June 21, 2021

Volume XI, Number 172

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June 18, 2021

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Bridging the Weeks: Dec 19 - Jan 6, and Jan 9, 2017 (Jon Corzine; Infiltrating E-Mails; ATS Gone Bad; Whistleblower Infractions)

More than five years after the collapse of MF Global Inc. delayed the repayment to its customers of 100 percent of their funds for approximately two and one-half years, Jon Corzine, the firm’s former chief executive officer, settled an enforcement action brought by the Commodity Futures Trading Commission for his role in the firm’s demise. He did this by agreeing to pay a US $5 million fine and to be subject to a CFTC-registration prohibition. Although Mr. Corzine agreed to pay this fine out of his own pocket and not through insurance, he was not required to admit to any of the substantive allegations in the CFTC’s original 2013 complaint against him, or in the consent order that formally resolved the enforcement action. Separately, three non-US persons were criminally indicted and sued by the Securities and Exchange Commission at the end of 2016 for allegedly illicitly infiltrating the email of two unnamed prominent law firms, obtaining nonpublic information regarding pending mergers and acquisitions, and trading for their advantage on such information. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:

  • Jon Corzine Agrees to US $5 Million Fine and Registration Ban to Settle CFTC Charges Related to Collapse of MF Global; Edith O’Brien to Pay US $500,000;

  • Non-US Traders Criminally and Civilly Charged With Trading on Nonpublic Information Cyber-Hacked From Law Firms (includes Compliance Weeds);

  • Firm Fined by ICE Futures US for ATS Gone Bad; NYMEX Summarily Denies Access to Member for Knowingly Submitting Inaccurate TAS Orders (includes Compliance Weeds);

  • Two Companies Charged by SEC for Whistleblower Infractions (includes Legal Weeds);

  • FINRA Sanctions 12 Member Firms for Failure to Maintain Electronic Records in Required Format (includes Compliance Weeds);

  • Investment Bank Agrees to Pay US $120 Million to Resolve Charges That It Attempted to Manipulate IRS Benchmark;

  • Tenth Circuit Holds SEC Administrative Tribunals Unconstitutional; and more.

Briefly:

  • Jon Corzine Agrees to US $5 Million Fine and Registration Ban to Settle CFTC Charges Related to Collapse of MF Global; Edith O’Brien to Pay US $500,000: Jon Corzine agreed to resolve charges brought by the Commodity Futures Trading Commission related to his oversight and control of MF Global Inc. in connection with the future commission merchant’s October 2011 collapse after the firm used nearly one billion US dollars of customer-segregated funds to support its own proprietary positions. At the time, Mr. Corzine was the chief executive officer of MFGI, as well as CEO and chairman of the board of MFGI’s parent corporation, MF Global Holdings Ltd. ("MFGH"). Similarly, Ms. Edith O’Brien — the former assistant treasurer of MFGI – also agreed to settle CFTC charges brought against her for her role in the firm’s collapse. The CFTC filed a civil lawsuit against Mr. Corzine and Ms. O’Brien as well as against MFGH and MFGI itself in June 2013 in a federal court in New York. The CFTC charged all four defendants with failing to segregate customer funds as required by law and for misusing customer funds. MFGH and Mr. Corzine were charged as controlling persons of MFGI; Ms. O’Brien was charged with aiding and abetting MFGI’s wrongful conduct; and MFGI and Mr. Corzine were also charged with failure to supervise. MFGI and MFGH previously settled the CFTC actions. Mr. Corzine agreed to pay a fine of US $5 million to resolve the CFTC’s enforcement action, committing to remit such funds solely from his personal assets and not from insurance proceeds. He also agreed never to act as a principal or employee of any FCM or ever to apply for registration with the Commission in any capacity. Ms. O’Brien agreed to pay a fine of US $500,000 to resolve this matter and consented not to act as a principal or employee of any FCM for 18 months. Neither Mr. Corzine nor Ms. O’Brien was required to admit to any substantive allegation in the original CFTC complaint or in the consent orders to resolve their CFTC litigation. Approximately two and one-half years after MFGI’s collapse, all customers of the firm were repaid all balances the FCM owed them.

  • Non-US Traders Criminally and Civilly Charged With Trading on Nonpublic Information Cyber-Hacked From Law Firms: At the end of last year, the US Attorney’s Office in New York City disclosed that criminal charges had been filed earlier in 2016 against three non-US persons in a federal court in New York City, claiming that they had hacked the email of two unnamed prominent law firms, illegally obtained emails regarding pending merger and acquisition transactions, and purchased and sold securities based on such information. On the same day, the SEC filed a civil action against the same persons in the same federal court related to the same facts. As alleged in the criminal indictment and by the SEC, between approximately April 2014 through late 2015, Ian Hong, Bo Zheng and Chin Hung, all citizens of China and residents of China or Hong Kong, caused malware to be installed on the law firms’ web servers which permitted unauthorized access to the firms’ email. The defendants used this access to obtain the relevant email that contained the confidential information on which they traded. According to the SEC, the defendants derived approximately US $4 million from their illicit activities. The SEC seeks an injunction, asset freeze, disgorgement and fines against the defendants. If convicted of all their criminal charges, the defendants face maximum prison terms in excess of 20 years. One defendant, Mr. Hong, was arrested in Hong Kong on December 25 and now faces extradition to the United States. As part of their scheme,  defendants also apparently tried to hack the email of five other law firms, alleged the criminal indictment, although these efforts appear to have been unsuccessful. 

Compliance Weeds: Not just financial services firms, but all businesses of every kind should maintain a robust cybersecurity program that includes regular risk assessments, installation and upgrades of anti-malware, antivirus and other protections, vulnerability and internal and external penetration testing, and training. Unfortunately, more and more there seems to be only two types of businesses: those that have been subject to cyber-attacks and are aware of it, and those that have been subject to cyber-attacks and are not aware of it. Help ensure your business is not in the latter category. There is a plethora of literature publicly available on what should be the elements of a robust cybersecurity program; click here for an excellent succinct summary published by the Securities and Exchange Commission’s Division of Investment Management that is intended for use by registered investment companies and investment advisers, but is sufficiently generic to be useful to all. Click here to access other generic and detailed information provided by the National Institute of Standards and Technology of the US Department of Commerce, including a brochure entitled “Framework for Improving Critical Infrastructure Cybersecurity.”

  • Firm Fined by ICE Futures US for ATS Gone Bad; NYMEX Summarily Denies Access to Member for Knowingly Submitting Inaccurate TAS Orders: Marquette Partners agreed to pay a fine of US $20,000 to resolve a disciplinary action brought by ICE Futures U.S. because of an alleged malfunction in an automated trade system it operated from January 23 through March 9, 2015. During this time, on “numerous occasions,” Marquette’s ATS allegedly entered orders in back months of cocoa futures then rapidly deleted such orders and immediately placed new orders all within one-thousandth of a second. Separately, the New York Mercantile Exchange summarily denied access to all CME Group markets to Eldorado Trading Group LLC for allegedly engaging in certain disruptive trading-type activities on numerous dates beginning in December 2016. According to NYMEX, Eldorado would knowingly place trading at settlement orders in multiple products with incomplete and wrong information in the “sender location” (Tag 142) field, gain queue priority when the TAS market opened, then modify the problematic data to correct it. (Click here for background on Tag 142.) This conduct continued, said NYMEX, even after the exchange warned Eldorado to stop it on December 22, 2016. Unrelatedly, a NYMEX business conduct committee also fined Hong Kong Weiye Industry Ltd. US $50,000 and suspended its access to all CME Group markets for not responding to exchange requests for information in connection with an investigation and settled charges against QuantRes Asset Management Ltd. for payment of a fine of US $40,000 for the firm’s alleged position limit violations in Henry Hub natural gas futures on three days in September 2016.

Compliance Weeds: TAS transactions permit trades to be executed during the trading day at the current day’s settlement price or in prescribed price increments above or below such price. Basis Trade at Index Close and Trade at Market transactions are analogous trades that permit executions at currently unknown prices. Each type of transaction, when available, is limited to certain products and times, and is subject to ordinary prohibitions against price manipulation or attempted price manipulation, disruptive trading, wash trading, and other violative conduct. (Click here for background in a relevant CME Group Market Regulation Advisory Notice and here for an ICE Futures U.S. TAS Frequently Asked Questions.)

  • Two Companies Charged by SEC for Whistleblower Infractions: Two publicly traded companies agreed to settle Securities and Exchange Commission enforcement actions related to their use of separation agreements that the Commission claimed inhibited ex-employees from communicating with the SEC, in violation of their whistleblower rights under federal law and SEC rule. Under this rule (click here to access SEC Rule 21F-17(a)), no person can take any action “to impede 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.” In one action, against NeuStar, Inc., the SEC claimed that, after the SEC’s whistleblower rule became effective on August 12, 2011, at least 246 Neustar employees executed the firm’s standard severance agreement containing a broad anti-disparagement requirement that precluded employees from engaging in any communication that “disparages, denigrates, maligns” the firm, including communications with the SEC. The SEC claimed this clause violated its prohibition. Neustar agreed to pay a fine of US $180,000 to resolve its enforcement action, and to amend its severance agreements to comply with legal requirements. Separately, Sandridge Energy, Inc. agreed to pay a fine of US $1.4 million for using a standard severance agreement following the SEC’s adoption of its whistleblower rule in 2011 that contained a prohibition against former employees voluntarily cooperating with any governmental agency in any complaint or investigation regarding the company. Additionally, the SEC accused the firm of retaliating against an employee who had raised concerns with senior management regarding the company’s method of calculating oil and gas reserves periodically reported to the Commission. The company conducted no formal investigation into the employee’s claims and solely began an internal audit review that was never finalized. The firm fired the employee on April 1, 2015. Retaliating against whistleblowers at publicly traded companies is expressly prohibited by federal law (Click here to access 15 USC § 1514A(a).)

Legal Weeds: In 2016, the SEC brought and settled a number of enforcement actions against firms that included in their standard severance agreements language that the Commission determined potentially impeded an employee from disclosing to the SEC a possible securities law violation. (Click here for background) It is clear that the SEC reads its anti-retaliation clause broadly. SEC and Commodity Futures Trading Commission registrants and SEC-regulated publicly traded companies should review their form employment and severance agreements to ensure they are consistent with regulatory requirements regarding employee whistleblower rights. (Click here to access existing CFTC whistleblower protections in Part 165 of its rules.) In 2016 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 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. No final action on this rule has been taken since the comment period closed on September 29, 2016. (Click here to access the CFTC proposal.)

  • FINRA Sanctions 12 Member Firms for Failure to Maintain Electronic Records in Required Format: The Financial Industry Regulatory Authority assessed a total of US $14.4 million in fines against 12 firms for “significant deficiencies” in their retention of required books and records on electronic storage media. In general, when broker-dealers use electronic storage media to retain books and records, the media must be in a “write once, read many” format (so-called “WORM format”). In addition, applicable Securities and Exchange Commission and FINRA rules require that each broker-dealer maintain an audit system “providing for accountability” regarding the input of books and records required to be preserved to electronic storage media and to retain a third-party vendor who has access and the ability to download data from the firm’s storage media and commits through an attestation that they will provide records to the SEC, FINRA or other regulator if the firm is unable to provide such records. (Click here to access the SEC’s requirements regarding acceptable electronic storage media at 17 CFR 240.17a-4(f).) FINRA claimed that the sanctioned firms typically did not retain electronic records in WORM format, failed to have a required audit system, did not obtain or maintain a required attestation from a third-party vendor, and did not have adequate written supervisory procedures reasonably designed to ensure compliance with applicable requirements. Firms (or affiliated firms) agreed to settle FINRA’s charges for individual fines ranging from US $4 million to US $500,000.

Compliance Weeds: All principal international regulators have rules related to the generation and retention of records by registrants in the futures and securities industry. These rules typically describe the type of records that must be prepared in the first instance; how long and in what format such records must be retained; and to whom and in what time period such records must be produced when requested by an authorized regulator. Unfortunately, given the large number of records that even a small size registrant generates in a given day, it is easy for a firm to run afoul of applicable requirements. This is why each registrant should (1) ensure it is fully familiar with applicable requirements, (2) design a comprehensive system that ensures compliance with these requirements in the first instance (including the development and implementation of written supervisory procedures), and most importantly, (3) routinely test that all required records are being retained and in the correct format. This testing should be two-fold: (1) from front to back, to ensure that the system is set up and functions according to requirements; and (2) back to front, to ensure that a wide variety sampling of documents (and with electronic communications, include attachments and so-called “bcc’s”) generated from different sources can be produced completely (and within time periods) as expected by regulators. Firms should periodically also ensure (1) that documents stored in electronic media are in non-rewritable and non-erasable format in accordance with local requirements and (2) that internal systems designed to capture electronic communications from different sources, capture and retain all aspects of those communications including attachments and bcc’s, as well as prior drafts. The Commodity Futures Trading Commission has similar rules as the SEC regarding the maintenance of required books and records on electronic storage media (click here to access CFTC Rule 1.31(b)).

  • Investment Bank Agrees to Pay US $120 Million to Resolve Charges That It Attempted to Manipulate IRS Benchmark: The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. settled charges brought by the Commodity Futures Trading Commission that, from January 2007 through March 2012, it attempted on multiple occasions to manipulate the US Dollar International Swaps and Derivatives Association Fix. (The ISDA Fix – now known as the ICE Swap Rate – is a global benchmark for market rates and spreads for standard interest rate swaps. Click here for details.) According to the CFTC, during the relevant time, Goldman made submissions to the daily disseminator of the ISDA Fix that were favorable to positions of Goldman, rather than reflecting the midpoint of where it would itself offer and bid a relevant swap, contrary to the requirements of the submission process. The CFTC claimed that Goldman’s submissions “involved multiple traders,” including the head of the firm’s interest rate products trading group in the United States. To resolve this matter Goldman agreed to pay a fine of US $120 million, among other sanctions, many of which reference remediation measures already taken.

  • Tenth Circuit Holds SEC Administrative Tribunals Unconstitutional: A federal court of appeals sitting in Denver, Colorado (the Tenth Circuit Court of Appeals), ruled that a Securities and Exchange Commission administrative law judge that presided over an SEC administrative enforcement action against David Bandimere was not appointed in accordance with requirements of the so-called “Appointments Clause” of the US Constitution (click here to access Article II, Section 2, second paragraph of the US Constitution). As a result, the Court set aside an adverse decision against him. The Court held that SEC ALJs were so-called “inferior officers” under the Appointments Clause and thus could only be constitutionally appointed by the US president, courts of law or department heads. SEC ALJs are officers and not just mere employees, held the Court, because, among other reasons, they exercise “significant discretion” in performing their functions and have the authority to issue initial decisions that determine a respondent’s liability and impose sanctions – which may become final if a respondent does not timely seek SEC review – as well as enter default judgments. The Court’s decision in this matter conflicted with a recent decision by a federal court of appeals sitting in Washington, DC, that held that SEC ALJs were not officers subject to the Appointment Clause. The DC Circuit Court of Appeals claimed that SEC ALJ decisions were not technically final decisions (click here to access the DC Circuit Court of Appeal’s decision).

And more briefly:

  • Individual FX Dealer Pleads Guilty to Currency Prices Manipulation: Jason Katz, previously employed by three financial institutions in New York City, pleaded guilty to manipulating foreign exchange prices from at least January 2007 through July 2013 by placing non-bona fide trades on an electronic FX platform and coordinating bids and offers with others. This coordination was accomplished, claimed the criminal complaint against Mr. Katz filed by the US Department of Justice in a federal court in New York City, through private chat rooms, text messages and other means. Parent companies of four banks pleaded guilty in May 2015 and agreed to pay a collective fine of more than US $2.5 billion for the banks’ role in manipulating the price of US dollars and euros exchanged in the FX market. (Click here for background.) Mr. Katz’s offense is subject to a maximum penalty of 10 years in prison and a fine.

  • Euro Stoxx 50 Index Dividend Futures Available for Trading by US Persons: The Eurex Exchange announced that US persons are now authorized to purchase and sell its EURO Stoxx 50 Index Dividend Futures contracts. This product can be accessed by US persons through Eurex terminals as Eurex is registered with the Commodity Futures Trading Commission as a foreign board of trade.

Follow-up:

  • CFTC Re-Proposed Position Limit Rules Published in Federal Register; Comments Due February 28; Meaningful After Chairman Massad Resignation?: The Commodity Futures Trading Commissions recently re-proposed amendments to its rules dealing with speculative position limits were published in the Federal Register on December 30. Accordingly, comments are due by February 28, 2017. In light of the announced resignation of Timothy Massad, a CFTC chairman as of January 20, it will be curious to see the direction this proposed rule takes under anticipated acting CFTC Chairman J. Christopher Giancarlo. In his concurrence to the publication of the CFTC’s re-proposed position limits – which occurred after the election of Donald Trump as US president – Mr. Giancarlo wrote, “I feel comfortable that the proposal before us provides the basis for the implementation of a final position limits rule that I could support.” We’ll see.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VII, Number 9
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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...

212-940-6558
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