June 21, 2021

Volume XI, Number 172


June 18, 2021

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Bridging the Week: MF Global; Customer Funds Investments; Whistleblowing; It’s Constitutional [VIDEO]

A week ago Friday, a federal court refused to dismiss a lawsuit brought by the plan administrator for MF Global against the firm’s former accounting and auditing firm for its alleged wrongdoing in providing advice that the plan administrator claims substantially led to MF Global’s collapse. In addition, over a vehement objection by one commissioner, staff of the Commodity Futures Trading Commission restricted futures commission merchants from investing customer funds in certain money market funds beginning October 14, except for their own funds in segregation in excess of a required buffer. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Court Refuses to Dismiss Malpractice Claim Against MF Global Accountant;

  • CFTC Staff Restricts FCM Investment of Customer Funds in Money Market Funds; Grants Exception to House Money in Segregation in Excess of Regulatory Requirements (includes My View);

  • SEC Sanctions Publicly Traded Company for Restricting Whistleblowing Claims in Employee Severance Agreements (includes Legal Weeds);

  • Appellate Court Says SEC Administrative Forums Constitutionally Okay for Enforcement Actions; and more.


  • Court Refuses to Dismiss Malpractice Claim Against MF Global Accountant: PriceWaterhouseCoopers LLP failed in its effort to have a federal court in New York City dismiss a malpractice claim brought against it by the plan administrator for MF Global Holdings, Ltd. for the accounting and auditing firm’s alleged role in the collapse of MF Global in 2011. According to a complaint previously filed by the plan administrator, PwC engaged in “extraordinary and egregious” professional negligence in approving MF Global’s accounting methods for certain transactions in European sovereign debt (known as repurchase to maturity or RTM transactions) and for certain tax advice regarding the propriety of not recording a valuation allowance against certain deferred tax assets (thus effectively increasing reported income). (For fiscal year 2011, MF Global accounted for its European sovereign debt transactions – which were structured as RTM transactions – as sales, thus not including a future obligation to repay as a liability on the firm’s balance sheet. This permitted MF Global to report the transactions as gains at the time of the sale, notwithstanding its subsequent obligation to repay the sale price.) PwC and the plan administrator disagree whether it was MF Global's own business decision to engage in the RTM transactions or whether it did so based on PwC's accounting advice; the parties also disagree why PwC did not record a valuation allowance until late October 2011. The plan administrator claims that MF Global's reliance on PwC's advice substantially caused the firm's collapse. PwC denies the plan administrator's allegations. Moreover, each party was likely at worse an equal wrongdoer, says PwC – a defense known as in pari delicto  – and thus, the plan administrator's lawsuit against it should not stand. However, in ruling against PwC, the court held that PwC had not satisfied its burden at this time to demonstrate the absence of “any genuine issue of material fact on the in pari delicto defense or on the Plan Administrator’s [negligence] claim.” The plan administrator initially filed its complaint against PwC in March 2014. Most of the plan administrator's causes of action against PwC were previously dismissed by order of the relevant federal court, except for the professional malpractice claim.

  • CFTC Staff Restricts FCM Investment of Customer Funds in Money Market Funds; Grants Exception to House Money in Segregation in Excess of Regulatory Requirements: Staff of the Commodity Futures Trading Commission issued both an Interpretation and No-Action Relief prohibiting future commission merchants and derivatives clearing organizations from investing customer funds in money market funds that reserve the right to suspend redemptions for up to 10 business days and/or impose liquidity fees under certain circumstances. This action follows the adoption by the Securities and Exchange Commission in August 2014 of new rules that require a money market fund to retain authority to suspend investor redemptions under enumerated circumstances and/or to impose liquidity fees if a fund’s liquidity drops below a threshold amount. Money market funds investing in corporate debt securities (Prime MMFs) must mandatorily adopt these conditions while MMFs investing in government securities (Government MMFs) may elect (but are not mandated) to adopt these requirements. According to staff, when the SEC’s rules become effective on October 14, FCMs may no longer invest customer funds in Government MMFs electing to impose the new requirements (electing Government MMFs) or in any Prime MMFs as FCMs will not be able to ensure that they can redeem 100 percent of their investment in such funds by the business day following a redemption request, as required by applicable regulation (click here to access CFTC rule 1.25(c)). Similarly, staff said that DCOs would likewise be precluded, beginning on October 14, from accepting as initial margin from FCMs on behalf of their customers, or investing funds from FCMs for the benefit of their customers in, Prime MMFs or electing Government MMFs because such investments would pose “more than minimal liquidity risks,” among other reasons. However, staff expressly authorized FCMs to invest their own funds maintained in customer-segregated accounts in excess of their targeted residual amount (i.e., the buffer of a firm’s own capital an FCM is required to maintain in its customer-segregated accounts to help ensure customer safety) in Prime MMFs or electing Government MMFs. CFTC Commissioner Sharon Bowen blasted this carve-out permission for FCMs as creating a “window dressing” of customer protection, claiming that “[i]f the funds are not suitable investments for customer funds then they are not suitable for the additional capital that the FCMs put in those accounts to protect against potential shortfalls.” Under both staff's Interpretation and No Action Relief, FCMs and DCOs can continue to handle non-electing Government MMFs mostly as they do now. Contemporaneously with staff issuing its guidance, the CFTC also issued an order and proposed an amendment to an existing rule to facilitate the holding by the Board of Governors of the Federal Reserve System of segregated customer funds’ accounts on behalf of certain DCOs.

My View: Although it appears that CFTC staff has clear authority to restrict investment of customer funds by FCMs in Prime or electing Government MMFs because of the express language of the relevant CFTC regulation, this authority is less evident for the action CFTC staff took regarding DCOs last week. In restricting the ability of DCOs to accept from FCMs on behalf of their customers as initial margin, or invest customer funds in, Prime or electing Government MMFs, CFTC staff applied definitions of the words “minimal” and “minimize” to interpret existing CFTC rules that broadly enumerate DCOs’ risk management, financial resources and customer protection obligations. (Click here to access CFTC Regulation 39.13(g)(10); here for CFTC Regulation 39.11(e)(1)(i); here for CFTC Regulations 39.15(c) and 39.15(e); and here for CFTC Regulation 39.36(f).) Although the outcome of the staff's guidance seems reasonable in light of the new SEC requirements, staff’s actions might have been more appropriately implemented through CFTC rulemaking – including considering public comment and conducting a cost/benefit analysis – given the widespread impact of staff's interpretation. On the other hand, it is not clear why Commissioner Bowen is so outraged by staff’s granting permission to FCMs to continue to invest their own funds in Prime and electing Government MMFs in their customer-segregated accounts in excess of their targeted residual amount (i.e., not changing the status quo). Whatever the potential limitations on FCMs recovering the full value of their MMF investment on the next business day following a request for redemption, having any FCM’s excess capital in customer-segregated accounts is preferable to having no FCM excess capital in such protected accounts. As Chairman Timothy Massad wrote in supporting staff’s initiative, “the system as a whole [is] better off if [an FCM’s] excess funds are on deposit, and we do not wish to incentivize FCMs to withdraw such excess funds from the segregated account.”

  • SEC Sanctions Publicly Traded Company for Restricting Whistleblowing Claims in Employee Severance Agreements: Blue Linx Holdings Inc., a publicly traded company listed on the New York Stock Exchange, agreed to pay a fine of US $265,000 and to certain undertakings to settle charges brought by the Securities and Exchange Commission that the company impermissibly inhibited whistleblowing by ex-employees. According to the SEC, Linx Holdings included provisions in severance agreements with ex-employees that prohibited them from sharing confidential information about the company learned while employed with any third party unless “compelled to do so by law or legal process.” This prohibition, said the SEC, violated provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that encourage whistleblowing and an SEC regulation that prohibits any person from impeding an individual “from communicating directly with the Commission staff about a possible securities law violation, including enforcing or threatening to enforce, a confidentiality agreement…with respect to such communication.” Two years after the SEC adopted this rule (SEC Rule 21F-17), Blue Linx amended its severance agreements to authorize whistleblowing, but added a standard clause requiring ex-employees to waive their right to any monetary recovery in connection with any complaint or charge filed with an administrative agency. Blue Linx agreed to add a provision to all its severance agreements expressly permitting ex-employees to file charges or complaints with administrative agencies, and to collect any relevant award among its undertakings as part of its settlement.

Legal Weeds: Both the Commodity Futures Trading Commission and the Securities and Exchange Commission have express rules that prohibit the waiver of the right of any person to file a whistleblower complaint with the agencies and receive a monetary award. (Click here to access CFTC Rule 165.19 and here to access SEC Rule 240.21F-17) Employees also may not be retaliated against for whistleblowing (Click here, e.g., to access Section 23(h)(1) of the Commodity Exchange Act, 7 USC §26(h)(1) and here for Part A to Part 165 of the CFTC Rules.) SEC and CFTC registrants and SEC-regulated publicly traded companies should review their form employment and severance agreements to ensure they are consistent with regulatory requirements regarding employee and ex-employee whistleblower rights.

  • Appellate Court Says SEC Administrative Forums Constitutionally Okay for Enforcement Actions: A federal court of appeals in the District of Columbia upheld the constitutionality of the Securities and Exchange Commission’s administrative judges to hear SEC-initiated enforcement proceedings. The petitioners in the action, Raymond J. Lucia Companies Inc. and Raymond J. Lucia, had argued that hearings before such administrative judges violated the US Constitution because the administrative judges hearing and deciding such actions were not appointed by the President of the United States. However, the appellate court rejected this argument, claiming that, because the SEC retains ultimate discretion to review an ALJ’s initial decision on its own initiative or upon a petition for review by a party or aggrieved person, only the SEC’s own order represents the final determination in an administrative proceeding. Since the US President appropriately appoints SEC commissioners, SEC administrative hearings are lawful, said the appellate court. Following an administrative hearing, the SEC previously imposed sanctions on the petitioners for violating its rules against misleading advertising by investment advisers (click here to access the relevant decision). Generally, the SEC may bring enforcement actions in an administrative tribunal or in a federal court.

And more briefly:

  • CFTC Addresses Filing Deadlines for FCM and Swap Dealer CCO Annual Reports: The Commodity Futures Trading Commission proposed amendments to existing rules to permit futures commission merchants, swap dealers and major swap participants to file mandated chief compliance officer annual reports with it by no later than 30 days following such entities’ filing of mandated annual financial reports (90 days after their fiscal year-end). Under existing rules, such CCO annual reports must be filed within 60 days after a registrant’s fiscal year-end; however, such reports may now be filed later under a staff no-action letter (click here to access the relevant no-action letter). In addition, the CFTC proposed to amend its rules to permit FCMs relying on substituted compliance with a foreign jurisdiction’s equivalent CCO requirements to file a comparable CCO annual report with it 15 days after the date such comparable report must be completed locally, and to delegate to CFTC staff the authority to grant extensions in time for the filing of CCO annual reports. The CFTC will receive comments on its proposed amendments for 30 days after they are published in the Federal Register.

  • FINRA Proposes to Update Gifts, Gratuities and Non-Cash Compensation Rules; Recommends Gift Threshold Increase: The Financial Industry Regulatory Authority proposed amendments to existing rules to permit an increase in the value of gifts persons associated with a member may give in connection with the securities business of the member from $100 to $175/annually, as well some revised related recordkeeping requirements. FINRA claimed that such increase was justified as a result of the impact of inflation on the $100 limit that was first adopted in 1992. FINRA also proposed to extend its restrictions on members and their associates making or receiving non-cash compensation (with some exceptions) solely in connection with the sale of certain enumerated products to all securities, and to require all members to adopt written polices and supervisory procedures related to business entertainment to avoid activity “that is intended to, or could reasonably be perceived as intended as, an improper quid pro quo.” FINRA will accept comments on its new proposals through September 23, 2016.

  • FINRA Reminds Members to Accurately Report Time of Execution on TRACE Reports: The Financial Industry Regulatory Authority issued a reminder to members to accurately report the time of execution for transactions in TRACE-eligible securities. (Under TRACE – FINRA’s trade reporting and compliance engine – broker-dealers must report transactions in certain fixed-income securities within certain time frames (typically 15 minutes; click here for precise time frames)). According to FINRA, the time of execution is typically “when the parties to the transaction agree to all of the material terms sufficient to calculate the dollar price of the trade – i.e., when there has been a ‘meeting of the minds’ with regard to material terms such as price and quantity.”

  • Investment Bank Agrees to FINRA Settlement for Internal Hoots That Allegedly Risked Leakage of Confidential Information: Deutsche Bank Securities Inc. agreed to pay a fine of US $12.5 million to the Financial Industry Regulatory Authority to settle charges that the firm failed, from January 2008 to the present, to have adequate supervisory systems, including written supervisory procedures, to preclude registered representatives from sharing potential nonpublic information obtained over internal broadcast system speakers (known as “Hoots”) with customers. This was despite, claimed FINRA, red flags that its supervision was inadequate from internal audit department findings and recommendations from compliance staff. DBSI was not charged with unlawfully providing any non-confidential information to clients but solely with failure to supervise.

  • Revised FINRA Reporting Requirements for NMS Stocks for ATSs Effective on November 7: The Financial Industry Regulatory Authority announced that the Securities and Exchange Commission has approved its new rule requiring the recording and reporting of certain order and execution information for national market system stocks by alternative trading systems, including so-called “dark pools.” This information includes data reported by all ATSs at the time of order receipt and at the time of order execution; data that displays subscriber orders; and data specific to ATSs that are registered as alternative display facility trading centers. (Click here for background on ADFs.)

  • NFA to Amend Rules to Encompass New FinCEN Beneficial Owner Requirements: The National Futures Association reminded members that the Financial Crimes Enforcement Network has adopted final rules requiring future commission merchants and introducing brokers to verify the beneficial owners of new legal entity customers (e.g., corporations, limited liability companies, partnerships) beginning May 11, 2018. NFA also reminded its members that FinCEN requires its members to maintain ongoing risk-based customer due diligence procedures in order to conduct ongoing monitoring and report suspicious activities. NFA said it will amend its own rules and interpretive notice (click here to access NFA Rule 2-9 and here for NFA’s related interpretive notice on anti-money laundering) to conform to FinCEN’s changes. (Click here for background related to FinCEN’s new final rule.)

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 228



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...