December 8, 2021

Volume XI, Number 342


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Bridging the Week: March 7 - 11, and 14, 2016 (Civil Rights Violation; Spoofing; Disorderly Liquidation; Risk Management; Disaggregation)

Last week, a federal court in New York permitted a lawsuit to proceed alleging that a United States Attorney and other government officials violated the civil rights of a former hedge fund operator. In addition, both ICE Futures U.S. and CME Group settled a number of disciplinary actions alleging possible spoofing and market disruption; liquidating positions in a disorderly fashion; and trading based on non-public customer information. Finally, IFUS proposed amending one of its rules to permit the possible disaggregation of certain positions among affiliated persons for position limits calculation purposes to parallel a rule proposed by the Commodity Futures Trading Commission that has not yet been adopted. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Federal Court Allows Former Hedge Fund Operator’s Lawsuit Alleging Civil Rights Violations to Proceed Against US Attorney and Other Government Officials (includes My View);

  • IFUS Charges Trader With Possible Spoofing and Market Disruption While Another Entity Is Charged With Allegedly Liquidating Positions in a Disorderly Fashion to Avoid Speculative Limits Issues (includes Compliance Weeds);

  • CFTC Staff Issues Guidance on Elements of an Effective FCM Risk Management Program (includes Compliance Weeds);

  • FINRA Sanctions Broker-Dealer for Requiring Newly Hired Salespersons to Disclose Their Prior Firm’s Private Customer Information;

  • Guaranteed IBs Authorized by CFTC Staff to Introduce OTC Swaps to Swap Dealer and Cleared Swaps to FCM Other Than Guarantor (includes My View);

  • Another Non-Registrant Sanctioned by CFTC for Failure to File Accurate Monthly Reports of Cash Positions (includes Compliance Weeds and My View);

  • IFUS to Adopt CFTC Proposed Aggregation Rule as Its Own in Advance of CFTC Adoption While ICE Futures Europe Permits Use of EFPs to Roll Forward Soft Commodities Futures Contracts Because of Delivery Issues (includes Compliance Weeds);

  • CME Member Sanctioned for Trading on Non-Public Customer Information; FCM Fined for Netting Down and Not Closing Out Open Positions; and more.

Video Version:


  • Federal Court Allows Former Hedge Fund Operator’s Lawsuit Alleging Civil Rights Violations to Proceed Against US Attorney and Other Government Officials: A federal court in New York City refused to dismiss a lawsuit against Preet Bharara, the US Attorney for the Southern District of NY, and various FBI agents and employees of the US Attorney’s Office alleging violations of certain constitutional rights of David Ganek, a former hedge fund operator. Mr. Ganek filed a lawsuit against the defendants in February 2015, after he shut down his hedge fund, Level Global Investors, following a highly publicized raid by FBI agents on Level Global’s offices in November 2010. The raid was part of the US Attorney’s Office investigation of possible insider trading by financial professionals. In his complaint, Mr. Ganek alleged that an affidavit presented to a magistrate to authorize the raid “contained deliberate misrepresentations that were later exposed by sworn trial testimony of an FBI agent and a government informant.” Specifically, Mr. Ganek alleged that defendants stated in the affidavit that a former Level Global employee, Sam Adondakis, obtained inside information from third-party consultants and provided it to Mr. Ganek. However, claimed Mr. Ganek, defendants had no basis for the statement that, in fact, constituted a fabrication. Even after Mr. Bharara and other supervisory defendants learned of contrary facts stated in the affidavit, they did not advise the magistrate to correct the record, alleged Mr. Ganek. Saying that Mr. Ganek’s complaint contained “grave allegations,” the Hon. William Pauley III ruled mostly against defendants’ motion to dismiss and permitted Mr. Ganek’s lawsuit, which also alleged violations of his civil rights, to proceed.

My View: Sadly, the decision in this matter reads like an episode of Billions, the Showtime series based on the relentless and highly personal efforts of a fictional US Attorney to indict an equally make-believe hedge fund operator for insider trading. However, there can be no amusement in real life when activities of law enforcement personnel result in the demise of a real business and the suffering by real persons. This is particularly the case, as alleged by Mr. Ganek, where the warrant that authorized the highly publicized raid on the premises of his hedge fund that led to its demise may have been based on knowingly false information provided by government employees. Mr. Ganek’s claims are indeed, as the judge hearing this matter stated, “grave allegations.”

  • IFUS Charges Trader With Possible Spoofing and Market Disruption While Another Entity Is Charged With Allegedly Liquidating Positions in a Disorderly Fashion to Avoid Speculative Limits Issues : ICE Futures U.S. filed and settled charges against James Shrewsbury claiming that, on multiple occasions from November 2014 to March 2015, he may have engaged in trading practices that constituted spoofing and disruptive trading in violation of exchange rules. IFUS alleged that, during the relevant time, Mr. Shrewsbury engaged in a “pattern of activity” where he would enter an iceberg order at the best bid or offer. He would then enter a large fully displayed order on the opposite side of the market that “appeared to create artificial pressure and appeared to mislead market participants into trading opposite the pre-positioned iceberg order,” alleged IFUS. IFUS claimed that Mr. Shrewsbury would then cancel his large order within seconds of his iceberg order being executed. To resolve this matter, Mr. Shrewsbury agreed to pay a fine of US $139,850 and to disgorge profits of US $69,850. He also agreed to a 10-day suspension from access to all IFUS trading platforms. Separately, Cornerstone Global Commodities, a Commodity Futures Trading Commission-registered introducing broker, agreed to pay a fine of US $40,000 to resolve IFUS charges that it may have mishandled customer orders and block trades “in multiple instances.” According to IFUS, Cornerstone may not have complied with recordkeeping requirements related to customer orders; may have misreported the correct execution time of block trades; and may have submitted block trades beyond IFUS’s 15-minute reporting deadline. In addition, said IFUS, in one instance, the firm may also have improperly disclosed a customer’s identity while negotiating a potential block trade, and may not have fully cooperated with IFUS’s investigation. Finally, Glencore Grain BV agreed to pay a fine of US $200,000 to settle charges by IFUS that, on one day, it may have violated position limits in the July 2014 Cotton No. 2 futures contract. In addition, alleged IFUS, the firm may have caused “price movement” in the relevant futures contract and a corresponding July/December 2014 futures spread when, in response to a request by IFUS to reduce positions, the firm “waited until the final 20 minutes of trading to execute a high proportion of their transactions on the day prior to first notice day.”

Compliance Weeds: From perusing ICE Futures U.S.’s Disciplinary Notice related to Glencore Grain’s settlement it is hard to fully understand the facts underlying the firm’s alleged wrongdoing. However, the allegations of wrongdoing reminded me that there are actually two important elements of bona fide hedging transactions: First, the hedging transactions or positions ordinarily represent a substitute for transactions to be made or positions to be taken in the future and are economically appropriate for the risk in the conduct and management of a commercial enterprise. Second, hedge positions must be ”established and liquidated in an orderly manner “ consistent “with sound commercial practices.” Both legs must be met; it’s not either or. (Click here for details in the CFTC’s definition of bona fide hedging transactions in CFTC Regulation 1.3(z).)

  • CFTC Staff Issues Guidance on Elements of an Effective FCM Risk Management Program: Staff of the Division of Swap Dealer and Intermediary Oversight of the Commodity Futures Trading Commission issued an advisory that provides guidance, in their view, regarding elements of an effective risk management program (RMP). Pursuant to applicable CFTC rule, future commission merchants are required to establish, maintain and enforce risk management policies and procedures designed to monitor and manage the risks associated with their business (click here to access CFTC Rule 1.11). Among the risks FCMs should address in their RMP are market, credit, liquidity, foreign currency, legal, operational, settlement, segregation, technological and capital risks. Each FCM’s RMP must be administered by a risk management unit (RMU) that is independent of the firm’s business unit (BU) and reports directly to the FCM’s senior management. In the advisory, staff makes specific recommendations or provides multiple observations regarding elements of what it appears to consider more effective RMPs. Among other items, staff suggests that FCMs may want to include in their RMPs a description of how independence of the RMU is maintained from the BU; how often an FCM considers the adequacy of resources of the RMU; and a description of risk tolerance limits, including, for each risk type, the methodology to determine the limits and the procedure to ensure quarterly review and approval by senior management and annual approval by the FCM’s governing body. Staff also made observations regarding the quarterly risk exposure reports that must be made to an FCM’s senior managers and governing body, and provided to the CFTC. Among other things, staff observed that some FCMs disclose actual risk exposures for each period for each risk metric rather than just discuss breaches. According to staff, “[f]or example, the maximum, minimum, median and standard deviation for risk exposures could be provided or shown graphically over the course of the quarter.” The staff's advisory is dated March 2, 2016.

Compliance Weeds: Although staff’s guidance is expressly limited to the application of its risk management program requirements to FCMs that handle customer funds, a similar requirement to maintain RMPs applies to swap dealers and major swap participants (click here to access the relevant CFTC Rule 23.600). Although staff indicated that similar guidance might be issued to SDs and MSPs later, this FCM guidance should be considered by SDs and MSPs, by analogy, to evaluate the adequacy of their own RMPs. Also, as staff commented in its guidance, an FCM must broadly evaluate its risks when designing its RMP. An FCM must consider risks posed by affiliates, all lines of the FCM’s business, all other FCM trading activity and “must describe in detail how the RMP has been integrated into risk management at the consolidated entity level.” (Click here for further CFTC guidance on RMPs in the Federal Register release adopting CFTC Rule 1.11 (pgs. 68517 – 68521).)

  • FINRA Sanctions Broker-Dealer for Requiring Newly Hired Salespersons to Disclose Their Prior Firm’s Private Customer Information: Raymond James & Associates, Inc. agreed to pay a fine of US $500,000 to settle charges by the Financial Industry Regulatory Authority that, from January 1, 2011, to March 31, 2015, it encouraged newly recruited salespersons to disclose non-public personal information about their customers at their prior employer. This constituted a violation of applicable requirements of the Securities and Exchange Commission because the firm failed to determine whether its new recruits or their prior broker-dealers had obtained consents from customers to disclose private information. (Click here to access SEC Regulation S-P; see in particular sections 7 and 10.) Among the non-public information obtained by Raymond James were customers’ names, addresses, telephone numbers, account types and other similar information.

  • Guaranteed IBs Authorized by CFTC Staff to Introduce OTC Swaps to Swap Dealer and Cleared Swaps to FCM Other Than Guarantor: Staff of the Commodity Futures Trading Commission’s Division of Swaps Dealer and Intermediary Oversight granted no-action relief to a futures commission merchant, permitting its guaranteed introducing brokers to arrange non-cleared over-the-counter swaps for its customers with swap dealers and cleared swaps that would clear through other FCMs. Ordinarily, a G-IB may only handle transactions for customers that carry their accounts on a fully disclosed basis with its guarantor FCM. (Unlike a non-guaranteed IB that must meet minimum capital requirements of US $45,000, a G-IB has no independent financial requirements. A G-IB’s obligations are fully guaranteed by its guarantor FCM.) Under the terms of staff’s no-action letter, the guarantor FCM will maintain net capital that exceeds the aggregate amount of net capital each of its G-IBs would have to maintain if non-guaranteed; the guarantor FCM’s and each of its G-IB’s guarantee agreement will be amended to accommodate the proposed activity; each G-IB client will be a highly qualified person or entity known as an “eligible contract participant;” for cleared swaps; each carrying FCM will be selected by the G-IB’s clients; and the G-IBs will receive no compensation from the clearing FCMs selected by its clients. Pursuant to the no-action letter, the guarantor FCM will be liable for all obligations of its G-IBs under applicable law. The staff's no-action relief is dated February 29, 2016.

My View: Attempted compliance by introducing brokers handling swaps transactions with applicable CFTC requirements provides an unsavory path past Scylla and Charybdis that perhaps only Odysseus can safely navigate. One CFTC rule still provides that each IB must open each customer’s account with a carrying FCM, while another states that each FCM statement must reflect that the account was introduced by an IB and identify the name of the IB. (Click here to access CFTC Rule 1.57(a) and here to access CFTC Rule 1.33(f).) These rules make no sense in connection with IBs introducing over-the-counter swaps transactions to swap dealers and cannot possibly be adhered to. The CFTC should amend its introducing broker rules to conform to the evolution of the role of IBs to handle swaps transactions and not leave a Damoclean sword hanging over swaps IBs. In the interim, staff should issue appropriate interpretive guidance.

  • Another Non-Registrant Sanctioned by CFTC for Failure to File Accurate Monthly Reports of Cash Positions: CHS, Inc. and CHS Hedging, LLC, a wholly owned subsidiary of CHS, agreed to pay a fine of US $1 million for their failure to file accurate reports of CHS’s physical commodity positions from at least January 2000 until May 2013. CHS is an agricultural cooperative not registered with the CFTC in any capacity, while CHS Hedging is registered with the CFTC as a futures commission merchant. According to the CFTC, during the relevant time, CHS maintained reportable positions in corn and soybean futures to hedge fixed price physical corn and soybean positions. As a result, the firm was obligated to file a monthly report of its fixed price physical positions, known as a Form 204, with the CFTC. During the relevant tine, CHS Hedging filed this report on behalf of CHS. However, said the CFTC, CHS Hedging mistakenly included the same fixed position throughout the relevant time period for one of the three CHS business units that it was required to aggregate to report CHS’s overall positions. As a result, CHS’s reported positions were incorrect. CHS subsequently filed corrected Form 204s for January 2013 to May 2013.

Compliance Weeds: CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bona fide hedging position under CFTC rules. These documents must be made as of the close of business on the last Friday of the relevant month. Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report. Part III of Form 304 (Unfixed Price Cotton “On-Call”) must be filed by any cotton merchant or dealer that holds a so-called reportable position in cotton (i.e., pursuant to large trader reportable levels; click here to access CFTC Rule 15.03) regardless of whether or not it constitutes a bona fide hedge. Form 304 (Part III) must be made as of the close of business on Friday every week and received by the CFTC in New York by no later than the second business day following the date of the report.

My View: There are many obligations under CFTC rules that apply to non-registrants. The obligation to file Forms 204 and 304 for certain traders of agricultural futures contracts who engage in hedging of corresponding physical positions is just one of many such requirements. The technical processes regarding Forms 204 and 304 are difficult to follow: sometimes a report is filed weekly not monthly. Sometimes the trigger for the filing is a reportable position; other times it is a position in excess of a speculative position limit. Sometimes a report is filed in New York; other times it is filed in Chicago. These are details that can often be lost in translation. As a result, it is not surprising that some recent enforcement actions regarding breaches in reporting requirements have involved non-US based firms. However, US-based non-registrants have also been subject to CFTC sanctions, as in the instant enforcement action Although the length of time of CHS’s and CHS Hedging’s violation was extensive, it is still questionable whether a fine of US $1 million is justified for an agricultural cooperative’s violation of a rule that is arcane at best and where there appears to have been no intentional wrongdoing.

  • IFUS to Adopt CFTC Proposed Aggregation Rule as Its Own in Advance of CFTC Adoption While ICE Futures Europe Permits Use of EFPs to Roll Forward Soft Commodities Futures Contracts Because of Delivery Issues: ICE Futures U.S. intends to implement a rule change that potentially permits a person from not having to aggregate its positions with a related entity to assess compliance with exchange speculative position limits. Under the IFUS amended rule, a person could apply to the exchange for authority not to aggregate its positions with another person where it holds a 10 percent or greater equity interest if (1) the individuals controlling the trading of the relevant accounts do not have knowledge of each other’s trading decisions; (2) the accounts are traded pursuant to separately developed and independent trading strategies; (3) there are written procedures precluding access to information regarding the trades, positions and strategies of each account; and (4) there is no sharing of information by the persons controlling each account’s trading decisions. The relief, modeled after a similar de-aggregation proposal of the Commodity Futures Trading Commission made in September 2015, would not apply to IFUS positions subject to federal position limits. (Click here to access details of the CFTC proposed de-aggregation rule.) The amended rule is scheduled to be effective March 18, 2016. Separately, ICE Futures Europe announced that, going forward, it would permit exchange for physical transactions for the purpose of rolling forward futures positions in soft commodities where delivery could not occur. To evidence that such EFPs were bona fide, parties would be required, upon request by the exchange, to produce evidence that there were performance issues that precluded delivery of the relevant physical commodity. Effectively, one party would sell the physical position it did not receive and buy a forward futures contract, and the other party would buy the physical position it did not deliver and sell a forward futures contract.

Compliance Weeds: Both of these developments are significant. Traditionally, an exchange of futures for a related position must involve the purchase (or sale) of a futures position (or option under certain circumstances) and the simultaneous sale (or purchase) of a related position. There must be customary documentation to evidence the related position transaction that must be produced to an exchange upon request. In connection with the limited circumstances of delivery issues involving soft commodities, ICE Futures Europe will now permit the use of exchange for futures transactions to roll forward a futures contract. Effectively, the cash leg of such transaction will be the physical position that was not delivered. This is a highly exceptional circumstance and the principle cannot, for now, be applied to other exchanges or even other products on ICE Europe. Likewise, ICE Futures U.S.’s proposed amendment of its rules to potentially permit accounts of related entities or persons to be disaggregated for purposes of complying with exchange-position limits in advance of the adoption by the Commodity Futures Trading Commission of a similar rule is a practical response to situations where accounts within a corporate group are truly independently traded and one entity does not coordinate directly or indirectly with the other. The CFTC currently permits disaggregation for certain accounts of eligible entities (mainly certain commodity pool operators or commodity trading advisors) subject to independent control, but not to accounts of non-eligible entities. Again, this potential relief will not apply to positions subject to federal speculative position limits.

  • CME Member Sanctioned for Trading on Non-Public Customer Information; FCM Fined for Netting Down and Not Closing Out Open Positions: Andrew Rudich, a member of the Chicago Mercantile Exchange, agreed to settle charges brought by the CME that, on numerous occasions between March 1, 2012, and July 25, 2012, he personally traded based on non-public information regarding a customer’s intended transactions. During this time, claimed CME, Mr. Rudich personally traded in Lean Hogs futures contracts prior to the beginning of the closing range based on his knowledge of a customer’s market on close orders. According to CME, Mr. Rudich then closed his positions during the closing range. Mr. Rudich agreed to resolve CME’s charges by disgorging profits of US $114,000, paying a fine of US $25,000 and not trading any CME Group product for one year. Separately, Penson Futures agreed to pay a fine of US $100,000 for impermissibly netting down certain long and short futures positions on the Chicago Board of Trade on 35 occasions between July and September 2010. According to the CBOT, during this time, Penson netted down long and short futures positions during the first two business days prior to the delivery month and during the delivery month for various expiring agricultural futures contracts. These close-outs exceeded one percent of the open interest of the relevant futures contract, in violation of relevant CBOT rule. Penson reported these close-outs were the result of an “error.”

And more briefly:

  • Now You See It, Now You Don't –​ CFTC EEMAC Withdraws Report Regarding Proposed Position Limits: The February 25, 2016 report issued by the Commodity Futures Trading Commissions's Energy and Environmental Markets Advisory Committee, saying there was no evidence justifying proposed CFTC position limits, was withdrawn last week. In a statement issued by Commissioner J. Christopher Giancarlo, sponsor of EEMAC, "[t]he report was never intended to be a distraction from the substantive policy work of the Committee and the volunteer members who give their time and expertise." No other explanation was provided for the withdrawal. (Click here for details regarding the EEMAC report.)

  • European Regulators Publish Draft Rules Regarding Margin Requirements for Uncleared Swaps: A joint committee of European regulators, including the European Securities and Markets Authority, published final draft regulatory technical standards outlining margin requirements for uncleared swaps. Among other things, the draft RTS requires that counterparties to uncleared swaps exchange initial and variation margin; specifies eligible collateral; discusses documentation and the timing of collateral transfers; and covers the procedures for intragroup transactions.

  • Inspector General Recommends Measures to Increase Productivity at CFTC Office of Chief Economist: The Office of the Inspector General of the Commodity Futures Trading Commission issued a follow-up report on its 2014 report regarding operations of the CFTC’s Office of Chief Economist. OIA’s 2014 report followed allegations by the Chicago Mercantile Exchange that CFTC economists were improperly accessing and publishing confidential trade data. Although OIA did not confirm CME’s allegations, it made recommendations regarding the OCE’s research program and pre-publication review process. In its current review, among other things, OIA made recommendations to improve OCE's academic productivity. It also identified “reports by multiple OCE economists of censorship of politically sensitive research topics.” CFTC management disputed the findings regarding censorship. OIA's report is dated January 13, 2016.

  • CFTC Staff Clarifies CPO-PQR FAQ: Staff of the Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight clarified certain Frequently Asked Questions recently issued by the Division regarding Form CPO-PQR (click here to access the relevant FAQ). CPOs are required to file this form on a quarterly basis with the National Futures Association if they have $1.5 billion in aggregated assets under management as of the close of business on any day during the quarter, or annually if otherwise (NFA Form PQR must be filed by CPOs of all sizes on a quarterly basis; click here for details). The CFTC form requires disclosure of specified information regarding the CPO and each of its pools. Among other things, the FAQ indicated that parallel managed accounts must be aggregated with the pool with the largest assets under management to which the parallel accounts relate. However, staff agreed to defer this requirement until the reporting period ending December 31, 2016. The staff's clarification is dated February 25, 2016.

  • CME Group Says Once a Position Is Closed, It’s Always Closed: CME Group amended certain of its rules to make clear that, for all futures and options contracts, it is not permitted to re-open a position once it has been closed out at the CME Clearing House and a corresponding change has been made to open interest. Positions may be re-established through authorized trading activity.

  • NFA Will Review and Approve Uncleared Swaps Margin Models for SDs and MSPs: The National Futures Association announced that it will review and approve initial margin models for uncleared swaps by swap dealers. Under recently adopted rules of the Commodity Futures Trading Commission related to uncleared swaps, relevant SDs may use a standardized methodology to calculate margin requirements or use an internal model approved by the CFTC or NFA. NFA will issue further details regarding its submittal process.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 74

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...