer Settles FINRA Options Reporting Disciplinary Action by Payment of $3.25 Million Fine (includes Compliance Weeds); and more

Video Version:

Briefly:

  • CFTC Inspector General Strongly Criticizes Cost-Benefit Analysis Underlying Commission’s Rule Establishing Margin for Uncleared Swaps: The Office of Inspector General of the Commodity Futures Trading Commission said that the agency “lacks an institutional commitment to robust cost-benefit consideration” in roundly criticizing the Commission’s analysis of the potential costs and benefits of its final margin rule for over‑the-counter swaps issued in December 2015. OIG claimed that, although the CFTC indicated that the final rule would “reduce systemic risk,” it never evaluated this claim against “unintended consequences that might undercut the asserted systemic risk-mitigating effects of margin or increase the burdens on market participants.” Among specific factors the CFTC did not consider, claimed OIG, was the impact of the rule on possibly reducing market liquidity and diminishing efficient risk‑hedging by certain market users; the pro-cyclical impact of margin requirements to heighten systemic risk during a time of market stress; and the increase in systemic risk that might occur because of “an industry-wide homogenous approach toward risk‑modeling in consequence to the Margin Rule’s initial margin modeling specification.” In part, claimed OIG, the CFTC’s deficiency in adequately considering costs and benefits was attributable to its “inadequate” data infrastructure. OIG called on the Commission to prepare more “economically rigorous” cost‑benefit analyses going forward. OIG has previously criticized the CFTC for taking a more legalistic view of cost-benefit analysis than an economic view. (Click here to access OIG's April 2011 report entitled "An Investigation of Cost-Benefit Analyses Performed by the Commodity Futures Trading Commission in Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank Act.")

Policy and Politics: In his recent defense of his proposed FY 2018 budget for the Commodity Futures Trading Commission before the US House Appropriations Subcommittee on Agriculture, Rural Development and Related Agencies, Acting Chairman J. Christopher Giancarlo, argued that one of justifications for increased CFTC funding was to enhance the agency’s ability to “systematically analyze large volumes of trade data and improve our understanding of the markets.” Mr. Giancarlo acknowledged that “[t]he current staff dedicated to economic analysis is inadequate to meet appropriate standards for econometric analysis required by a regulatory agency with oversight of more than 35 percent of the global derivatives markets.” (Click here for background on Mr. Giancarlo’s testimony and his FY 2018 budget request for the CFTC.)

  • Members of Broker Association Charged by CME With Not Complying With Strict Conditions to Trade Opposite Other Members of Same Group on Trading Floor; IFUS Charges FCM and Client for Block Trades by Non-ECP: 

CBOT and CME Disciplinary Actions

In a rare current disciplinary action involving floor-trading, the Chicago Mercantile Exchange brought and settled disciplinary actions against five individuals associated with the same broker association, four of whom allegedly traded customer orders opposite each other without complying with strict exchange rules that permit such trading with severe restrictions.

According to a CME Business Conduct Committee panel, on numerous occasions between September 2015 and December 2016, four members of a single broker association traded customer orders opposite other members of the same association that were improperly verified as being at the best and only bid and offer at the time. This apparently was done to avoid volume percentage limitations members of the same broker association may trade opposite each other without being subject to mandatory fines (click here to access CME Rule 515.E).

The BCC charged that one runner and trade checker for the association, John Calarco, was responsible for improperly documenting customer orders to conform to the exchange’s requirements and on one or more occasions, along with another non-member employee, endorsed and submitted trading documents to Market Regulation with fabricated witness signatures. For this, John Calarco agreed to pay a fine of US $10,000 and be suspended from access to all CME trading venues for two years.

In addition, Frank Calarco and Philip Mansfield, principals of the association, agreed to pay fines of $47,500 and $77,5000 respectively. Each was charged with failure to supervise their association’s member and non-member employees. Moreover, Mr. Mansfield was also alleged to have executed one Eurodollar option order on September 23, 2015 against another broker in a non‑competitive fashion. To resolve the disciplinary actions against them, John Calarco also agreed to a 30-business day trading venue access suspension, while Mr. Mansfield agreed to a 40-business day time out.

Finally, Andrew Schwieters and Joseph Cosenza, other members of the association, also agreed to pay fines of US $10,000 and $15,000 respectively for their alleged role in this matter, and to serve trading suspensions of five business days and 20 business days, respectively. Mr. Cosenza was also alleged to have to have engaged in a separate non-competitive execution of a Eurodollar option order on September 23, 2015 against another broker in a non-competitive fashion.

Unrelatedly, Coastland Capital LLC agreed to pay a fine of US $15,000 for allegedly entering into a transitory exchange for a related position transaction on April 5, 2016. According to the CME BCC, as part of its EFRP transaction, Coastland bought E‑mini S&P 500 futures contracts and sold SPDR S&P exchange‑traded fund (SPY) contracts. Contemporaneously against the same counterparty, Coastland allegedly sold the SPY contract and bought other contracts. The CME BCC claimed that, as a result, Coastland did not incur market risk related to the SPY contracts. Also, Nidera US LLC consented to pay a fine of US $40,000 for violating position limits from the close of business one day through the next when it liquidated its overage in connection with a disciplinary action brought by the Chicago Board of Trade.

ICE Futures U.S. Disciplinary Actions

Separately, Arlington Commodities LLC agreed to pay a fine of US $10,000 for entering into a block trade when it was alleged it was not an eligible contract participant, as required. Additionally, ED&F Man Capital Markets, Inc. consented to pay US $100,000 for purportedly not conducting adequate due diligence to ensure that one of its customers that executed a block trade was an ECP. ED&F Man also agreed to implement procedures to verify that its customers are ECPs before permitting them to engage in block trades. Finally, Wedbush Securities Inc. consented to pay a fine of US $10,000 for not timely filing a copy of its annual certified financial statement with the exchange.

Compliance Weeds: On CME, three contracts – Eurodollar options, Eurodollar MidCurve options and S&P 500 price index futures – are subject to strict rules to accommodate members of broker associations that may trade opposite each other in trading pits. Most basically, members of a broker association cannot trade opposite each other for more than a designated volume of their trading without incurring mandatory fines. However, trades executed between members of a broker association will not be counted towards such volume thresholds if one member was the best and only bid at the time, and the other was the best and only offer. Another member or exchange official present at the time must sign the relevant member’s trading record attesting that these conditions were met, and provide the information to Market Regulation. (Click here for further details regarding trading in so-called “restricted contracts” in the applicable CME Market Regulation Advisory Notice.) CME Group closed all of its New York trading floors in 2016 and most of its Chicago trading floors in 2015 (click here for background).

  • Broker-Dealer Settles FINRA Options Reporting Disciplinary Action by Payment of $3.25 Million Fine: Wells Fargo Securities, LLC (WFSL) agreed to pay a fine of US $3.25 million to resolve administrative charges brought by the Financial Industry Regulatory Authority that from January 2008 through March 2017 the firm failed to have “any” system of supervision to ensure its compliance with its position reporting obligations for over-the-counter options transactions. According to FINRA, after WFSL (formerly known as Wachovia Capital Markets LLC) executed a large OTC options trade in 2008, the firm recognized its need to develop systems to report OTC options trades. However, said FINRA, because of various business combinations in Fall 2008, the firm never fully implemented this project until WFSL became self-clearing in mid-2014. However, even after developing a system to ensure compliance with its reporting obligations, WFSL continued to have reporting problems with its OTC options trades through March 2017, said FINRA. FINRA also charged WFSL with violating options position limits and other violations. In determining the amount of the settlement, FINRA credited WFSL’s “extraordinary cooperation.”

Compliance Weeds: Generally, FINRA requires members to report or have reported on their behalf any options position in any account or multiple accounts where the firm or any customer, whether alone or in concert, maintains an aggregate position of 200 or more options contracts (whether long or short) of the put class and the call class on the same side of market for the same underlying security or index. All positions must be reported to LOPR by no later than close of business on the business day following the day the transaction or transactions happened that necessitated the filing. Where aggregate positions meet the 200-contract threshold, the option position of each individual account must be reported. Accounts must be aggregated when they are under common control or acting in concert. Control is presumed for all parties to a joint account who have authority to act on behalf of the account, all general partners of a partnership account, a person or entity that has a 10 percent or more ownership interest in an entity or shares 10 percent or more of an account’s profits and losses, accounts with common directors or management, or an individual or entity who has authority to execute transactions in an account. (Click here to access the May 2016 guidance by FINRA regarding member firms’ LOPR obligations.)

More briefly:

  • ICE Europe Advises Clearing Members of New Obligations for Granting Clients Direct Electronic Access Following MiFID II Roll-Out: ICE Futures Europe published guidance regarding member obligations related to their use of electronic systems to access the exchange beginning January 3, 2018 – the roll-out date of the Markets in Financial Instruments Directive II. These requirements include setting criteria or conditions for pre- and post-trade controls, qualification of staff in key positions, technical and electronic conformance, policy on fill or kill functionality, and, for clearing members, standards to assess whether such entities can provide direct electronic access to their clients and applicable conditions for such grant. ICE EU’s new guidance applies to all members, including persons from outside the EU. Additionally, the UK took further steps to implement MiFID II and a related regulation into national law. (Click here for details.)

  • Acting CFTC Acting Chairman J. Christopher Giancarlo Testifies Before US Senate Ag Committee; Commission Commissioner Sharon Bowen Reveals Intent to Leave: J. Christopher Giancarlo emphasized his commitment to robust enforcement of applicable laws, swaps reform enacted as part of the Dodd Frank Wall Street Reform and Consumer Protection Act, and reviewing Commodity Futures Trading rules to apply them “in ways that are simpler, and less burdensome” during his confirmation hearing last week before the US Senate Committee on Agriculture, Nutrition and Forestry. Mr. Giancarlo was nominated by President Donald Trump to serve as chairman of the CFTC on March 14. Separately, Sharon Bowen announced her intent to resign as a commissioner from the CFTC within the next few months or sooner if another nominee is confirmed. Ms. Bowen began serving as commissioner on June 9, 2014; she was appointed to a five-year term by then-President Barack Obama.

  • Former Broker-Dealer Operations Head Charged with Supervisory Failure for Firm’s Improper ADR Handling: Anthony Portelli, a former managing director of ITG Inc., agreed to pay a fine of US $100,000 to resolve charges brought by the Securities and Exchange Commission for failing to reasonably supervise personnel on ITG’s securities lending desk which purportedly resulted in improper practices with respect to the so‑called “pre-release” of American Depositary Receipts. Earlier this year, ITG agreed to pay a fine and disgorgement totaling US $24.4 million to settle charges by the SEC that it caused the issuance of pre-release ADRs since at least 2011, when it had not taken reasonable steps to ensure that the concomitant number of the underlying shares were owned and custodied by the person on whose behalf ITG was acting, as required by SEC rules (click here to review a copy of the relevant SEC Order). During the relevant period, Portelli was directly responsible for overseeing the securities lending desk’s supervisors and the desk generally. (An ADR is a negotiable certificate that ultimately evidences ownership of shares of a non-US company that have been deposited with a bank. In a lawful pre-release transaction, foreign shares have been purchased but not yet delivered to a custodian; in such circumstances the shares must be owned and custodied by the person on whose behalf the pre-released ADRs are obtained.)

  • UK Financial Regulator Initiates Criminal Proceedings Against Former Bank Compliance Officer for Insider Trading: The UK Financial Conduct Authority initiated criminal actions against Walid Choucair and Fabiana Abdel-Malek, a former compliance officer for UBS AG’s London branch, for prohibited insider trading. The alleged wrongful conduct occurred from June 2013 to June 2014. According to the FCA, Ms. Abdel‑Malek disclosed confidential information on five separate occasions to Mr. Choucair, who traded on the information. If convicted, the each individual faces up to seven years’ imprisonment.

  • HK SFC Suspends Broker Eight Months for Transferring Proprietary Information and Company Date from Former to New Employer: The Hong Kong Securities and Futures Commission barred Mr. Fok Chi Kin, a former vice president of JPMorgan Funds (Asia) Limited (JPFL), from engaging in any licensed securities activities for eight months for transferring proprietary information and client data on several occasions without permission from JPFL to BNP Paribas Investment Partners Asia Limited, his new employer. Specifically, the SFC found that Fok sent JPFL sales presentations and a client list to his personal email prior to leaving as an employee, and then transferred the client list to his email at BNP. In addition to the suspension, Mr. Fok was terminated from his position as a client relationship manager at BNP Paribas. JPFL discovered Mr. Fok’s wrongdoing as a result of an internal investigation. Separately, the SFC suspended Mr. Wu Biwei, a former responsible office and managing director of iSTAR International Futures Co. Limited (now known as Rifa Futures Limited) for six months for failing to comply with anti-money laundering regulatory requirements when processing third-party fund transfers. Earlier this year, SFC claimed that from January through July 2014 iSTAR accepted third-party deposits on behalf of clients without appropriate documentation and, in one instance, permitted a payment from a client’s account to the account of one of unnamed iSTAR officer; this officer now appears to have been Mr. Wu. iSTAR agreed to pay a fine of HK $3 million (approximately US $386,000) to resolve this matter. The SFC claimed that Mr. Wu, who was iSTAR’s most senior officer at the time, contributed to his firm’s failure to have proper AML controls.

  • CPO Settles NFA Charges of Facilitating Loans by Fund to Fund Manager: Hansa Capital Management, a Commodity Futures Trading Commission-registered commodity pool operator and commodity trading advisor, and its principal, Lothar Ruehling, agreed to pay a fine of US $20,000 to settle charges by the National Futures Association that a commodity pool they administered – Hansa Investment & Trading LLC – made non‑permitted loans or advances to Hansa Capital and engaged in other prohibited conduct. An NFA rule expressly prohibits a CPO from permitting a commodity pool to make a direct or indirect loan to the CPO or any other affiliated person or entity (click here to access NFA Rule 2-45).

  • Australian Brokerage Firm Fined AU $505,000 for Not Halting Suspicious Trades or Filing Suspicious Activity Report: Macquarie Securities (Australia) Limited agreed to pay a fine of AU $505,000 (US $382,629) to resolve charges by the Australian Securities and Investment Commission that it had engaged in “reckless” conduct when it permitted a customer to continue trading for 39 days after raising concerns that the activity might be suspicious, and for failing to file a suspicious activity report. According to ASIC’s Markets Disciplinary Panel, in 2014, Macquarie took on a client with a business model that was a “departure” from its usual customer business and customized its automated order processing system to accommodate the new activity. Although Macquarie’s trade surveillance monitoring software raised alerts regarding a substantial number of orders entered, it failed to take appropriate action. ASIC noted that Macquarie was aware of suspicious trading and failed to implement adequate measures to “minimize the risk of, and opportunity for breaches of the market integrity rules.”

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©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VII, Number 177
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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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