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Volume XII, Number 147


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Bridging the Week: October 24 to 28 and October 31, 2016 (Tipper and Tippees; Block Pre-Hedging; Regulation AT Amendments; FINRA, SEC Sweep)

CME Group commenced and settled disciplinary actions against two apparently related individuals that sounded eerily like securities industry tipper and tippee insider-trader actions, while ICE Futures U.S. and CME Group finalized interpretations that permit pre-hedging of certain block trades prior to execution by the relevant principals. In addition, the Commodity Futures Trading Commission announced that amendments to proposed Regulation AT will be forthcoming later this week. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Non-Member Tipper and Tippee Fined by CME Group for Insider-Trading Type Offenses; Two Member Firms Fined for Algo System Gone Wild (Includes Legal Weeds and Compliance Weeds);

  • Pre-Hedging by Principals Authorized in Block Trade Clarification Implemented by IFUS and Adopted by CME Group (includes Compliance Weeds1 and Compliance Weeds2);

  • Supplemental Regulation AT Proposal To Be Issued November 4;

  • FINRA Announces Review of Cross-Selling by Broker-Dealers of Affiliated Bank and Other Products; SEC Announces Review of IAs and BDs Compliance With Whistle-Blower Requirements (includes Legal Weeds);

  • FinCEN Issues Advisory Saying Cyber Attacks May Be Required To Be Reported Through SARs; and more.


Non-Member Tipper and Tippee Fined by CME Group for Insider-Trading Type Offenses; Two Member Firms Fined for Algo System Gone Wild

Two apparently related non-members of the Chicago Mercantile Exchange agreed to be permanently barred from ever trading on CME Group exchanges and to remit trading profits of US $407,491 for allegedly trading on misappropriated information.

According to CME, between January 2011 and October 2012, Stuart Madden disclosed non-public order information of his employer to Paul Madden, and Paul Madden used that information to establish positions in Euro FX futures positions that he often offset through trading opposite the employer’s account.

In an unrelated matter, Aardvark Trading LLC agreed to pay a fine of US $205,000 to the CME because of two incidents with its automated trading systems. CME claimed that on November 13, 2014,  an Aardvark ATS did not function as intended because of “improper configuration and modification of the ATS’s code” that caused the execution of 17,000 contracts in the associated legs of the Eurodollar complex. This, said CME, caused price and volume “aberrations” over a nine-second period. Also, charged CME, on “several occasions” in June and October 2014, “ATSs that Aardvark operated did not operate as intended as a result of supervisory errors,” although there was no “significant” market impact.

Aardvark also agreed to pay a separate fine of US $40,000 to the Chicago Board of Trade because of alleged configuration errors and a failure to deploy self-match prevention technology that caused numerous self-matched trades, as well as price and volume “aberrations” on July 6, 2015 in the September 2015 Two-Year Treasury futures contract.

Similarly, Natixis agreed to pay a fine of US $75,000 to resolve CBOT charges that one of its automated trading systems allegedly entered incorrect orders in 29 Federal Futures contract months causing “aberrant prices.” According to CBOT, at least part of the cause of Natixis’ incorrect orders arose from the failure of an employee to deactivate a certain pricing tool associated with its ATS.

In addition, Noble Resources Pte. Ltd., a CBOT member firm, agreed to pay a fine of US $75,000 for engaging in pre-execution communications with a counterparty related to proposed soybean futures hedges in connection with the execution of prepaid soybean swap agreements. Under CME Group rules, pre-execution communications involving soybean futures are not permitted.

Legal Weeds: Earlier this year, a panel of the Business Conduct Committee of the New York Mercantile Exchange found that, from April 18 through December 10, 2012, Jon Ruggles, a nonmember and former trader for Delta Airlines, traded two accounts of his wife, Ivonne Ruggles, relying on confidential information of his employer in a manner that disadvantaged it. The BCC concluded that as a result, Mr. Ruggles earned in excess of US $3.3 million as a result of his unauthorized trading. In response, the BCC imposed a fine of US $500,000 against Mr. Ruggles, ordered disgorgement in excess of $2.8 million, and imposed a permanent CME Group all-products trading prohibition. Later, in September 2016, the Commodity Futures Trading Commission brought and settled charges against Mr. Ruggles for the same offense, claiming that Mr. Ruggles’ conduct constituted trading on illicitly misappropriated information, and based its action, in part, on a theory equivalent to the securities concept of insider trading. (Click here for details.) The disciplinary actions against Stuart and Paul Madden rely on an express CME Group rule that prohibits inducing any person from disclosing non-public trading information to another person or from taking any action based on non-public information no matter how acquired (click here to access CME Group Rule 532). However, it may not be too long before the CFTC applies the relatively new provision of law and CFTC rule that prohibits employment of a manipulative or deceptive device or contrivance in connection with futures or swaps trading that it relied on in its enforcement action against Mr. Ruggles as authority to bring an enforcement proceeding against a trader who not only misappropriates trading information and passes it illicitly to another, but also against the recipient of illicitly-obtained information who trades on it – a so-called “tipper” and “tippee” scenario. (Click here to access Commodity Exchange Act Section 6(c)(1), US Code § 9(1), and here to access CFTC Rule 180.1. Click here for a discussion of a recent federal appeals court decision regarding tipper and tippee liability under US securities law in the article, "Appeals Court Sets Aside Insider Trading Convictions Saying Traders Distance From Corporate Insiders Too Far" in the December 14, 2014 edition of Bridging the Week.)

Compliance Weeds: Generally, for approved contracts only, CME Group exchanges permit pre-execution communications to facilitate trading subject to strict requirements. Among these requirements are that the party on whose behalf a communication is made previously consented to such communication and that no person involved in pre-trade communications takes advantage of information conveyed except to facilitate the relevant trade. Other than for CBOT EU Wheat futures and options, pre-execution communications are never permitted for CBOT grain and oilseed futures at any time. Moreover, CME Group rules regarding cross trades vary by product and by futures and options. Even the mechanical steps vary for executing a cross trade following a conversation. There are Globex Crosses, Agency Crosses, Committed Crosses, and RFQ and RFC Crosses. (Click here to access the relevant CME Group Market Regulation Advisory Notice regarding Pre-Execution Communications (August 16, 2016).) 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. Most simply, all noncompetitive trades are strictly prohibited under CFTC rules, and any violation of a CME Group rule regarding pre-execution communications could also be deemed a violation of this CFTC requirement.


  • Pre-Hedging by Principals Authorized in Block Trade Clarification Implemented by IFUS and Adopted by CME Group: As previously proposed, ICE Futures U.S. updated its block trading Frequently Asked Questions as of today to authorize the pre- or anticipatory hedging of futures and related options block trades by principal counterparties prior to a transaction’s execution under limited circumstance. Parties to a block trade may now “engage in transactions to hedge positions which they believe in good faith will result from the consummation of the block trade which is under negotiation.” (Click here for background on IFUS’s proposal.) However, such authority is not available to intermediaries (i.e., agents) that take the opposite side of a customer’s order. If an intermediary takes a customer’s order for a block trade neither it, nor any affiliate may enter into a hedging trade until after the block trade is formally executed. Last week, CME Group also updated its Market Regulation Advisory Notice regarding block trades to parallel IFUS’s new guidance. Absent CFTC objection, CME Group’s proposed guidance will be effective November 8.

Compliance Weeds1: IFUS and CME Group will likely be requested to provide additional clarifications of their new block trade guidance. However, in a nutshell, there seems to be at least three scenarios covered by the exchanges’ new interpretations:

Assume that “A” is an eligible contract participant. It maintains a brokerage relationship with “B,” a registered futures commission merchant. B also maintains a proprietary trading desk, “C.” “D” is an affiliate of B that engages solely in proprietary trading.

  1. If an employee for D initiates or receives a solicitation from A to enter into a futures or related options block trade, D may pre-hedge its block trade as soon as it reasonably believes in good faith that it will enter into the relevant block trade. D will not be acting as an intermediary (i.e., agent) for A but solely as a counterparty.

  2. If an employee for B receives a solicitation from A to execute a block trade, and the employee facilitates the execution of the block either by C or D, neither C nor D may pre-hedge the block trade. Each entity must wait until the block trade is executed before hedging it. This is because B is acting as an intermediary for A.

  3. An employee for B receives a solicitation from A to execute a block trade. The employee declines the solicitation; however the employee advises A it may contact C or D directly to execute the block. After receiving a solicitation from A directly, C (which is also part of B) or D may pre-hedge its block trade as soon as it reasonably believes in good faith that it will enter into the relevant block trade. C or D will not be acting as an intermediary for A but solely as a counterparty. B is also not acting as an intermediary for A in this transaction.

Compliance Weeds2: In the United States, block trades are an exception to the CFTC’s requirement that all futures contracts be executed on a derivatives contract market. Block trades may be executed off the marketplace by eligible contract participants subject to CFTC-approved DCM rules. These rules typically state which DCM products are subject to block trades (and sometimes, during which times); minimum thresholds; what constitutes a fair and reasonable price; and reporting requirements. The rules also typically address the use of nonpublic information regarding block trades. Notwithstanding IFUS’s and CME Group’s new guidance, as before, solicited parties to a block trade that decline to enter into the transaction may not trade on such information until after a public report of the relevant transaction. Recently, JSC VTB Bank (VTB), a Russia-based bank, and VTB Capital PLC (VTB Capital), a UK-based bank that is ultimately 94% owned by VTB, were sued by the CFTC for engaging in block trades with each other contrary to CME Group rules because the prices of their block trades were not fair and reasonable. This was despite the block trades' prices reflecting the midpoint between the prevailing bid-ask spread of related swap contracts at the time when relevant Chicago Mercantile Exchange futures contracts were illiquid. (Click here for details.)

  • Supplemental Regulation AT Proposal To Be Issued November 4: The Commodity Futures Trading Commission will host a public meeting on November 4 to consider a supplemental proposal regarding Regulation Automated Trading initially issued in November 2015. Previously, Timothy Massad, CFTC Chairman, indicated that amendments to initially proposed Regulation AT would likely modify, but not eliminate, initial requirements related to registration, source code and who is obligated to maintain risk controls. (Click here for background.) Last week, during a conference on The Evolving Structure of the US Treasury Market, Mr. Massad indicated that one of the justifications for adding a volumetric test to assess who should be newly required to register as a so-called AT person is that often, “a small number of traders can represent a large percentage of total trading volume.” For example, he noted that during the recent collapse of the British Pound on October 6, 2016 during illiquid trading hours, the ten most active trading firms constituted 60 percent of all trading activity in the Chicago Mercantile Exchange’s British Pound futures contract. Separately, at the same conference, Mary Jo White, Chair of the Securities and Exchange Commission, suggested that there is “significant concern” that certain principal traders that effectively act as dealers in US Treasury securities are not currently required to register with the SEC. She also indicated that SEC staff is currently reviewing disruptive trading practices in the equities markets and will soon publish a report for public comment.

  • FINRA Announces Review of Cross-Selling by Broker-Dealers of Affiliated Bank and Other Products; SEC Announces Review of IAs and BDs Compliance With Whistle-Blower Requirements: The Financial Industry Regulatory Authority announced that it was conducting an industry-wide inquiry to review cross-selling programs at broker-dealers. Among other things, it will be reviewing what incentives are provided to broker-dealer employees to promote bank products of an affiliate or parent company to retail customers; add features such as securities-based loans or credit and debit cards to broker-dealer retail accounts; and the opening of additional broker-dealer retail accounts for customers. Separately, the Securities and Exchange Commission announced that it will be reviewing registrants’ compliance with “key whistleblower provisions” arising from the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among other things, the Office of Compliance Inspections and Examinations will be looking at registered investment advisers’ and broker-dealers’ compliance manuals, code of ethics and employment and severance agreements to ensure that there is nothing inhibiting employees to take advantage of their whistleblower rights.

Legal Weeds: Recently, Blue Linx Holdings Inc., a publicly traded company, agreed to pay a fine of US $265,000 and to certain undertakings to settle SEC charges that the company impermissibly inhibited whistleblowing by ex-employees. According to the SEC, Blue Linx included provisions in severance agreements with ex-employees that prohibited them from sharing with any third party confidential information about the company learned while employed 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 240.21F-17; click here to access), 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. To resolve this matter, Blue Linx, among its undertakings, 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. (Click here to access the SEC Blue Linx Order.) Like the SEC, the Commodity Futures Trading Commission has a general rule that prohibits the waiver of the right of any person to file a whistleblower complaint and receive a monetary award from it (click here to access CFTC Rule 165.19). Employees of registrants and non-registrants may also not be retaliated against for whistleblowing. (Click here 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.) Recently, the CFTC proposed to amend its whistleblower program to more closely emulate that of the SEC. Among other things, the CFTC proposed (1) new procedures to review whistleblower claims; (2) to clarify that the CFTC may bring enforcement actions against any employer that violates its anti-retaliation provisions; and (3) to expressly prohibit any agreement or condition of employment, including a confidentiality or pre-dispute arbitration agreement, from containing a provision that might “impede” an individual from communicating a possible violation of law to CFTC staff. (Click here for details.) SEC and CFTC registrants, SEC-regulated publicly traded companies and entities subject to CFTC rules should review their form employment and severance agreements to ensure they are consistent with regulatory requirements regarding employee and ex-employee whistleblower rights.

  • FinCEN Issues Advisory Saying Cyber Attacks May Be Required To Be Reported Through SARs: The Financial Crimes Enforcement Network of the US Department of Treasury issued an advisory stating that covered financial institutions must file a suspicious activity report following certain cyber-events. Mandatorily reportable incidents are those where a financial institution is targeted by a cyber-event where it knows, or has reason to suspect, the event “was intended, in whole or in part, to conduct, facilitate, or affect a transaction or series of transactions” that involves or aggregates or could involve or aggregate to US $5,000 or more in funds or other assets. It would not matter whether the transaction or series of transactions ended up actually occurring. In addition, FinCEN indicated that it encourages but does not require SAR filings when a financial institution sustains “egregious, significant or damaging cyber-events” that may not require mandatory reporting. An example of this would be a massage barrage of messages aimed at a financial institution (known as a “DDoS attack”) that damages its website and prevents customers from accessing their accounts for a prolonged period of time. Covered financial institutions include banks, broker-dealers, future commission merchants, introducing brokers and mutual funds

And more briefly:

  • IFUS Formally Implements Authorization To Use EFRPs in Connection with Forward Agreements and Swaps: ICE Futures U.S. amended its guidance regarding exchange for related position transactions to make clear that swaps that will settle or forward contracts that may settle through EFRPs will not be considered to be part of prohibited transitory EFRP arrangements where the swap or forward contract is “subject to market risk that is material in the context of the transaction.” IFUS initially proposed this guidance amendment earlier this month. 

  • NASDAQ Futures To Modify Self-Match Prevention Functionality November 1: Nasdaq Futures, Inc. will require all futures participants using its self-match prevention functionality to select one of two options beginning November: either to have the newest order that might cross with a resting order or quote cancelled (so-called “Cancel Newest”) or to have a resting order or quote cancelled if the newest order might cross with it (so-called “Cancel Oldest”). If a clearing member fails to advise NFX by noon, the following day, which option it prefers, the SMP functionality will default to Cancel Newest.

  • UK Financial Service Regulator Proposes Mission Statement; Describes When It Will Bring Enforcement Actions: The UK Financial Conduct Authority under Andrew Bailey, its new Chief Executive, issued a mission statement in which, among other things, it suggested when it might take enforcement action. According to FCA, “[w]e are more likely to take action where the actual or potential severity [of misconduct] is high …or the impact on the wider financial markets is greatest.” Moreover, the FCA indicated that, going forward, it will help ensure that parties in enforcement actions “are able to clearly track FCA action from harm to causes identified in interventions” to help firms better understand FCA’s expectations. Responses to specific questions raised in FCA’s mission statement will be accepted through January 26, 2017.

©2022 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 305

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...