June 19, 2021

Volume XI, Number 170


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June 17, 2021

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June 16, 2021

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Bridging the Week: March 20 - 24 and March 27 (SARs and Red Flags; International Spoofing; Pre-Execution Discussions; Making Capital Markets Great Again)

Last week, a registered broker-dealer was charged by the Financial Industry Regulatory Authority for failing to consider whether problematic trading by certain direct market access clients that caused it to limit or stop their trading also warranted filing suspicious activity reports with the Financial Crimes Enforcement Network. Additionally, stock traders were substantially penalized in Singapore and China for engaging in spoofing-type conduct following first-of-their-kind enforcement activities by local authorities. Finally, Jay Clayton, President Trump’s nominee to serve as Chairman of the Securities and Exchange Commission, testified before a Senate committee that, if confirmed, he hoped to enhance US capital markets to make them more attractive to potential new issuers – perhaps by reducing regulations. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Clearing Firm’s Failure to File Suspicious Activity Reports in Response to Red Flags Charged as Violation of FINRA Requirements (includes Compliance Weeds);

  • Malaysian National Sentenced by Singapore Court to 16 Weeks Imprisonment for Stock-Based Spoofing; PRC Resident Fined by China Regulator for Similar Conduct (includes My View);

  • SEC Chairman Nominee Urges Making US Capital Markets Great Again (includes My View);

  • Floor Broker and Former Floor Broker Settle CME Disciplinary Action Alleging Pre-Execution Arrangement of Customer Fill (includes Compliance Weeds);

  • Brokerage Firms Fined Almost US $2 Million by HK Regulator for Position Reporting and Electronic Trading Systems Breaches;

  • Commentators Generally Supportive of CFTC’s Proposed Record Retention Amendments; and more.



  • Clearing Firm’s Failure to File Suspicious Activity Reports in Response to Red Flags Charged as Violation of FINRA Requirements: Electronic Transaction Clearing, Inc., a registered broker-dealer, was charged by the Financial Industry Regulatory Authority for failing to consider whether suspicious activity reports should have been filed with the Financial Crimes Enforcement Network after the firm limited or stopped certain direct market access customers’ trading activity. ETC had restricted trading by certain of its customers after 30 instances where the firm identified problematic conduct, including prearranged trades or trading without an apparent economic reason – red flags, charged FINRA. However, in connection with these circumstances, ETC did not additionally consider whether to file a SAR, despite also being advised that FINRA intended to bring charges against the firm for prior incidents of the same type. FINRA also charged ETC with not having an appropriate due diligence program for customers who might be foreign financial institutions; miscalculating amounts required to be set aside for its customers for parts of each month from August 2013 through March 2014 (i.e., reserve requirement); and violating Securities and Exchange Commission Regulation SHO for improper short sales handling, among other charges. FINRA seeks monetary penalties and other sanctions. Last year, the SEC set aside a determination by the Chicago Board Options Exchange, Inc. that ETC and two of its principals, Kevin Murphy and Harvey Cloyd, Jr., failed to apply its customer identification program to individuals trading on behalf of two omnibus accounts; failed to apply margin rules to the same traders; and failed to implement adequate surveillance tools for identifying suspicious activities of its customers. (Click here for details of this SEC determination.)

Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions of at least US $5,000 which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. In August 2015, for example, FINRA fined Aegis Capital Corp US $950,000 for selling unregistered penny stocks and related supervisory violations, and suspended and fined two individuals – Charles Smulevitz and Kevin McKenna – who served successively as chief compliance and anti-money laundering officers for the firm. According to FINRA, Mr. Smulevitz and Mr. McKenna failed to “reasonably” detect and review red flags of potentially suspicious transactions. As a result, they did not make a “reasoned determination whether or not to report the suspicious transactions to the Financial Crimes Enforcement Network … by filing a Suspicious Activity Report … as appropriate.” Recently, FinCEN said that covered institutions might also have to file SARs following cyber-events. Covered financial institutions should continually monitor transactions they facilitate and ensure they maintain and follow written procedures to identify and evaluate red flags of suspicious activities and file SARs with FinCEN when appropriate. (Click here for a helpful overview of anti-money laundering requirements for broker-dealers, including SAR requirements. Click here for a similarly helpful compilation of AML resources for members of the National Futures Association.) Moreover, covered institutions should ensure that problematic transactions identified by non-AML personnel (e.g., compliance staff) that may be violative of legal or regulatory standards are evaluated by AML personnel to determine whether a SAR should be filed with FinCEN. Indeed, the more of a consolidated ledger a firm can maintain of potential problems identified across otherwise separate surveillance functions, the more likely a firm will be able to recognize and act holistically upon material red flags.

  • Malaysian National Sentenced by Singapore Court to 16 Weeks Imprisonment for Stock-Based Spoofing; PRC Resident Fined by China Regulator for Similar Conduct: Dennis Tey Thean Yang, a Malaysian national, was sentenced to 16 weeks imprisonment by a Singapore judge after he pleaded guilty to charges that he engaged in spoofing-type conduct involving the trading of contracts for differences and their underlying securities between October 2012 and January 8, 2013. (CFDs involving securities typically are contracts between an investment bank and an investor where the parties exchange the difference in the price of a specific quantity of a security between the beginning and end of the term of the contract.) According to the Monetary Authority of Singapore, during the relevant time, Mr. Tey placed “false orders” in the underlying securities listed on the Singapore Exchange in order to influence the prices in the corresponding CFDs offered by IG Asia Pte Ltd and CMC Markets Singapore Pte. After executing the CFDs, Mr. Tey cancelled his orders in the underlying securities. He realized profits of Sing $30,239 (US $22,000) through his activities, said MAS. Mr. Tey was charged with his alleged offenses following an investigation by MAS and the Commercial Affairs Department of the Singapore Police Force. This action marked the first criminal enforcement effort by the Singapore authorities. Separately, the China Securities Regulatory Commission sanctioned Hanbo Tang RMB 251 million (US $36.4 million) including disgorgement of RMB 42 million (US $2.1 million), for engaging in cross-border market manipulation in China using the stock connect arrangement between the Hong Kong Exchange and the Shanghai Stock Exchange. According to CSRC, Mr. Tang accomplished his objectives with the assistance of his trader, Tao Wang (who also was fined RMB 600,000 (US $87,000)) by using three accounts in HK and one in China to engage in various manipulative practices, including spoofing and wash trading of a stock listed on the Shanghai Exchange. (Click here for background on the Shanghai and Shenzen Stock Connect – a means to access China stock markets through accounts in HK.) Both Mr. Tang and Mr. Wang are citizens of China. This case was the first enforcement action by CSRC related to cross-border market manipulation.

My View: Last year, Michael Coscia, the first individual prosecuted and convicted under the provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act that expressly prohibits spoofing, was sentenced to three years in prison. This was after Mr. Coscia settled civil actions related to the same conduct with the Commodity Futures Trading Commission, the Financial Conduct Authority and the CME Group by payments of aggregate fines of approximately US $3.1 million; disgorgement of profits; and a one-year trading suspension. Subsequent to his sentencing, Mr. Coscia appealed his conviction to a Federal Court of Appeals where oral arguments were held on November 10, 2016. As I have written many times, although Mr. Coscia’s conduct may have been problematic, he was convicted under a provision of law that prohibits “spoofing” but defines it as “bidding or offering with the intent to cancel the bid or offer before execution.” However, many legitimate orders, including stop loss orders, are placed with the goal or hope not to have the order executed, as that would mean the value of a position is declining. The Federal District Court judge overseeing Mr. Coscia’s trial did not have a problem with the clarity of the relevant statute and, in any case, believed that Mr. Coscia should have known his specific trading was prohibited. Soon we should know what the Court of Appeals thinks.

  • SEC Chairman Nominee Urges Making US Capital Markets Great Again: During testimony before the Senate Committee on Banking, Housing and Urban Affairs last week, Jay Clayton – nominated by President Donald Trump to become Chairman of the Securities and Exchange Commission – expressed concern that “our public capital markets are less attractive to business than in the past” and promised to pursue improvements to make them more attractive again. Reducing regulations could help this, he said. During his testimony, Mr. Clayton also suggested that fining companies for law violations may unfairly penalize shareholders and that “individual accountability drives behavior more than corporate accountability.” Mr. Clayton said, “Companies should be held accountable. If they make illicit profits, those profits should be disgorged. There should be deterrence at the company level but shareholders do bear those costs and we should keep that in mind.” Previously, President Trump nominated J. Christopher Giancarlo to serve as chairman of the Commodity Futures Trading Commission. His confirmation hearing before the Senate Committee on Agriculture Nutrition and Forestry has not yet been scheduled.

My View: In 2015, a not-for-profit think tank headed by Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, called for a substantial overhaul of the federal regulatory system that oversees US financial services, including merging the Commodity Futures Trading Commission and the Securities and Exchange Commission. Claiming that the oversight of US financial institutions “is highly fragmented, outdated, and ineffective,” the Volcker Alliance issued a report that recommended the creation of a so-called “twin-peaks” model of regulation. This paradigm would consolidate prudential oversight currently administered by a number of banking and financial regulators into one new independent federal agency—a prudential supervisory authority—and collapse the CFTC and the SEC’s investor protection and capital markets oversight functions into another new independent body. (Click here for background on the Volcker Alliance’s proposal.) Paul Atkins, a former SEC commissioner and current advisor to President Trump, has also called for a merger of the CFTC and SEC. (Click here for the Statement of Mr. Atkins before the Committee on Financial Services of the House of Representative on September 15, 2011.) For me, the alphabet soup of federal agencies with oversight over financial firms, products and markets needs to be rationalized, and the CFTC and the SEC should long ago have been merged. It is solely a naming convention to label financial products as either futures or securities (and now swaps too), and a terrible mistake to base regulatory structure on the nomenclature of products rather than their essential characteristics and purposes. Hopefully, after new chairpersons of the CFTC and SEC are confirmed, a debate on what is the most effective and efficient means of regulating our nation’s markets and participants can begin.

  • Floor Broker and Former Floor Broker Settle CME Disciplinary Action Alleging Pre-Execution Arrangement of Customer Fill: Oral Valentin, Jr., a former Commodity Futures Trading Commission-registered floor broker, agreed to pay a fine of US $35,000 and serve a 10-day CME Group trading suspension to resolve a disciplinary action brought by the Chicago Mercantile Exchange for allegedly receiving nonpublic information about a pending customer order for a Eurodollar options spread from a currently registered floor broker, and arranging and later executing his own order against the broker’s customer order. The CME claimed this transaction, which occurred on March 13, 2015, was a prohibited pre-negotiated and noncompetitive transaction. The floor broker, Mark Donahue, a CME member, also settled a corresponding disciplinary action by agreeing to pay a fine of US $20,000 and serving a 15-day trading suspension. Mr. Valentin, who is not a CME member, was recently registered as a floor broker from May 30, 2012 through June 11, 2013. Separately, Saxo Bank A/S, a member firm, agreed to pay an aggregate fine of US $190,000 to the Chicago Board of Trade and the Chicago Mercantile Exchange to resolve two disciplinary actions against it for the way it liquidated futures positions of its customers that were under-margined. According to the exchanges, on multiple dates between October 2014 and March 2015, Saxo employed a liquidation algorithm that automatically entered market orders for the entire amount of an under-margined customer’s positions. The exchanges said it did so without considering market conditions. As a result, on at least three occasions on the CBOT and two occasions on the CME, the liquidation caused “significant price movements.” CME Group said that the liquidations were a violation of its prohibition against entering actionable messages “with intent to disrupt, or with reckless disregard for the adverse impact on, the orderly conduct of trading or the fair execution of transactions.”

Compliance Weeds: Generally, for approved Globex-traded contracts, CME Group permits pre-execution communications to facilitate trading subject to strict requirements. (Pre-execution communications are never permitted in connection with open outcry transactions with the sole exception of CME options on S&P futures undertaken in accordance with large order execution rules.) These requirements include that the party on whose behalf a communication is being made previously must have consented to such communication and that no person involved in pre-trade communications may take advantage of information conveyed except to facilitate the relevant trade. Unfortunately, CME Group rules regarding cross trades vary by product and by futures and options. Even the mechanical steps for executing a cross trade following a conversation varies. There are Globex Crosses, Agency Crosses, Committed Crosses, and RFQ and RFC Crosses too. However, despite the complexity, the consequences of getting it wrong can be severe, resulting in not only potential CME Group sanctions, but possible sanctions by the Commodity Futures Trading Commission too. Fortunately, hidden in the middle of the relevant Market Regulation Advisory Notice related to pre-execution communications is a link to a very helpful matrix of eligible products and associated crossing protocols (click here to access).

  • Brokerage Firms Fined Almost US $2 Million by HK Regulator for Position Reporting and Electronic Trading Systems Breaches: Merrill Lynch Far East Limited (MLFE) and Merrill Lynch (Asia Pacific) Limited (MLAP) were fined HK $15 million (approximately US $2 million) by the HK Securities and Futures Commission for not complying with large order position reporting requirements for futures and stock options; for deficiencies of governance, testing, recordkeeping and risk controls for MLFE’s electronic trading system for futures; and for distributing futures research reports without disclosing their market making activities. In response, the firms engaged an independent consultant during the last quarter of 2016 to review their internal controls related to these matters. In determining the firms’ sanction, SFC considered MLFE’s and MLAP’s “prompt cooperation.” Without this, said SFC, “similar failures would have resulted in a substantially higher level of fine.”

  • Commentators Generally Supportive of CFTC’s Proposed Record Retention Amendments: Comments received by the Commodity Futures Trading Commission by the close of its comment period to its recent proposal to revise its record retention rule were overwhelmingly supportive. In its January 2016 proposal, the CFTC proposed a new “technology neutral” recordkeeping requirement that would eliminate the existing requirement that electronic records be maintained in their native file format and preserved exclusively in a non-rewritable, non-erasable format. Instead, the revised rule would be more principles-based. Electronic records would have to be maintained in a manner that ensures their reliability and authenticity, and each person required to maintain regulatory records would have to create, put in place and adhere to written policies and procedures “reasonably designed” to ensure the person’s compliance with the Commission’s recordkeeping requirements. (Click here for background on the CFTC’s proposal.) FIA’s comments were typical. They said “We… welcome and strongly support the proposed amendments.” Notwithstanding, the organizations recommended that the CFTC clarify that the proposed new rule extends to all required records, even if created prior to the effective date of such new rule. ICE Futures U.S. asked that the CFTC consider not requiring designated contract markets to keep every correction or amendment to every record. This is because, said IFUS, records are not defined for DCMs. As a result, noted IFUS, although it makes sense to keep an accurate history of certain information – for example audit trails and related audit trails – it does not make sense to for DCMs to keep copies of every proposed invoice and subsequent amendment, as well as drafts of meeting minutes, correspondence, sales presentations and other documents. The Edison Electric Institute asked the Commission to consider adding a provision in the final rule that makes clear that the new rule is not intended to add additional reporting requirements for entities that have limited recordkeeping obligations and are not registered with the agency. FIA, SIFMA and SunTrust requested the CFTC to work with the Securities and Exchange Commission to harmonize their recordkeeping rules. Consistent with this argument, a group of managed funds industry organizations, including the Managed Funds Association, requested that the CFTC adopt a substituted compliance regime so that persons registered with the SEC as investment advisers or are affiliated with IAs could comply with CFTC recordkeeping requirements by complying with recordkeeping mandates under the SEC’s recordkeeping rules for investment advisers.

And more briefly:

  • Most Securities to Settle in Two Not Three Days Beginning September 5: The Securities and Exchange Commission amended an existing rule to require broker-dealers to settle most securities purchases and sales two days after trade date as opposed to three days as currently done. Impacted securities will include stocks, bonds, municipal securities, exchange-traded funds and certain mutual funds; they will not include exempted securities. This new requirement is effective September 5. (Click here for background.)

  • FINRA to Industry: Can We Talk More?: The Financial Industry Regulatory Authority sought comment on how to enhance its interactions with members and other stakeholders to better “understand what it regulates.” FINRA believes that, through engagement, it can “enrich its regulatory programs and identify ways to protect investors and promote market integrity that are more practical, tailored and effective.” FINRA will accept comments through May 5.

  • HK Regulator Amends Position Limit Regime: Rejects Blanket Hedging Exemption But Expands Excess Limits Regime: The Hong Kong Securities and Futures Commission published its conclusions regarding a number of proposed enhancements to its position limits and reportable position regime that it proposed in September 2016. (Click here for background.) Among other things, the regulator rejected introducing a hedging exemption, saying that its alternative client facilitation excess limit regime is “intended to provide a mechanism for market participants to use exchange-traded futures and options to hedge their relevant business activities.” As part of its updated requirements, SFC will recommend to the HK Legislative Counsel that it be given the authority to raise the cap on excess positions it may approve from 50 percent to 300 percent.

  • Australian Regulator Announces How It Will Assess Service Providers Offering Digital Ledger Technology: The Australian Securities and Investments Commission published a framework it will apply when considering whether use of distributed ledger technology by financial services providers will enable them to comply with their requirements to have adequate technological resources, risk management arrangements and adequate human resources. Six questions firms will be required to answer are (1) how will DLT be used; (2) what DLT platform is being used; (3) how is DLT using data; (4) how is DLT run; (5) how will DLT comply with law; and (6) how does DLT impact others.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VII, Number 86



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...