June 21, 2021

Volume XI, Number 172


June 18, 2021

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Bridging the Week: October 17 to 21 and October 24, 2016 (Floor Trader Registration; Source Code; Soliciting From Abroad; Liability May Not Equal Fines) [VIDEO]

Amendments to proposed Regulation AT will likely be issued by the Commodity Futures Trading Commission very soon in a supplemental proposal that will modify, but not eliminate, initial requirements related to registration, source code and who is obligated to maintain risk controls. In addition, related non-US bank entities settled with the Securities and Exchange Commission for advising and handling securities transactions with US persons for over a decade without appropriate registration. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Registration Based on Quantitative Test Likely to Be Part of Supplemental Regulation AT, Suggests CFTC Chairman (includes My View);

  • Non-US Bank Charged by SEC With Providing Cross-Border Brokerage Services to US Persons Without Registration (includes Compliance Weeds);

  • Accounting Firm Sanctioned by SEC for Not Detecting Client’s Fraud;

  • Broker-Dealer Fined US $2.8 Million by FINRA for Inaccurate Reporting of Millions of Trades Over Four Years;

  • Follow-up: Recent CME Group Disciplinary Action Suggests Liability May Not Automatically Mean Fines (includes My View); and more.

Registration Based on Quantitative Test Likely to Be Part of Supplemental Regulation AT, Suggests CFTC Chairman

Timothy Massad, Chairman of the Commodity Futures Trading Commission, indicated last week that he continues to support a federal registration requirement for certain algorithmic traders not currently required to be registered with the CFTC – as currently proposed in the agency’s November 2015 Regulation Automated Trading. However, Chairman Massad suggested that, in a forthcoming CFTC-issued supplemental proposal he supports, the universe of affected traders would be limited by an unspecified “volume-based” quantitative test.

Mr. Massad made his comments regarding Regulation AT before the Managed Funds Association’s Outlook 2016 Conference. In his presentation, Mr. Massad did not reveal when the Commission might issue a supplemental proposal but expressed his “hope” that the CFTC would act on it very soon.

Regulation AT, as proposed, is a comprehensive set of new rules that, if adopted, would potentially impose many new risk controls and other obligations on certain CFTC registrants (termed “AT Persons”) that use algorithmic trading systems – including both black box trade origination systems and smart automated order routing systems – to trade futures, related options or swaps on designated contract markets. Under the CFTC’s proposed initiative, any person that uses an algorithmic trading system that electronically and directly routes orders to a DCM other than first through a clearing-member futures commission merchant must be registered with the CFTC as a floor trader unless such person is otherwise registered with the CFTC in another capacity. Once registered as a floor trader, such person would be subject to all requirements of other AT Persons. As currently proposed, there is no volume or other quantitative threshold to limit the potential universe of new registrants and many commentators warned that, as a result, the universe of potential new registrants could be in the thousands. (Click here for background on the requirements of proposed Regulation AT.)

Chairman Massad suggested that the purpose of introducing a quantitative threshold would be to ensure that the number of persons newly required to register as floor traders would not be “too broad” but would solely capture “the most active firms.”

In addition, Mr. Massad indicated that a controversial provision of proposed Regulation AT obligating AT Persons to produce algorithmic systems’ source code upon request by the CFTC or the Department of Justice (as opposed to pursuant to subpoena) would likely remain in the supplemental proposal but would include measures “that respect the proprietary value and confidentiality of source code.” He did not indicate what those measures might be.

Finally, Chairman Massad indicated that he agreed with commentators to Regulation AT who argued that requiring all algorithmic traders, FCMs and DCMs to be responsible for maintaining risk controls – as proposed – was too redundant. He said he now supported a proposal that DCMs and either FCMs or traders be responsible for risk controls. He noted that he also supported suggestions that risk controls should pertain to all electronic trading – not just algorithmic trading.

A supplemental proposal to an existing proposed new regulation should be subject to a period of public comment following its issuance.

My View: It is ironic that, shortly after the CFTC proposed Regulation AT, President Obama signed into law the Defend Trade Secrets Act that heightened the protections afforded all intellectual properly. As proposed, Regulation AT provides the CFTC and the DoJ an unfettered right of access to an AT Person’s algorithmic systems’ source code – whether developed proprietarily or by a third party – without any protections against inadvertent or even purposeful misappropriation. In response, many commentators questioned the practical benefit for the CFTC ever to obtain source code from an AT Person in the first place. However, even if the CFTC could effectively utilize source code, many commentators also questioned the fairness (let alone constitutionality) of the agency obtaining source code through its inspection authority, rather than through a subpoena. It appears that Chairman Massad believes that the CFTC should not relent on its goal of having the authority to acquire source code through the Commission’s inspection powers, although he seems to acknowledge that this authority should not be unfettered and should afford certain protections. However, as recognized by the Defend Trade Secrets Act, all intellectual property, including source code, should be afforded the highest protections. Consistent with the objective of this new law, if the CFTC or the DoJ seeks access to source code, at a minimum, they should be permitted to do so only through a subpoena that can be challenged and negotiated before an independent federal court to ensure adequate protections. 


  • Non-US Bank Charged by SEC With Providing Cross-Border Brokerage Services to US Persons Without Registration: Non-US-based Bank Leumi entities (collectively, Bank Leumi) agreed to pay a fine of US $1.6 million to the Securities and Exchange Commission and admit wrongdoing to resolve charges that they advised and handled securities transactions for US persons from at least 2002 through 2013 without being registered as investment advisers or broker-dealers. According to the SEC, although Bank Leumi recognized its potential SEC exposure and began limiting its securities interactions with US customers beginning in 2008, it did not terminate most of its US customer securities accounts until 2011, nor fully cease its problematic conduct until 2013. In December 2014, Bank Leumi entered into a deferred prosecution agreement with the US Department of Justice after it admitted that it had helped US taxpayers file false tax returns with the Internal Revenue Service by hiding income and assets in offshore bank accounts. (Click here for details of this DoJ action) As part of Bank Leumi’s settlement with the SEC it agreed to disgorge profits from its wrongful activity that it did not already disgorge to the DoJ in connection with this related matter. The related Bank Leumi entities subject to the SEC action were Bank Leumi le-Israel B.M., Leumi Private Bank and Bank Leumi (Luxembourg) S.A.

Compliance Weeds: Both the Commodity Futures Trading Commission and the Securities Commission have rules related to the authorized solicitation and handling of certain transactions for US persons by non-US brokers and advisers. The CFTC maintains rules related to the execution of non-US futures and options only for US persons (click here to access CFTC Rules 30.5 and 30.12), as well as the carrying of accounts for non-US futures and options for US person (click here to access CFTC Rule 30.10). Under limited circumstances, a non-US broker affiliated with a US futures commission merchant may also execute US futures and options for US persons (click here to access CFTC Rule 3.10(c)(4)). The SEC has a rule too that provides an exemption from broker-dealer registration for non-US broker-dealers that, for US persons, may engage in unsolicited securities transactions; provide research reports to major institutional investors and effect transactions in subject securities for such investors; solicit and effect transactions with or for US institutional investors or major US institutional investors if chaperoned by a US broker-dealer; and solicit and effect transactions with or for certain designated US persons such as registered broker-dealers, banks acting in a broker-dealer capacity and certain international organizations (click here to access SEC Rule 15a-6 and here for an SEC-published FAQ regarding Rule 15a-6). The approach of the CFTC and SEC to lawfully conducting business from abroad with US persons is vastly different, and the devil, of course, is in the details. Separate CFTC and SEC requirements govern what non-US-originated products may be offered and sold to US persons.

  • Accounting Firm Sanctioned by SEC for Not Detecting Client’s Fraud: Ernst & Young agreed to pay sanctions in excess of $11.8 million to the Securities and Exchange Commission to resolve charges that it failed to comply with applicable accounting standards in its ongoing reviews of the financial statements of Weatherford International Ltd. Last month, Weatherford itself settled charges by the SEC that, from 2007 through 2012, it issued false financial statements of its earnings that inflated its income over US $900 million as a result of an “accounting fraud” organized by two corporate officers (click here for details of this SEC action). According to the SEC, during the relevant years, Weatherford inflated its earnings by regularly making “unsupported” post-closing adjustments in connection with each year’s financial statements that E&Y was aware of but did not sufficiently follow up on. This was despite the firm being assessed as a “particularly risky and difficult client” by E&Y. Also named in the SEC’s complaint and settling were Craig Fronckiewicz and Sarah Adams, E&Y partners who were members of its Weatherford audit team. The SEC charged that both individuals “failed to perform audit procedures required by the Public Company Accounting Oversight Board … standards that would have likely uncovered the fraudulent scheme as early as 2007 and in each year thereafter.” To resolve this matter, E&Y agreed to pay a fine of US $1 million and disgorge profits with prejudgment interest of over $10.8 million. The firm also agreed to a number of undertakings. Both Mr. Fronckiewicz and Ms. Adams agreed to forfeit their authority to practice before the SEC with the ability to apply for reinstatement after some time. The SEC acknowledged E&Y’s remedial steps to improve its system of quality controls in connection with high-risk audits and its cooperation in accepting the firm’s settlement.

  • Broker-Dealer Fined US $2.8 Million by FINRA for Inaccurate Reporting of Millions of Trades Over Four Years: Merrill Lynch, Pierce, Fenner & Smith resolved a complaint by the Financial Industry Regulatory Authority by agreeing to pay a fine of US $2.8 million related to its alleged widespread trade reporting violations between 2010 and 2015. According to FINRA, because of a “system configuration error,” during part of the relevant time, Merrill Lynch inadvertently reported over 20 million trades inaccurately to FINRA’s Trade Reporting Facility. In some cases, said FINRA, the firm reported purchases as principal sales; agency crosses as principal transactions; purchases as short sales; and reported some trades that were not required to be reported. FINRA also claimed that, during part of the relevant time, Merrill Lynch reported millions of inaccurate reportable order events to the Order Audit Trail System. FINRA uses OATS data as part of its automated market surveillance program to detect manipulative conduct and potential violation of its rules and applicable securities laws. Merrill Lynch settled this matter without admitting or denying any findings.

And more briefly:

  • SEC Chief of Staff Provides Insight Into Expectations of Compliance Staff: Andrew Donohue, Chief of Staff of the Securities and Exchange Commission, observed that there were two distinct models for compliance functions within firms: one where the objective is for compliance staff to identify potential regulatory issues and work with business management to develop and insure implementation of appropriate policies and procedures, and one where compliance staff is more proactive in ensuring that a firm is compliant with applicable regulatory requirements by utilizing technology to “efficiently detect and prevent violations.” Although Mr. Donohue believes the compliance function will more and more gravitate toward the latter approach, he warns that “it is important that businesses not view this as an opportunity to abdicate their responsibility. It is critical that businesses remain accountable and not view compliance as being responsible for any and all violations.” Mr. Donohue shared his observations before the National Society of Compliance Professionals 2016 National Conference.

  • Court Approves Special Master for Investment Bank Charged by CFTC With Swaps Reporting Violations: After initially delaying its approval, a federal court in New York agreed to the joint motion of the Commodity Futures Trading Commission and Deutsche Bank AG related to the appointment of a special master to help ensure the bank’s compliance with the CFTC’s reporting requirements for swaps transactions. However, the court chose its own special master, as opposed to any of the three potential candidates proposed by the CFTC and Deutsche Bank. In August, the CFTC filed charges against Deutsche Bank for its alleged failure to accurately report information regarding its swaps transactions, as required by law, from April 16, 2016, through the date of its complaint. The CFTC charged that Deutsche Bank’s alleged failures violated the terms of a prior settlement order that followed a previous enforcement action that also alleged swaps reporting problems. (Click here for background on the latest action. Click here for details of the court's reluctance to automatically appoint a special master.)

  • CFTC Issues Final Order Expanding Exclusion From Private Rights of Actions to Southwest Power Pool for Certain Electricity Transactions: The Commodity Futures Trading Commission entered an order and amended an existing order to exempt certain electric energy transactions from most requirements under the Commodity Exchange Act and CFTC regulations, as well as from private lawsuits. The existing order was for the benefit of certain regional transmission organizations (“RTOs”) and independent system operators (“ISOs”) but did not exempt the transactions from private lawsuits. The current order was sought by the Southwest Power Pool (SPP) and also amended the prior order for the RTOs and ISOs. The order and amended order exempt eligible transactions on the SPP and on certain RTOs and ISOs from all provisions of applicable law and CFTC regulations with the exception of anti-fraud and anti-manipulation requirements, as well as specified scienter-based prohibitions.

  • Retail Metals and Principal Firm Ordered to Pay $1.56 Million Fine and Disgorge US $30 Million of Profits for Off-Exchange Transactions: A federal court in New York ordered Yorkshire Group, Inc. and Scott Platto, its principal, to pay a fine of US $1.54 million and disgorgement of almost US $30,000 in connection with their off-exchange sale of precious metals to retail clients on leverage, contrary to law. The CFTC had claimed that, in arranging transactions for their customers, Yorkshire and Mr. Platto acted for Hunter Wise Commodities, LLC. Neither Yorkshire nor Hunter Wise delivered any precious metals to customers in connection with their transactions, charged the CFTC.

  • CFTC Staff Issues Advisory on Investments in Certain Money Market Funds: Staff of the Division of Swap Dealer and Intermediary Oversight of the Commodity Futures Trading Commission provided “practical” guidance on its prior authorization for futures commission merchants 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 money market funds or electing Government MMFs. 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. Among other things, staff’s guidance addresses how an FCM should report on its daily segregated calculation an investment of funds in a Prime or Electing MMF that has suspended redemptions and how asset-based and issuer-based concentration limits are applied to Government MMFs. (Click here for background.)

  • US Treasury Securities Required to Be Reported Through TRACE in July 2017: The Securities and Exchange Commission approved a requirement by the Financial Industry Regulatory Authority that, beginning July 10, 2017, all member firms must begin reporting transactions in US Treasury securities through FINRA’s Trade Reporting and Compliance Engine. Separately, the Board of Governors of the Federal Reserve System announced that it plans to collect data from banks for secondary markets transactions in US Treasury securities and will enter negotiations with FINRA for it to potentially act as the Fed’s collection agency for the data.

  • ESMA Publishes Guidelines Under MAR and Remuneration Guidelines Under UCITS and AIFMD: The European Securities and Markets Authority issued guidelines under the Market Abuse Regulation on when it is appropriate for issuers to delay and not to delay the disclosure of material inside information, as well as the procedures and training individuals receiving market soundings should follow to avoid acting on insider information. Likewise, ESMA issued guidance on sound remuneration policies under the UCITS (Undertakings for Collective Investment in Transferable Securities) Directive and the Alternative Investment Fund Managers Directive.


  • My View  Recent CME Group Disciplinary Action Suggests Liability May Not Automatically Mean Fines: I recently reported on a CME Group disciplinary action against Geneva Trading USA, LLC and two of its employees. (Click here to access more details.) What was unique about this action was that, although the firm was charged on a strict liability basis because of the alleged spoofing activities of its two employees, it was able to resolve this action by disgorging profits only and not being assessed a fine or other sanctions. At a panel I sat on at the FIA Expo last week, a CME officer noted, without expressly referencing this disciplinary action by name, that although a firm may be held strictly liable for the acts of its employees under CME Group rules, where the firm has and enforces robust policies and procedures governing the allegedly improper conduct of its employees, it might be appropriate to require the firm to return any profits attributable to the employees’ improper conduct, but not to be subject to a fine or other sanctions. This would be the case despite the employees not following such policies and procedures! If only the CFTC took the same reasoned view when applying its duty to supervise provision against registrants. (Click here to access CFTC Regulation 166.3.)

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 298



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...