December 6, 2021

Volume XI, Number 340


December 03, 2021

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Bridging the Week: October 31 to November 4 and November 7, 2016 (Regulation AT Amended; Audit Partners; EFRPs; Form 40; Brexit) [VIDEO]

Last week, the Commodity Futures Trading Commission published its highly anticipated supplemental notice of proposed rulemaking regarding Regulation Automated Trading, initially released in November 2015. It contains new proposals regarding Floor Trader registration and who might be deemed a so-called “AT Person” in an effort to reduce the number of persons that might be subject to the harshest of the proposal’s requirements. However, the revised proposal also substantially broadens the concept of direct electronic access; indirectly subjects third-party algorithmic trading system providers to CFTC requirements; and still enables the CFTC to request an AT Person’s algorithmic trading source code through its inspection authority – albeit using special calls expressly authorized by the Commission – in addition to by subpoena. Unrelatedly, beginning November 18, a new Form 40 must be used by CFTC reportable traders and electronically filed. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Proposed Regulation AT Amended by CFTC; Attempts to Reduce Universe of Most Affected to No More Than 120 Persons (includes My View);

  • SEC Files Enforcement Action Against Audit Partner for Providing Unqualified Opinions to Venture Capital Fund in the Face of Alleged Red Flags;

  • Alleged Transitory EFRPs and Algo Gone Bad Subject of NYMEX Disciplinary Actions (includes Compliance Weeds);

  • New Form 40 Obligations to Begin November 18 – Be Prepared (includes Compliance Weeds);

  • …And Don’t Forget Brexit; and more.

Proposed Regulation AT Amended by CFTC; Attempts to Reduce Universe of Most Affected to No More Than 120 Persons

On Friday, the Commodity Futures Trading Commission issued a supplemental notice of proposed rulemaking ("SNPRM") regarding Regulation Automated Trading, initially proposed during November 2015.

Among other things, the new proposal attempts to reduce the number of persons potentially subject to Regulation AT’s most onerous requirements to no more than 120 persons; to provide a methodology to assign certain regulatory responsibilities of AT Persons for third-party developed algorithmic trading systems to the third party developers; and to provide a heightened process for the CFTC to request algorithmic trading source code through its inspection authority and additional confidentiality assurances.

The CFTC’s revised proposal contains six broad elements:

  1. Risk Controls at Two Not Three Levels: In its initial proposal, the CFTC required risk controls for so-called “algorithmic trading” to be maintained at three levels: designated contract markets, futures commission merchants and so-called “AT Persons.” In its new proposal, the CFTC proposes that risk controls only be maintained at DCMs and either by FCMs or AT Persons – but not both. An AT Person would have the prerogative to delegate its risk control obligations to its FCM if its FCM agreed. Equivalently, FCMs would not be obligated to implement risk controls on automated order messages if they were already subject to an AT Person's-administered risk controls. Orders emanating from electronic trading from non-AT Persons would have to be subject to an executing FCM’s risk controls. (Electronic trading is a new and broader category of trading incorporating algorithmic trading that is introduced in the CFTC's supplemental proposal.)

  2. Volumetric Threshold to Be Used to Determine Floor Broker Registration Requirement and AT Person Determination: As first proposed, Regulation AT required the registration of persons as Floor Traders if they engaged in so-called algorithmic trading for their own accounts through direct electronic access on a DCM and they were not registered with the CFTC in any one of certain enumerated capacities (i.e., an FCM, floor broker, swap dealer, major swap participant, commodity pool operator, commodity trading advisor or introducing broker (collectively, "enumerated registrants")). The Floor Trader registration requirement is continued in the supplemental proposal. However, under the new proposal, the registration requirement would only apply to an otherwise relevant non-registered person if the person “trades” 20,000 or more contracts in aggregate across all DCMs on an average daily basis during the prior six month counting period (i.e., January 1 through June 30 or July 1 through December 31). Traded contracts only include "consummated transactions" according to the CFTC's SNPRM. 

The 20,000 contracts volume threshold test would also apply to existing enumerated registrants who engage in algorithmic trading on or subject to a DCM’s rules. Previously, these enumerated registrants were automatically deemed "AT Persons" under the CFTC’s November 2015 proposed rules. Under the CFTC's new proposed scheme, such registrants would only be deemed AT Persons (and thus subject to most of Regulation AT’s most onerous requirements) if they exceeded the volume threshold test.

In assessing its volume of traded contracts against the volume threshold, a person would have to aggregate both its proprietary and customer contracts (if applicable) across all products on all electronic trading facilities of all DCMs. A person would also have to include with its own trading volume that of any other person controlling, controlled by or under common control with it. Calculations would be based on the number of actual trading days during the relevant six month counting period whether the relevant person traded on those days or not.

  • CFTC Inspection of Source Code and Obligations of AT Persons for Third-Party Provided Algorithmic Trading Systems: In its November 2015 proposal, the CFTC required that all AT Persons maintain their algorithmic trading source code in a special repository and be required to make such source code available – whether proprietary or third-party developed – to CFTC staff or staff of the US Department of Justice upon request. In its revised proposal, the CFTC requires all AT Persons to retain algorithmic trading source code and certain ancillary records in their native format for five years, but eliminates the requirement to maintain source code in a special repository. The CFTC retains the ability, however, to request source code either through a special call or a subpoena that it expressly authorizes.

AT Persons using third-party developed algorithmic trading systems or components would be obligated to produce the third party’s source code themselves or cause the third party to produce such source code to the CFTC directly when requested by the Commission. An AT Person would be ultimately responsible if the third-party source code was not produced. The CFTC proposes to protect any source code provided to it under a new confidentiality rule, as well as under existing law. For purposes of CFTC requirements, algorithmic trading source code would be very broadly defined to include “generally computer commands written in a computer programing language that is readable by natural persons.” The CFTC says that, at a minimum, this includes computer code, logic embedded in electronic circuits, scripts, parameters input into an algorithmic trading systems, formulas and configuration files.

  1. Wider Application of Risk Controls: In its revised proposal, the CFTC says risk controls should apply to all electronic trading. In its initial proposal, the CFTC dealt only with algorithmic trading.

  2. Certifications Not Annual Reports: The CFTC’s initial proposal required all AT Persons and FCMs to provide each DCM on which they operated an annual report covering certain regulatory obligations. The CFTC’s new proposal substitutes a certification requirement for all AT Persons and executing FCMs made by the chief compliance officer or chief executive officer. These annual certifications must be provided to each relevant DCM and each DCM would be required to periodically review and evaluate AT Persons’ and executing FCMs’ compliance with certain of their obligations under Regulation AT (i.e., for AT Persons, compliance with pre-trade risk controls and algorithmic trading system development and monitoring requirements; for executing FCMs, compliance with risk management obligations).

  3. Granularity of Risk Controls: The CFTC’s November 2015 proposal required pre-trade risk controls to be established at the level of each AT Person or more granular level as the AT Person, FCM or DCM determined was appropriate. The CFTC proposes to give AT Persons, FCMs and DCMs greater flexibility to determine at what level pre-trade controls must be set.

According to the CFTC, in its supplemental proposal, it endeavored to address concerns that its initial proposal would capture “substantially more” than the 420 persons it was intended to mostly affect – 100 new registrants, and 320 existing registrants.

However, as the CFTC acknowledged, it did not try to accomplish a reduction in the potential reach of its initial proposal by reducing the scope of what constituted algorithmic trading (e.g., by eliminating smart order routing from scope). Rather, in its latest proposal, it solely added a volume threshold test to try to limit which enumerated registrants might qualify as AT Persons in the first instance or which currently unregistered persons might have to register for the first time (as Floor Traders) and also be deemed AT Persons. 

Moreover, the CFTC proposes to broadly expand the definition of direct electronic access under its new proposal. This is relevant to assess which algorithmic traders that are not currently registered with the CFTC in any capacity must be registered for the first time.

Originally, the CFTC defined DEA to mean an arrangement where a person electronically submits an order to a DCM without the order first being “routed” though a clearing member of a derivatives clearing organization to which the DCM submits trades for clearing. Under its new proposal, DEA broadly means the electronic transmission of an order “for processing” on or subject to the rules of a DCO (including any modification or cancellation) unless the order, modification or cancellation is transmitted to the DCO by an FCM that the FCM “first received from an unaffiliated natural person by means of oral or written communications." The CFTC's amended approach would appear to classify as DEA all electronic orders emanating from clients that are processed in any manner through an FCM's electronic order handling infrastructure even if they are not routed directly by a client to a DCO or are physically intermediated at some point by a natural person at an FCM.

Additionally, the CFTC now proposes that, when considering the registration of certain currently non-registered persons as Floor Traders, if a group of related companies in aggregate satisfies the volume threshold test, at least one or more persons within the group must register as a Floor Trader. The CFTC also now proposes a strict, express anti-evasion provision to preclude persons trading through multiple entities for the purpose of avoiding the Floor Trader registration requirement or to avoid meeting the definition of an AT Person.

Under the CFTC’s proposed amended rules, an enumerated registrant (other than a Floor Trader) that was previously deemed an AT Person because it engaged in Algorithmic Trading and met the volume threshold test, would no longer be considered an AT Person if it failed to satisfy the volume threshold test for two consecutive annual periods. It does not appear that this potential exit from strict oversight possibility would apply to Floor Traders. Additionally, as proposed, a person who does not meet the requirements of an AT Person may voluntarily elect to become an AT Person by registering as a Floor Trader. Such person thereafter would be obligated to comply with all requirements of an AT Person. Potentially this capability could be useful if the CFTC and a non-US regulator were to negotiate access rights to markets based on comparable oversight of relevant persons.

In connection with AT Persons’ use of third-party provided algorithmic trading systems, AT Persons may obtain certifications from a provider that the third party complies with CFTC-required system development, testing and other regulatory requirements rather than complying with the CFTC’s relevant requirements itself. The CFTC says it expects the certification would at least “list the specific regulatory obligations that the third party is certifying compliance with, describe the components of the ATS at issue (or the whole system, if applicable), and explain how such component or system complies with the regulatory obligations.” The AT Person would be expected to “conduct due diligence to reasonably determine the accuracy and sufficiency of a certification.” However, says the CFTC, the due diligence could be limited to the “accuracy of the certification.” In any case, if – despite its representations in the certification – the third party failed to comply with its regulatory testing, development and other requirements, or failed to produce source code when requested by the CFTC, the AT Person could be liable.

Finally, in its SNPRM, the CFTC indicated that it planned to defer to “a second phase of rules” considerations of proposals it raised in its November 2015 issuance regarding greater transparency regarding DCMs’ matching platforms and the use of self-match prevention tools. It did not disclose, however, when this might occur. The CFTC also indicated that it might make other changes to the initially proposed Regulation AT that would eliminate certain obligations that were much criticized following their release (e.g., it might eliminate from the definition of “Algorithmic Trading Compliance Issue” references to noncompliance with an AT Person’s own internal rules, or those of its clearing member, any DCM or a registered futures association (i.e., the National Futures Association). The CFTC indicated it could do this without an additional supplemental proposal.

As part of its new proposal, the CFTC provided a comprehensive cost-benefit analysis that included its estimate of the expense of certain of its proposals. For example, the CFTC estimated that the cost to each third-party algorithmic trading system vendor to provide a first certification to an AT Person and cooperate with such AT Person’s due diligence would be $4,884. It estimated the cost to such vendors to provide subsequent certifications and comply with subsequent due diligence requests would be $2,892/episode.

The CFTC’s supplemental proposal will be subject to a 60-day comment period after it is published in the Federal Register. The CFTC made clear that its supplemental proposal only addresses topics where it believes “that additional notice and comment may be appropriate before enacting final rules.” Unless noted, said the CFTC, all other provisions of the initially proposed Regulation AT remain under consideration for adoption in final rules.

My View: There is little doubt in my mind that, in its supplemental Regulation AT proposal, the CFTC and its staff responsibly and often creatively endeavored to address many of the industry’s most vehement objections to the Commission’s initial proposal.

However, it is not apparent to me how the CFTC’s revised proposal will reduce to only 120 the number of persons mostly affected. Although the Commission’s revised proposal introduces a volume threshold amount to try to limit the number of the most impacted persons, the threshold value appears relatively nominal (although it is based solely on consummated transactions on DCMs and ignores unexecuted orders). Moreover, the proposal also expands the definition of direct electronic access and does not eliminate smart order routing from the definition of algorithmic trading. Indeed, the CFTC candidly acknowledges that its 120 person estimate “may omit some firms that would meet the volume threshold requirements” and seeks comment on its projection.

Additionally, at first blush, it does not seem intuitive how the CFTC’s proposed handling of source code underlying an algorithmic trading system provided by a third party and used by an AT Person would practically work. Although the AT Person using a third-party developed algorithmic trading system could rely on a certification by the third party that it complies with CFTC-required system development, testing and other regulatory requirements, the AT Person must still conduct due diligence “to reasonably determine the accuracy and sufficiency of the certification.” Moreover, the AT Person must itself provide the underlying source code or ensure that the third party does, when requested by the CFTC. If the third party does not comply with regulatory requirements or provide the source code, the AT Person could be liable. These seem like very heavy burdens for an AT Person, as well as for a non-CFTC-regulated third party.

Finally, although the CFTC has tried to enhance the protections around its potential request for and receipt of an AT Person’s source code by adding a new distinct regulation, it’s not clear that, without further amendment, why the existing CFTC regulation mandating books and records to be turned over to the CFTC or the Department of Justice upon request would not continue also to apply. (Click here to access CFTC Regulation 1.31.) It is also highly likely that many will not consider nearly satisfactory the heightened processes for the CFTC to request source code utilizing its inspection authority (in his vehement dissent, Commission J. Christopher Giancarlo previewed these objections; click here to access). Moreover, the potential universe of what must be retained and potentially produced to the CFTC is expanded to include not only source code itself, but records that track changes to the source code and any logs or log files recording the activity of an AT Person’s Algorithmic Trading system, if ordinarily generated.

Through Regulation AT, the CFTC legitimately seeks to ensure markets’ integrity and that it can access evidence that might help it detect and/or prevent a potential manipulation, market disruption or other regulatory violation. However, at first blush, it is not apparent that the CFTC’s proposed amended version of Regulation AT will accomplish this goal practically, let alone without adding tremendous costs and uncertainty to many participants in the futures industry. As before, the best way for the CFTC to accomplish its objectives is by leveraging more of the existing requirements of DCMs and best practices already followed by the majority of the industry, in a principals-based not prescriptive way.


  • SEC Files Enforcement Action Against Audit Partner for Providing Unqualified Opinions to Venture Capital Fund in the Face of Alleged Red Flags: The Securities and Exchange Commission filed an enforcement action in its administrative tribunal against Adrian Beamish, an audit partner at PricewaterhouseCoopers, for his alleged role in not acting on red flags and certifying as correct financial statements of Burrill Life Sciences Capital Fund III for 2009 through 2012. During this time, the Fund, led by Steve Burrill, its founder, paid millions of dollars to other companies Mr. Burrill owned and controlled to keep the companies afloat, to travel on family vacations or for other unauthorized purposes. (Click here for background in the SEC’s order settling an enforcement action against Mr. Burrill and others for this conduct.) According to the SEC, Mr. Beamish failed adequately to follow up on bookkeeping characterizations that payments to Mr. Burrill’s related companies were advances of future management fees despite such fees being paid many months, and in some cases, years before such fees arguably would be earned. Among other things, the SEC seeks a determination temporarily or permanently barring Mr. Beamish from appearing or practicing before it as an accountant.

  • Alleged Transitory EFRPs and Algo Gone Bad Subject of NYMEX Disciplinary Actions: The New York Mercantile Exchange settled disciplinary actions against two trading firms for engaging in alleged transitory exchange for related position transactions. In one action, George E. Warren Corporation, a member, agreed to pay a fine of US $20,000 for executing two EFRPs involving the October 2015 RBOB Gasoline futures contract on October 1, 2015 – the last day of scheduled trading for the contract – that the exchange’s business conduct committee claimed were “contingent upon each other” and thus, impermissible. Moreover, claimed the NYMEX BCC, as a result of these transactions, GE Warren established a new position in the October 2015 RBOB contract following the termination of the contract’s scheduled trading – which also is not permitted. Setana Energy Ltd, a non-member, agreed to pay a fine of US $15,000 for apparently trading opposite GE Warren on these transactions and thus also allegedly engaging in prohibited transitory EFRPs. Unrelatedly, Aardvark Trading LLC agreed to pay a fine of US $40,000 to NYMEX because of two breakdowns in one of its automated trading systems. NYMEX claimed that on August 17 and 23, 2012, an Aardvark ATS did not function as intended and caused self-match calendar spread trades in the exchanges’ crude oil contract. This, said NYMEX, caused price and volume “aberrations” on both sides of the market. Previously, Aardvark agreed to settlements with Chicago Board of Trade and the Chicago Mercantile Exchange to resolve similar disciplinary actions. (Click here for background.) Finally, HTG Capital Partners LLC agreed to pay a fine of US $15,000 to resolve charges by NYMEX that, on July 9, 2016, an ATS it operated entered five Trading at Settlement orders prior to receiving a security status message that the relevant product group was eligible for TAS orders. Placing TAS orders outside approved times is prohibited by NYMEX rules (click here to access NYMEX Rule 524.A).

Compliance Weeds: Recently both CME Group and ICE Futures U.S. have amended their rules and guidance regarding exchange for related position transactions. Among other things, CME Group recently adopted amendments to its rules and guidance that, among other things, make clear that firms executing or clearing EFRPs must exercise “due diligence” to identify situations where a customer’s EFRP transactions may be “non-bona fide,” and permit EFRPs to contain multiple exchange components that may not have the same market bias. Similarly, ICE Futures U.S. amended its EFPR guidance 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.”

And more briefly:

  • Five Foreign Boards of Trade Authorized by CFTC for Direct Access by US Persons: The Commodity Futures Trading Commission issued formal orders authorizing five non-US foreign board of trades to provide identified members or other participants located in the United States with direct access. The five FBOTs are CME Europe Limited, Eurex Deutschland, ICE Futures Europe, London Stock Exchange and the London Metal Exchange.

  • Package Transactions No-Action Relief Extended One More Time by CFTC Staff: The Commodity Futures Trading Commission’s Division of Market Oversight provided a delay until November 15, 2017, for the application of the Commission’s trade execution requirements in connection with the swap portion(s) of certain so-called “package transactions” that would otherwise be subject to mandatory trading on a designated contract market or a swap execution facility. This is the fifth time the CFTC has extended the trade execution requirement for these types of transactions.

  • ICE Futures US Copies CFTC Prohibition Against Use of Manipulative Device to Defraud in New Rule: ICE Futures U.S. proposed to adopt an express rule to prohibit the use or employment of any manipulative device, scheme or artifice to defraud mirrored after a similar rule of the Commodity Futures Trading Commission the agency adopted after enactment of the Dodd-Frank Wall Street Fraud and Consumer Protection Act in 2010. The CFTC has recently expanded the use of its equivalent rule to bring an enforcement action against a person that traded on allegedly misappropriated information of his employer. (Click here background.) IFUS’s proposed new rule is scheduled to take effect on November 14.

  • NASDAQ Futures Adopts Block Pre-Hedge Guidance Similar to CME Group and IFUS: NASDAQ Futures Inc. proposed amendments to its futures block trading guidance to authorize the pre- or anticipatory hedging of futures and related Opinions block trades by principal counterparties prior to a transaction’s execution under limited circumstances. This proposal is similar to recent amended advisories issued by the CME Group and ICE Futures U.S. (Click here for background.) However, unlike the guidances issued by these two entities that limit such pre- or anticipatory hedging where parties believe “in good faith will result from the consummation of the block trade,” NASDAQ Futures’ proposal would limit such pre- or anticipatory hedging to situations where parties “have a good faith belief that the block trade will be consummated.” NASDAQ Futures' advisory is scheduled to be effective November 10.

  • Minimum Security Deposit for British Pound Retail Forex Transactions Increased by NFA for Forex Dealer Members: In light of market volatility, the National Futures Association increased the minimum security deposit that Forex Dealing Members must assess their retail clients for currency pairs involving the British Pound to 5 percent. This increase is effective as of 5 p.m. on November 7.


  • Compliance Weeds – New Form 40 Obligations to Begin November 18 – Be Prepared: Beginning November 18, persons owning or controlling reportable positions in futures or swaps and subject to a special call by the Commodity Futures Trading Commission must file electronically a revised CFTC Form 40 or 40S with the CFTC. (Click here to access a sample new Form 40. Designated contract markets will also utilize the revised Form 40s.) Persons are deemed to control a reportable position if they maintain positions or trade volumes in excess of enumerated threshold levels. Moreover, unlike now, reportable traders filing a new Form 40 will be under a continuous obligation “per direction in the special call” to freshen information in a previously filed Form 40; it is not clear within what time frame such information must be updated. Additionally, there are many new concepts introduced in the new Form 40 – some of which are not defined and some of which seem practically incompatible with guidance previously issued by staff of the Division of Market Oversight regarding the meaning of “trading account controller” in connection with a related CFTC form (click here to access the CFTC’s staff guidance). One such unclear concept is raised in question 12 of the new Form 40 which asks reportable traders to “[l]ist any other person[s] that directly or indirectly influence, exercise authority over, some or all of the trading of the reporting trader, but who does not exercise ‘control’…” Reportable or potential reportable traders should begin reviewing the revised Form 40 to anticipate how they will respond to each question when asked and to review how they will to file the revised Form 40s electronically beginning November 18.

  • …And Don’t Forget Brexit: Last week, the High Court of Justice’s Queen’s Bench Division in the United Kingdom threw a potential monkey wrench into the planned withdrawal of the United Kingdom from the European Union when it decided that only Parliament may authorize the actual withdrawal. Following the referendum by the UK public, Prime Minister Theresa May announced she would honor the public referendum by beginning the process of withdrawal without first gaining the formal approval of Parliament. The High Court ruled, however, that government ministers’ authority does not permit this because under the United Kingdom’s constitutional law, the Crown’s (and therefore such ministers’) “prerogative power” is limited. The UK government has announced it will appeal this court decision.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 312

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...