January 25, 2022

Volume XII, Number 25


January 25, 2022

Subscribe to Latest Legal News and Analysis

January 24, 2022

Subscribe to Latest Legal News and Analysis

Bridging Weeks: AML; DLT; Attempted Manipulation; Manipulative Device; Registration; EFRPs; Block Trades; Hedge Exemptions

During the last two weeks, numerous important regulatory and litigation developments occurred worldwide that impacted financial services firms. In the United States, the Securities and Exchange Commission sanctioned a broker-dealer for anti-money laundering breakdowns, while the Commodity Futures Trading Commission proposed, going forward, to authorize exchanges to grant certain hedge exemptions to speculative position limits (much as they do currently) under its 2013 proposed position limits regulations, and will hold a public roundtable on proposed Regulation Automated Trading this week in Washington, DC. Meanwhile, the European Securities and Markets Authority issued an important think piece on distributed ledger technology; while the principal Hong Kong securities regulator fined a brokerage firm for not being able to ascertain the identities of certain ultimate retail clients of an intermediate broker that was its direct customer. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • Broker-Dealer Sanctioned by SEC for Anti-Money Laundering Breakdowns (includes Compliance Weeds);

  • ESMA Seeks Comment on Distributed Ledger Technology (includes Helpful to Getting the Business Done);

  • International Bank and Affiliates Settle Two CFTC Enforcement Actions for Alleged Benchmarks Manipulation (includes Legal Weeds);

  • HK SFC Sanctions Broker for Effectuating Transactions for Korean Intermediary Without Ability to Know Ultimate Client Identities;

  • Investment Adviser Settles With SEC for Acting as a Broker-Dealer Without Registration;

  • Broker-Dealer Charged by FINRA for Failing to Protect Customer Assets; Other Broker-Dealers Sanctioned for Not Complying With Customer Confirmation and Best Execution Requirements;

  • CME Group Settles With Non-Members for EFRP and Disruptive Trading Violations (includes Compliance Weeds);

  • Federal Appeals Court Says Defendant Must Wait Before Challenging SEC Administrative Process;

  • CFTC Proposes to Authorize Exchanges to Grant Physical Commodity Users Hedging Exemptions Related to Speculative Position Limits (includes My View);

  • IFUS and ICE Futures Europe Update Block Trade Guidance (includes Compliance Weeds);

  • Dan Roth, NFA Veteran, Current President and CEO, Announces Retirement; and more.

  • Broker-Dealer Sanctioned by SEC for Anti-Money Laundering Breakdowns: Albert Fried & Company, LLC, a Securities and Exchange Commission-registered broker-dealer, agreed to pay a fine of US $300,000 to resolve charges by the SEC that, from August 2010 through October 2015, it failed to file reports of suspicious activities (SARs) by customers with the Financial Crimes Enforcement Network of the US Department of Treasury, as required by law. According to the SEC, during this time on multiple occasions, Albert Fried received large-volume deposits of penny stocks from a number of customers. Afterwards, the customers sold the stocks in transactions that often constituted a “substantial portion” of the daily volume in the thinly traded securities. These liquidations, alleged the SEC, were often accompanied by other suspicious indicators. These red flags included, among other things, that Albert Fried received regulatory inquiries and grand jury subpoenas regarding certain of its customers’ penny stock trading; other broker-dealers rejected the firm’s effort to transfer the certain penny stocks; and after liquidating one issuer’s penny stock, a customer transferred one hundred percent of its cash proceeds from its Albert Fried account. At the relevant time, Albert Fried maintained written procedures that required the firm to take certain steps to know its customers, approve deposits of penny stocks, and monitor large volume trading. The procedures also required the firm to file SARs with FinCEN for “trading that constitutes a substantial portion of all trading for the day in a particular security;” “heavy trading in low-priced securities;” and “unusually large deposits of funds or securities.” The firm did not adequately follow its procedures, alleged the SEC.

Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions or patterns of transactions involving at least US $5,000 which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. Previously, the Financial Industry Regulatory Authority also fined Brown Brothers Harriman & Co. US $8 million for failing to file SARs in connection with similar activity involving penny stocks. In that matter, FINRA also fined and suspended the firm’s global anti-money laundering compliance officer for his alleged role in the firm’s alleged misconduct. Covered entities should continually monitor transactions they effectuate and ensure they maintain written procedures they follow to identify and evaluate red flags of suspicious activities and file required SARs with FinCEN when appropriate. (Click here for a discussion of another more recent FINRA disciplinary action against a member for alleged widespread AML breakdowns.)

  • ESMA Seeks Comment on Distributed Ledger Technology: The European Securities and Markets Authority published a discussion paper to solicit comments on distributed ledger technology – a more generic term for what is sometimes referred to as the “Blockchain.” (The Blockchain, however, is more appropriately regarded as a form of DLT associated with Bitcoin – one form of digital currency.) Generally, DLT refers to records or ledgers of electronic transactions that are maintained on a shared network of participants and not by a single entity. There is no central validation of such transactions. Security is maintained throughout the system using computer-based encryption techniques. Whereas the Blockchain is an open system where all participants can contribute to the system’s validation, DLT developed for financial markets would most likely be restricted only to authorized persons. According to ESMA, DLT could be used to “speed the clearing and settlement of certain financial transactions by reducing the number of intermediaries involved and by making the reconciliation process more efficient.” ESMA also observed that DLT could be used to record ownership of securities and the safekeeping of assets while so-called “smart contracts” could be linked with DLT to automate the processing of corporate actions or to automate certain contractual terms (e.g., payment on the occurrence of certain conditions). Among other things, ESMA seeks to understand potential uses for DLT in connection with securities and derivatives transactions (not with digital currencies); potential technological issues (e.g., how DLT might interface with fiat currency ledgers and existing market infrastructures); potential regulatory and legal issues; potential governance and privacy issues; and potential risks, including security and cyber risks, fraud and money laundering. ESMA will accept comments through September 2.

Helpful to Getting the Business Done: ESMA’s discussion paper is a very succinct primer on DLT and should be reviewed by all finance industry professionals who wish to acquire a basic understanding of the subject. Although ESMA takes no view on a possible need to regulate DLT, it identifies a number of potential legal and regulatory issues. Among other things, ESMA observes that “[t]he capacity of the DLT to fit into the existing regulatory framework may limit its deployment.” ESMA specifically wants feedback on the legality and enforceability of records maintained on the DLT, and how a specific DLT application might be supervised, given its cross-border nature and the differences in privacy, insolvency and other requirements across countries. ESMA’s desire to learn more in commendable, but it should keep in mind CFTC Commissioner J. Christopher Giancarlo’s cautionary advice to all regulators in thinking about DLT, mainly to “do no harm” in order not to impede the development of this new technology. To accomplish this, US and foreign regulators should “coordinate to create a principles-based approach for DLT oversight in order to provide the flexibility, certainty, and harmonization necessary for this technology to flourish,” Mr. Giancarlo stated a few months ago. (Click here for further insight into Mr. Giancarlo’s thinking.)

  • International Bank and Affiliates Settle Two CFTC Enforcement Actions for Alleged Benchmarks Manipulation: Citibank, N.A. and two affiliates settled two separate enforcement actions brought by the Commodity Futures Trading Commission related to the entities’ alleged attempted manipulation of benchmarks. In one action, solely against Citibank, the CFTC alleged that, beginning in January 2007 through January 2012, the bank attempted to manipulate the US Dollar International Swaps and Derivatives Association Fix (commonly known as “ISDAFIX”) when some of its traders, on multiple occasions, made submissions that were used to set the day’s ISDAFIX rates that were for the benefit of the bank’s existing derivatives trading positions, rather than reflecting the midpoint where it would itself offer and bid a relevant swap based on the relevant rates. In another action, against Citibank, Citibank Japan Ltd., and Citigroup Global Markets Japan Inc., the CFTC charged that, from spring 2008 through August 2010, the respondents similarly attempted to manipulate two other benchmarks – the London Interbank Offered Rate (commonly known as LIBOR) for Yen and the Euroyen Tokyo Interbank Offered Rate – to likewise benefit the respondents’ derivatives trading positions. The CFTC also alleged in this second lawsuit that Citibank made submissions in connection with US Dollar LIBOR that did not accurately reflect the bank’s assessment of the cost of borrowing funds in the London interbank market in order to avoid “negative scrutiny” during the 2008-2009 financial crisis. The CFTC alleged that, during this time, the bank, on occasion, purposely made US Dollar LIBOR submissions below its actual costs “to shield the institution fro negative market perception regarding its liquidity, strength and creditworthiness.” Citibank and its affiliates agreed to pay an aggregate fine of US $425 million and implement certain remedial measures to resolve these matters.

Legal Weeds: In connection with the CFTC’s action singularly naming Citibank, NA, in addition to charging the bank with attempted manipulation and making false reports, the CFTC charged Citibank with using or attempting to use a manipulative device in connection with its allegedly problematic conduct that occurred on or after August 15, 2011, in violation of applicable law and CFTC regulation. (Click here to access 7 USC §§ 9(1) and here for CFTC Regulation 180.1(a).) The CFTC continues to use its newly gotten anti-manipulative, deceptive device and contrivance authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act to prosecute a wide range of conduct from its first use in the JP Morgan “London Whale” episode to allegations of illegal off-exchange metals transactions, insider trading, claims of more traditional manipulation and attempted manipulation (without endeavoring to show an artificial price) and allegations of spoofing. The CFTC has made clear it sees its new Dodd-Frank authority “as a broad, catch-all provision reaching fraud in all its forms – that is, intentional or reckless conduct that deceives or defrauds market participants” and will use it whenever possible. Market participant beware this new junkyard dog of the CFTC’s enforcement arsenal!

  • HK SFC Sanctions Broker for Effectuating Transactions for Korean Intermediary Without Ability to Know Ultimate Client Identities: The Securities & Futures Commission of Hong Kong fined Guotai Junan Securities (Hong Kong) Limited HK $1.3 million (US $130,000) for its failure to provide the SFC with the identities of the ultimate customers of an intermediary Korean omnibus broker for whom it processed transactions. Under SFC requirements, a licensed entity should provide ultimate client information to it or an HK exchange within two days of a request. Although the SFC does not mandate the manner by which licensed persons might comply with this requirement, it advises that one method “is by using an agreement whereby the licensed person’s client would agree to provide the details of the ultimate beneficiary and of the person originating the instruction for a transaction directly to [r]egulators on request.” HK licensed persons are required to refuse business from clients that “are not prepared” to provide the requisite client information within two days after a request. In the instant matter, on July 7, 2014, the SFC requested that Guotai provide ultimate client information for transactions involving a number of shares in an equity traded on the Stock Exchange of Hong Kong. On July 10, Guotai advised the SFC that the transactions were on behalf of a Korean broker acting for retail clients. Under its client agreement with Guotai, the Korean broker agreed to provide ultimate client information within two days and confirmed that its clients had waived any benefit of local law that might preclude it from complying with its agreement with Guotai. Notwithstanding, after not producing client identity information timely, the Korean broker advised Guotai it could not comply with the SFC’s request under Korean law without the clients’ written consent. The ultimate clients’ identification was finally provided to the SFC on January 12, 2015 – many months after the SFC's initial request. In the interim, Guotai continued to transact substantial business on behalf of the Korean broker. However, said the SFC, by August 1, Guotai should have reasonably realized its Korean broker client might not comply with its agreement to provide ultimate client identity within two days as required, and should have ceased conducting business with it. Accordingly, the SFC claimed that “Guotai[’s] conduct was deliberate” and its actions could have jeopardized the “integrity of the market.”

  • Investment Adviser Settles With SEC for Acting as a Broker-Dealer Without Registration: Blackstreet Capital Management, LLC (BCM), a private equity fund adviser registered with the Securities and Exchange Commission as an investment adviser, and Murry Gunty, its managing member and principal owner, settled charges brought by the Securities and Exchange Commission claiming that BCM acted as a broker-dealer without registration. The SEC also alleged that BCM, without express authorization in the funds’ governing documents, charged two portfolio companies owned by one of its funds operating partner oversight fees and used fund assets to make political and charitable contributions, as well as engaged in other impermissible actions. In determining that BCM acted as an unregistered broker-dealer, the SEC claimed that “[r]ather than employing investment banks or [registered] broker-dealers to provide brokerage services with respect to the acquisition and disposition of portfolio companies, some of which involved the purchase or sale of securities, BCM performed these services in-house, including soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions.” BCM received substantial transaction-based compensation for providing these brokerage services, alleged the SEC. The SEC also charged that BCM failed to adopt and implement written policies and procedures reasonably designed to prevent the allegedly wrongful conduct. To resolve the SEC’s complaint, BCM and Gunty agreed to pay sanctions of over US $3.1 million, comprising a disgorgement of over US $2.3 million and a civil monetary penalty of US $500,000.

  • Broker-Dealer Charged by FINRA for Failing to Protect Customer Assets; Other Broker-Dealers Sanctioned for Not Complying With Customer Confirmation and Best Execution Requirements: The Financial Industry Regulatory Authority brought charges against one member broker-dealer for its alleged failure to comply with requirements related to the protection of customers assets, while settling charges against two other broker-dealers for not complying, respectively, with certain of their customer confirmation and best execution obligations. In one matter involving Wedbush Securities Inc., FINRA alleged that the broker-dealer failed on multiple occasions from June 2009 through June 2012 to comply with requirements under applicable law and SEC rule to promptly obtain and maintain physical possession or control of fully-paid-for securities and excess margin securities carried for its customers (its so-called “segregation requirement”), and to set aside on at least a weekly basis in a special account for the benefit of its customers – its so-called “reserve account” – any amounts it owes customers in excess of amounts its customers owe it. FINRA claimed that Wedbush created and/or increased deficits in its segregation requirement by improperly delivering stock shares or returning stock shares borrowed for stock loan transactions when it did not have sufficient excess shares above the firm’s segregation requirement. The firm’s reserve account deficiencies resulted from calculation errors, said FINRA. FINRA alleged that Wedbush failed to implement and maintain an adequate supervisory system to avoid the purported violations, despite being put on notice as a result of FINRA exams as early as 2004 that it failed adequately to protect customer assets. The firm also received a Letter of Caution from FINRA on the subject in 2008. Separately, FINRA brought and settled charges against UBS Securities, LLC for the firm’s alleged failure on occasion to disclose certain required information on trade confirmations to institutional customers related to their execution of trades through foreign affiliates. FINRA claimed that, on more than 15,500 occasions from April 2012 through March 2015, the firm disclosed to such customers that it acted in agency capacity instead of on a riskless principal basis in connection with certain trades because of a system configuration error. UBS agreed to pay a fine of US $110,000 to resolve this matter. FINRA also resolved a disciplinary action against E*Trade Securities for its alleged failure from July 2011 through June 2012 to conduct adequate “regular and rigorous reviews” regarding the quality of the execution of its customer orders as required by FINRA. According to FINRA, during the relevant time, the firm did not adequately consider the impact of its internalization model through which it routed the majority of its market and marketable limit orders to G1 Execution Services, an affiliated market maker; relied on execution quality statistics that were based on purportedly flawed data; and relied too much on comparisons of the firm’s execution quality with industry and customer averages, as opposed to actual execution quality provided by the market centers where the firm routed orders. E*Trade agreed to pay US $900,000 to resolve this matter.

  • CME Group Settles With Non-Members for EFRP and Disruptive Trading Violations: CME Group Exchanges brought and settled 12 separate disciplinary actions involving violations of its rules related to exchange for related position transactions involving eight non-members and one member for fines between US $15,000 and US $35,000 apiece. The actions involved allegations of engaging in EFRPs without a transfer between the relevant parties of ownership of the cash commodity underlying the exchange contract, or a by-product, related product or an over-the-counter instrument; engaging in transitory EFRPs (e.g., involving a simultaneous or close-in-time offset of the related position to the EFRP between the relevant parties without market risk); or engaging in EFRPs for the impermissible purpose of transferring positions between related entities of a corporate group. In a separate action, the New York Mercantile Exchange brought and settled charges against Joshua Bailer, a non-member, for allegedly layering large orders on one side of the market to effectuate fills of smaller orders on the other side of the market on multiple times from October 2014 through January 2015. Mr. Bailer agreed to pay a fine of US $35,000 and serve a 10-business-day CME Group product trading prohibition to resolve this matter.

Compliance Weeds: Although most of the CME Group disciplinary actions involved incidents from 2013 and 2014, some involved conduct that occurred in 2015. Hopefully, by now, it is clear that the CME Group is aggressively prosecuting violations of its EFRP rules. All EFRP transactions must involve the bona fide transfer of the cash commodity underlying the exchange contract, or a by-product, related product or an over-the-counter instrument. A liquidation of the related position that occurs simultaneously or close-in-time without the parties incurring market risk will likely cause the EFRP to be deemed a prohibited transitory EFRP. Although EFRPs may be conducted between different trading units within one corporate group or even within one company, they must be for units under independent control and not to transfer positions from one trading operation to another.

Federal Appeals Court Says Defendant Must Wait Before Challenging SEC Administrative Process: The United States Court of Appeals in New York upheld a lower court decision that dismissed a challenge by Lynn Tilton (the so-called “Diva of Distressed”) to the administrative judicial process of the Securities and Exchange Commission. In April 2015, the SEC commenced administrative proceedings against Ms. Tilton, and companies she owns and controls claiming that, since 2003, the respondents misled investors about the declining value of assets in collateralized loan obligation funds they managed. In response, the respondents filed a lawsuit against the SEC in federal court in New York City seeking to enjoin the agency from proceeding with the administrative proceeding, and instead require it to proceed against respondents in a federal court. Among other things, the respondents claimed that the SEC process for appointing and removing administrative law judges violated the so-called “Appointments Clause” of the US Constitution. (Click here for further details on the SEC case against Ms. Tilton.) The court dismissed Ms. Tilton’s lawsuit, holding that the administrative law judge proceeding and the SEC itself, in the first instance, were the appropriate forum to hear the respondents’ constitutional arguments. The US Court of Appeals upheld the lower court’s decision, saying that under relevant law, “Congress implicitly precluded federal district court jurisdiction over the appellants’ constitutional challenge.” The Court of Appeals ruled that Ms. Tilton’s Appointments Clause challenge should be handled through the SEC’s administrative law regime “and could reach a federal court only on petition for review of a final decision by the Commission.” If Ms. Tilton loses her action before an administrative tribunal she may petition for a new consideration before the Commission, and the party that loses there may seek review by a federal court of appeals. (Click here for details on the lower court’s decision.)

  • CFTC Proposes to Authorize Exchanges to Grant Physical Commodity Users Hedging Exemptions Related to Speculative Position Limits: The Commodity Futures Trading Commission proposed modifications and additions to its 2013 proposed regulations and guidance related to speculative position limits in order to potentially authorize derivatives exchanges to recognize certain derivatives positions as constituting valid non-enumerated hedges or enumerated anticipatory hedges. The CFTC also proposed to grant derivatives exchanges authority to recognize certain spread positions as justifying an exemption from speculative position limits too. These new powers would be available to designated contract markets and swap execution facilities that satisfy certain minimum requirements related to their listing of a relevant derivatives contract. All exemptions from position limits granted by exchanges would be subject to CFTC review. In addition, the CFTC recommended temporarily delaying its previously proposed requirement that derivatives exchanges establish and monitor speculative position limits on swaps. The Commission made this proposal because, practically, derivatives exchanges do not necessarily have access to information to satisfy this obligation at this time. (Click here for further details regarding the CFTC’s proposal.)

My View: Although the proposed amendments to the CFTC’s 2013 position limits regulations and guidance are a big leap in the right direction by permitting exchanges to make assessments regarding purported hedging strategies of entities trading on their facilities, there are potential burdens that hopefully will be alleviated in the final rules. Among other things, it appears that an entity granted a non-enumerated hedge exemption would have to report to the relevant exchange when it established its hedge and its offsetting cash position. Likewise, in connection with anticipatory hedge exemptions granted by an exchange, it appears that a trader similarly would have to file reports that detail its anticipatory hedge position with the CFTC and a copy to the exchange. These may be onerous requirements if too much detail or frequency is mandated. If an exchange-granted hedge exemption is later overturned by the CFTC, a trader would be afforded a “commercially reasonable amount of time” to liquidate its futures position – but the Commission says that ordinarily would be less than one day. This appears to be a very unreasonably short time period. Under the proposed amendments, exchanges would be required to maintain complete books and records of all applications for non-enumerated hedge exemptions. This would include records of all written and oral communications between the exchange and an applicant. It seems a bit of overkill to require exchanges to keep records of oral communications. Again, however, the proposed amendments are a big step forward by mostly restoring the status quo of permitting exchanges to process hedging exemptions to position limits in the first place. Not exactlyBack to the Future; more like Future from the Back!

  • IFUS and ICE Futures Europe Update Block Trade Guidance: ICE Futures U.S. proposed an amendment to its block trade frequently asked questions to clarify when pre-hedging or anticipatory hedging of a block trade is permitted. (Click here to access the current IFUS block trade FAQs.) Under IFUS’s proposed guidance, the principal parties to a block trade may engage in pre- or anticipatory hedging of the position they believe in “good faith” will result from the “consummation” of a block trade. However, this ability will not exist for “an intermediary that takes the opposite side of its own Customer order.” As proposed, an intermediary will be permitted to enter into transactions to offset the position that will result from the block trade only after the block trade has been consummated, including the period of time before the block trade is publicly reported by the exchange. Under IFUS’s recommended guidance, no person may front run a block trade by another person if it received non-public information regarding such transaction “through a confidential employee/employer relationship, broker/customer relationship or in breach of a fiduciary responsibility.” IFUS's proposed guidance will be effective June 16 absent CFTC objection. ICE Futures Europe also proposed non-substantive amendments to its separate block trade guidance related to specific contracts.

Compliance Weeds: In the United States, block trades are an exception to the Commodity Futures Trading Commission 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; and reporting requirements. The rules also typically address the use of nonpublic information regarding block trades. Currently, CME Group prohibits pre-hedging or anticipatory hedging of any portion of a block trade in the same or related product by all parties to an impending block trade. However, parties to a block trade may hedge or offset the risk associated with a block trade following its consummation before the transaction is reported publicly by the exchange. Under IFUS’s proposed interpretation, this strict restriction will only exist for intermediaries that participate in block trades, not principals that deal directly with each other. Third parties on both exchanges will not be able to trade on insider information related to block trades under any circumstance until after a public report of the relevant transaction. It is also important not to assume that IFUS’s and ICE Futures Europe’s requirements on block trades are identical. Among other things, the parties that may participate in block trades and the prohibitions regarding use of impending information regarding block trades may be different between the ICE exchanges located on the opposite sides of the Atlantic Ocean.

And more briefly:

  • CFTC to Hold Public Roundtable Regarding Regulation AT; Five Topics to Be Discussed Including Who Should Be Covered: The Commodity Futures Trading Commission announced that staff will host a public roundtable to discuss five aspects of Regulation Automated Trading, initially proposed in November 2015. The broad matters to be addressed are (1) the definition of direct electronic access; (2) market participants covered by Regulation AT; (3) alternatives to the Commission’s proposed requirements to mandate pre-trade risk controls and system testing by all impacted registrants that engage in algorithmic trading; (4) how impacted registrants might comply with Regulation AT’s requirements when using third-party software or systems; and (5) source code retention and access. The roundtable will be held on June 10, 2016, at the CFTC’s offices in Washington, DC beginning at 9 am and can be accessed remotely (click here to access international dial-in numbers). In addition, the CFTC announced that, in conjunction with the roundtable, it would reopen the comment period for Regulation AT for items on its agenda, as well as items that may come up during the roundtable. The supplemental comment period will run from June 10 through June 24, 2016. (Click here for further information and analysis regarding the CFTC roundtable.)

  • Bitcoin Exchange Sanctioned by CFTC for Not Being Registered: BFXNA Inc., doing business as Bitfinex, agreed to settle charges brought by the Commodity Futures Trading Commission that, from approximately April 2013 through at least February 2016, it allegedly engaged in prohibited, off-exchange commodity transactions with retail clients and failed to register as a futures commission merchant, as required. According to the CFTC, during the relevant time period, Bitfinex “operated an online platform for exchange and trading cryptocurrencies, mainly Bitcoins.” The CFTC said that Bitfinex’s platform allowed users that were not eligible contract participants to borrow funds to purchase Bitcoins from other platform users. (ECPs include, among others, individuals who invest more than US $10 million on a discretionary basis, or more than US $5 million to hedge the risk of an asset; click here to access the Commodity Exchange Act §1a(18) for a definition of an ECP.) However, financed Bitcoins purchased were not delivered to purchasers within 28 days as required for retail clients under applicable law. Bitfinex agreed to pay a fine of US $75,000 to resolve the CFTC’s charges and to cease and desist from future violations. The CFTC acknowledged that Bitfinex’s cooperation with it was “significant” during the course of its investigation. In a 2015 enforcement action, the CFTC held that Bitcoin and other virtual currencies are commodities under applicable law and within the remit of the CFTC. (Click here for details.)

  • Final Cross Margin Rule for Uncleared Swaps Issued by CFTC: The Commodity Futures Trading Commission adopted a final rule regarding the cross-border application of margin requirements for uncleared swaps by swap dealers and major swap participants that are not subject to requirements of prudential regulators. Under the final rule, substituted compliance with local requirements is available for initial margin posted to any non-US counterparty (including SDs and MSPs under the oversight of prudential regulators) provided the uncleared swap is not guaranteed by a US person. Substituted compliance will not apply to initial margin collected from a non-US counterparty. Commissioner J. Christopher Giancarlo dissented from the final margin rule claiming that its “preconditions to substituted compliance … is overly complex, unduly narrow and operational impractical.”

  • Retail Forex Transactions Barred by Broker-Dealers as July 31; NFA Proposes Higher Fees for Forex Dealers: The Securities and Exchange Commission has not renewed its rule that currently permits broker-dealers, including duly registered future commission merchants, to engage in Forex transactions with any person other than an eligible contract participant. (Click here to access SEC Rule 15b12-1; click here to access the Commodity Exchange Act §1a(18) for a definition of an ECP.) As a result, broker-dealers are prohibited to engage in Forex transactions with non-ECPs as of July 31, 2016. Prohibited Forex transactions do not include spot Forex transactions; forward contracts that create an enforceable obligation to make or take delivery where each counterparty has the ability to deliver and accept delivery in connection with a line of business; or options traded on a national securities exchange. Separately, the National Futures Association submitted to the Commodity Futures Trading Commission for its approval a proposed increase in assessment fees for Forex Dealer Members from US $.02 to US $.04 on each order segment submitted by FDMs to the NFA Forex Transaction Reporting Execution Surveillance System.

  • Former Bank CEO Sentenced to 18 Months in Prison for Obstructing Fed Examination: Timothy Owen, former chief executive officer and chairman of Voyager Bank and president and CEO of Voyager Financial Services Corporation, was sentenced to 18 months’ imprisonment after pleading guilty to criminal charges emanating from his alleged obstruction of an examination by the Board of Governors of VFSC in 2009. According the US Attorneys’ office in Minnesota, after the FRB requested VFSC’s Board of Directors to review certain loans to Mr. Owens, Mr. Owens obtained the letter, did not disclose the letter to the Board and prepared a false and misleading response.

  • NFA to CPOs and CTAs: File Late, Pay a Late Fee: The National Futures Association submitted a rule amendment to the Commodity Futures Trading Commission for its approval that would require commodity trading advisers and commodity pool operators automatically to remit to the NFA US $200 for each business day a required Form PQR or Form PR is late at the time it finally files its required form. CPOs are required to file Form PQR each quarter to provide NFA information about their operations and the operations of pools they operate. CTAs are similarly required to file Form PR each quarter to provide NFA information about themselves, their trading programs, the pool assets they direct and principal-carrying broker relationships, among other information.

  • ESMA Provides Guidance When Commodity Business Is Ancillary: The European Securities and Markets Authority issued an opinion describing when a non-financial firm’s commodity derivatives trading should be considered ancillary to its main business and thus not subject to certain requirements of the Markets in Financial Instruments Directive II. Previously, ESMA proposed a trading activity and business activity test to measure the scope of the entity’s speculative commodity trading activity compared to the size of the relevant commodity market and relevant to the entity’s total trading activity. In response to a request by the European Commission, ESMA is also proposing a capital test as an alternative to the business test. However, ESMA stated that it is not a proponent of the capital test, fearing that, “given the differences in size and the wide variety of sectors and participants represented in commodities derivatives markets, introducing such a test is not likely to meet the principle of ensuring a level-playing-field for market participants.”

  • FINRA to Implement OATS Requirement to Identify Non-Member Broker-Dealers as of August 1: The Financial Industry Regulatory Authority will require, beginning August 1, that all firms that report information to its Order Audit Trading System (OATS) include the identity of US-registered broker-dealers that are not members of FINRA and broker-dealers that are not registered in the United States but have received a self-regulatory organization-assigned identifier by a national securities exchange or a national securities association to access certain FINRA trade reporting facilities.

  • ESMA Clarifies Requirements Regarding Indirect Clients: The European Securities and Markets Authority issued two final draft regulatory standards on indirect clearing under the Markets in Financial Instruments Regulation and the European Market Infrastructure Regulation. Among other things, the drafts offer a choice of account structures to indirect customers reflecting different degrees of segregation and address the management of the default of a firm providing indirect clearing services.

  • SEC Alleges Plumber Received Great Tips for Great Services Rendered – Albeit Illegal Insider Tips: The Securities and Exchange Commission filed a civil complaint in a federal court in New York charging Steven McClatchey and Gary Pusey (both from Long Island, NY) with engaging in an illegal insider trading scheme. According to the SEC, Mr. McClatchey provided nonpublic information learned from his employer about pending mergers and acquisitions to his plumber and close friend, Mr. Pusey. In return, Mr. Pusey allegedly remodeled a bathroom in Mr. McClatchey’s home for free, placed cash in Mr. McClatchey’s gym bag or handed McClatchey cash directly. All told, Mr. Pusey made US $76,000 trading on his illicitly obtained tips, said the SEC. The SEC seeks disgorgement of illicit trading profits and gains from Mr. McClatchey and Mr. Pusey and civil monetary penalties.

And finally:

  • Dan Roth, NFA Veteran, Current President and CEO, Announces Retirement: Dan Roth, president and chief executive officer of the National Futures Association, announced his plan to retire in the coming year. Dan first joined NFA in 1983 and has held increasingly important positions until he assumed his current roles in 2003. Under his leadership, NFA has expanded its oversight activities to include 107 newly registered swaps dealers and foreign exchange dealers, in addition to well over 3,800 future commission merchants, introducing brokers, commodity pool operators and commodity trading advisors. Dan has brought great intelligence and humor to his role, and most importantly is fundamentally a very nice guy. He is an icon and will be missed.

©2022 Katten Muchin Rosenman LLPNational Law Review, Volume VI, Number 158

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...