July 3, 2022

Volume XII, Number 184


July 01, 2022

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Bridging the Weeks by Gary DeWaal: October 22 to November 2 and November 5, 2018 (UK and HK Regulation of Cryptoassets; EFRPs; Order Routing Disclosures; EU CCP Overreach)

During the prior two weeks, three financial authorities in the United Kingdom as well as the Hong Kong Securities and Futures Commission issued reports assessing distributed ledger technology and risks associated with the trading of cryptoassets. As part of their studies, the SFC determined to restrict investments in HK funds trading cryptoassets to professional HK investors, while the UK authorities committed to consider whether all derivatives based on cryptocurrencies should be banned for UK retail investors. In the United States, futures exchanges brought a number of disciplinary actions alleging violations of rules related to exchange for related position transactions, spoofing, pre-execution communications, and audit trail requirements for clearing members and clients connecting by direct access to an exchange's electronic trading system. As a result, the following matters are covered in this week’s edition of Bridging the Weeks:

  • UK Regulators Contemplate Banning All Cryptocurrency-Based Derivative Sales to Retail Clients While HK SFC Restricts Investments in Virtual Currency Portfolios to Professional Investors (includes My View);
  • Bank Fined by CME for Non-Bona Fide EFRPs After Surveillance System Breaks Down (includes Compliance Weeds); and more.

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Article Version


  • UK Regulators Contemplate Banning All Cryptocurrency-Based Derivative Sales to Retail Clients While HK SFC Restricts Investments in Virtual Currency Portfolios to Professional Investors: Three UK financial authorities – HM Treasury, the Financial Conduct Authority and the Bank of England – issued a report setting forth actions they will take over the coming months to address certain perceived risks of cryptoassets while simultaneously promoting the development of distributed ledger technology. Among other things, the authorities indicated they may ban the sale to UK retail clients of all derivatives based on cryptocurrencies, including options and futures.

Separately, the Hong Kong Securities and Futures Commission announced it would require the licensing of and compliance with applicable regulatory requirements by all firms that manage or intend to manage portfolios investing in cryptoassets, as well as firms that distribute funds investing in such financial instruments subject to a de minimis exception. These obligations would apply whether or not the cryptoassets were of the nature of securities or futures clearly within the SFC’s remit.

Additionally, the SFC indicated it will consider whether cryptoasset platforms not currently subject to oversight are suitable for regulation by potentially placing them in its regulatory sandbox. If SFC considers such trading platforms are appropriate for regulation, it will grant participating trading platforms a license and subject them to close oversight. Alternatively, it may determine that perceived risks cannot be “sufficiently addressed” and determine to grant no licenses. Among other things, participating firms would have to agree to limit their services solely to professional investors and ensure that no security issued as part of an initial coin offering was traded prior to 12 months following its launch.

The SFC announced the establishment of a regulatory sandbox for firms offering innovative financial technology during September 2017 (click here to access details).

UK Authorities

A taskforce comprising three UK financial authorities concluded that, generally, DLT “has the potential to deliver significant benefits in financial services and other sectors in the future” and committed to support its development. However, it found “limited evidence” of benefits in the current generation of cryptoassets, but said these may arise in the future. Moreover, the taskforce identified certain risks associated with cryptoassets: risks of financial crime, risks to consumers, risks to market integrity and potential implications for financial stability.

As a result, the UK financial authorities agreed to consult on implementing “one of the most comprehensive responses globally” to address the use of cryptoassets for illegal activities; to potentially ban the sale of derivatives based on cryptoassets to retail persons; to issue guidance on how certain cryptoassets are already captured by the existing “regulatory perimeter”; and whether the regulatory perimeter requires expansion to capture all cryptoassets.

Among other objectives, the UK financial authorities expressly committed to clarify by the end of 2018 how existing regulation applies to security tokens, and how initial coin offerings might be overseen by early 2019. The UK financial authorities also said they would consider by early 2019 how virtual currencies (termed “payment tokens” in the United Kingdom), as well as related firms such as exchanges and wallet holders, could be regulated


Going forward, HK firms managing funds that solely invest in cryptoassets that are not securities or futures contracts will nonetheless require a license enabling them to deal in securities if they distribute interests in their funds to persons in Hong Kong. Likewise, HK firms that are already licensed for asset management activity for handling funds dealing in securities or futures contracts will also be subject to SFC oversight if they invest solely or partially in cryptoassets that do not constitute securities or futures. These requirements will not apply if a relevant fund invests less than 10 percent of its gross asset value in cryptoassets.

To address perceived risks of cryptoassets, SFC has developed terms and condition that all licensed portfolio managers intending to invest in cryptoassets should observe. Among these terms are that only professional investors should be permitted to invest in a cryptoassets portfolio  Generally under HK law individuals are professional investors if they have an investment portfolio of HK $8 million or more (approximately US $1 million or more), or for corporations, a portfolio of HK $8 million or more or total assets of not less than HK $40 million (approximately US $5 million). (Click here to access relevant definitions under the HK Securities and Futures (Professional Investor) Rules.)

Similarly, if the SFC ultimately determines to grant a license to a cryptoasset platform operator in its regulatory sandbox, the firm will be licensed similarly to an automated trading service and be subject to certain core principles. In addition to limiting access to professional investors and prohibiting the trading of ICO-issued coins until at least 12 months after launch, SFC will require all cryptoasset transactions to be pre-funded and without leverage and that all trading activity occur under a single legal entity, among other requirements.

In other recent noteworthy developments regarding cryptoassets:

  • IFUS to Launch BAKKT Bitcoin Daily Futures December 12: ICE Futures U.S. announced it will launch its Bakkt Bitcoin (USD) Daily Futures Contract on December 12. As proposed, IFUS’s bitcoin futures contracts – which will be physically settled – will be cleared by ICE Clear US, Inc. and bitcoin apparently will be held at Bakkt LLC, an affiliated entity.
  • Bitcoin Dealer Pleads Guilty of Operating an Unlicensed Money Transmission Business: Jacob Campos pleaded guilty to running a money transmitter business without obtaining an appropriate license from the Financial Crimes Enforcement Network of the US Department of Treasury. Additionally, as part of his plea agreement, Mr. Campos consented to disgorge US $823,357 of ill-gotten gains. According to the Department of Justice – which prosecuted him – Mr. Campos sold bitcoin to customers throughout the United States from 2015 through 2016 that he sourced initially through a US-based exchange, but then subsequently obtained through a bitcoin-trading platform in Hong Kong. Charges were filed against Mr. Campos in a US federal court in California.
  • Investor Lawsuit Against Coinbase Alleging Impropriety in Listing of Bitcoin Cash for Trading Dismissed – for Now: A lawsuit filed in a US federal court in California in May 2018 against Coinbase, Inc. alleging that the exchange had permitted insider trading of bitcoin cash in December 2017, was dismissed. However the plaintiff, Jeffrey Berk, was authorized to re-file his complaint within 21 days of the dismissal order. Mr. Berk had generally alleged that Coinbase committed negligence when bitcoin cash spiked just prior to Coinbase authorizing trading on the cryptocurrency. (Click here for access to Mr. Berk’s initial complaint.) However, the court ruled that Mr. Berk’s complaint did “not sufficiently articulate the legal bases for his claims.” Separately, Coinbase Custody Trust Company LLC was approved to be established as a limited purpose trust company by the New York State Department of Financial Services and authorized to offer custody services in bitcoin, bitcoin cash, ether, ether classic and litecoin. (Click here to access the NYDFS approval announcement.)
  • Ongoing Operation Cryptosweep Results in Termination of Five ICOs by Two State Regulators: The Colorado Division of Securities (CDS) and the North Dakota Securities Department (NDSD) independently shut down five companies from offering initial coin offerings to their respective residents. Both state regulators are participants in “Operation Cryptosweep”, an ongoing campaign by the North American Securities Administrators Association to identify potential investment frauds in the cryptoasset market. Since August 2018, the investigation has led to more than 200 crypto-related cases being investigated and 46 enforcement actions. The CDS signed two cease and desist orders shutting down the DavorCoin and CCI Token ICOs. Separately, the NDSD issued three cease and desist orders closing down the Life Cross Coin, Tizacoin, and Crystal Token offerings. These ICOs were marketed to state residents through their respective online websites. Both state regulators stated that the ICOs were securities under applicable state law, were not registered (or exempt from registration), and the ICO marketing material contained potentially fraudulent statements and material omissions. (Click here for details regarding Operation Cryptosweep.)
  • SEC Notes Many Open ICO Investigations in Annual Overview of Enforcement Activities: In its annual report of enforcement activities, the Securities and Exchange Commission noted that, during its 2018 fiscal year, it opened “dozens” of investigations related to ICOs and digital assets, “many of which were ongoing” as of September 30. Overall, the SEC said it brought 821 enforcement actions (including 490 so-called stand-alone cases) and obtained over US $3.9 billion in fines and disgorgement in FY 2018 pertaining to all types of underlying offenses. It said that it charged individuals in 70 percent of its stand-alone cases. (For the SEC, a stand-alone action is one initiated by the SEC without a prior federal court proceeding and does not include cases to revoke registrations of companies for not filing required reports.)

My View: Distributed ledger technology and associated cryptoassets continue to provide challenges to international regulators as the new technologies often do not fit neatly within existing laws. Although uniform best practices are appropriate for market participants to adopt voluntarily, there is a great danger that uniform or near uniform international regulations could stifle innovation. 

For example, the new requirement by the SFC that restricts the participation in HK funds investing in cryptoassets to HK professional investors, as well as a possible prohibition against UK retail persons being able to purchase derivatives based on cryptocurrencies, is directly contrary to approval in the United States by the Commodity Futures Trading Commission of derivatives based on bitcoin accessible to all market participants, and guidance by the National Futures Association that permits funds accessible to all to invest in cryptoassets provided appropriate disclosures are made. 

Uniformity in regulations sounds like a good thing, provided the regulations are right; however, what is right is in the eye of the beholder and may vary from person to person. As a result, efforts to promote common worldwide regulation of DLT and associated cryptoassets is likely inappropriate at the current time, when the relevant technologies are in their infancy and often misunderstood. 

It would be better at this point for regulators to agree, at most, on common broad objectives (e.g., eradicate fraud, heighten anti-money laundering requirements), but encourage individual jurisdictions to adopt regulations they believe most suitable in light of their own particular experiences. This way, controversial regulations might, at worse, inhibit innovations locally but will not have a deleterious international impact.

  • Bank Fined by CME for Non-Bona Fide EFRPs After Surveillance System Breaks Down: The Chicago Mercantile Exchange brought and settled a disciplinary action against Deutsche Bank AG for purportedly engaging in a prohibited exchange for related position transaction on February 6, 2017, between two of its accounts with common beneficial ownership. The CME said this transaction involved a simultaneous exchange of futures with no corresponding exchange of a related position. According to CME, this transaction – which involved Eurodollar futures – occurred despite DBAG’s use of a “multi-tiered pre- and post-execution system to monitor EFRP transactions.” However, because of a number of unspecified mistakes, this system did not prevent the non-bona fide transaction. DBAG agreed to pay a fine of US $75,000 to resolve this matter. 

Unrelatedly, George E. Warren agreed to pay a fine of US $20,000 to resolve charges that on February 1, 2018, it sold one EFRP to a counterparty involving February 2018 NY Harbor ULSD futures and bought another EFRP from the same counterparty involving March 2018 NY Harbor ULSD futures at the identical price. NYMEX claimed these transactions were contingent on each other and were executed to avoid market risk.

Separately, Jacek Jarosz was sanctioned by CME for entering into several orders without the intent to trade from June 14 through August 4, 2017. CME alleged that Mr. Jarosz entered into smaller NASDAQ 100 futures orders on one side of the market, and subsequently entered larger NASDAQ 100 futures orders on the other side of the market to induce execution of his smaller orders. After receiving fills of his smaller orders, Mr. Jarosz allegedly cancelled his larger orders. Mr. Jarosz resolved his CME disciplinary action by agreeing to pay a fine of US $25,000 and consenting to a 15-day all CME Group exchanges trading ban.

A number of other individual nonmembers were also sanctioned by the Commodity Exchange, Inc. and the New York Mercantile Exchange for engaging in purported spoofing-type conduct and not participating in exchange disciplinary actions. Each was fined from US $50,000 to US $100,000 and permanently barred from any CME Group exchange trading. The individuals were Shi Bing Cheng, Wei Fan, Wang Jian, and Wang Yiwu.

Two individuals – Michael Caponiti and Christopher Kenny – agreed to the imposition of sanctions by Nymex for engaging in pre-execution discussions to consummate trades from February 10, 2017, through June 15, 2017, without afterwards submitting Requests for Quote and Requests for Cross, as required by exchange rules. Mr. Kenny agreed to pay a fine of US $10,000 and be barred from all CME Group exchange trading for five business days, while Mr. Caponiti consented to the imposition of a penalty of US $25,000.

Finally, five clearing members or direct access clients of clearing members were recently summarily fined by ICE Futures U.S. for not retaining audit trail data corresponding to orders they placed by direct access to IFUS's electronic trading system. Under IFUS rule, each clearing member is responsible to maintain or cause to be maintained and produce upon request of the exchange audit trail information for all orders submitted to the exchange through its direct access connection and any order routing system; each person authorized by a clearing member for direct access is also required to maintain or cause to be maintained the same audit trail record. ABN AMRO Bank N.V., BNP Paribas, INDY Research Labs, LLC, and Macquarie Futures USA LLC were each fined US $2,500 for their purported violations while Quiet Light Trading LLC was penalized US $5,000.

Compliance Weeds: Although the amount of IFUS’s fines on clearing members and certain clients for noncompliance with audit trail requirements was small, the number of fines serves as a reminder that each designated contract market has express requirements regarding the audit trail each clearing member and certain clients must maintain in connection with direct access orders. (Click here to access CME Rule 536.B and here to access IFUS Rule 4.19. Click here to access CME Group Market Regulation Advisory Notice RA1520-5.)

Moreover, the CFTC recently fined a futures commission merchant US $160,000 for not retaining required electronic audit trail information for 65 clients. This problem was discovered when the CFTC found gaps and missing transaction records in the firm’s production in response to a request for documents related to one client. Afterward, the FCM initiated an internal investigation and discovered its more widespread breakdowns. These were caused by the failure of an archiving system to copy data supplied to the firm by an external vendor from January 24, 2014, through August 28, 2015. The CFTC noted that, although the FCM had a recordkeeping system in place, it had no system to monitor whether its archiving system was properly collecting or storing data. (Click here to access the relevant CFTC order.)

More Briefly:

  • More Disclosure by Broker-Dealers Regarding Client Order Routing and Handling Required by New SEC Rule: The Securities and Exchange Commission approved a new disclosure requirement for broker-dealers requiring them, upon request of any customer, to provide specific information related to the routing and execution of the customer’s not-held NMS stock orders for the prior six months with two exceptions. The SEC also updated quarterly disclosure information that must be made publicly available by broker-dealers regarding held NMS stock orders. 

The information that must be disclosed, upon request, for not-held orders pertains to the internal handling of such orders; the routing of such orders to different trading centers; the execution of such orders; and how such orders provided or removed liquidity along with the average transaction rebates or fees paid by the broker-dealer. Broker-dealers are not required to provide not-held reports to any customer if, during the prior six months, (1) not held NMS orders constituted less than 5 percent of the customer’s total NMS stock orders, or (2) if a customer’s trades involved, on a monthly average basis, less than US $1 million of notional value of not-held orders in NMS stocks. 

The SEC’s new amendments will be effective 60 days after they are published in the Federal Register while compliance is required by 180 days after publication. NMS is a reference to the US national market system, including all formal US stock exchanges and the Nasdaq market. Not-held orders give brokers price and time discretion for execution, while a broker-dealer must try to execute a held order immediately.

  • EU Proposes Comprehensive Oversight Over Non-EU CCPs: The European Union proposed subjecting systematically important non-EU clearinghouses authorized to conduct business for EU persons to certain potential ongoing requirements, including providing information to the European Central Bank “upon its reasoned request”; cooperating with the ECB in connection with stress tests conducted by the European Securities and Markets Association; opening an overnight deposit account with the ECB; and other unspecified measures “in exceptional circumstances that the [ECB] considers necessary.” These measures may relate to liquidity risk control, margin requirements, collateral, settlement arrangements or interoperability arrangements. 

Moreover, as proposed, all systemically important third-country-recognized CCPs would be subject to potential on-site inspections by ESMA in connection with investigations. 

J. Christopher Giancarlo, Chairman of the Commodity Futures Trading Commission, previously threatened retaliation if the EU were to exercise “extraterritorial overreach” and threaten US markets and market participants. (Click here to access Mr. Giancarlo’s October 17 keynote speech at FIA Expo.)

  • NFA Sanctions Swap Dealer US $900,000 for Not Adequately Assessing Risks of Uncleared Swaps: Mizuho Capital Markets LLC – a swap dealer provisionally registered with the Commodity Futures Trading Commission – agreed to pay a fine of US $900,000 to resolve a National Futures Association complaint, charging that it failed to adequately assess the risk of the firm’s uncleared swaps. NFA also charged that the firm did not back test, benchmark and validate its margin model as required by CFTC rules; did not take necessary steps to satisfy CFTC initial margin and variation margin collections requirements; failed to diligently supervise its business activities related to margin monitoring, and “repeatedly” submitted “inaccurate, incomplete and inconsistent in reports provided to the NFA.” (Click here to access CFTC Part 23 rules, subpart E.)
  • CFTC Staff Amends Ability of FCMs to Post Customer Securities as Margin With UK Brokers: Staff of the Commodity Futures Trading Commission updated a previously issued no-action letter to permit futures commission merchants to continue to post customer-owned securities as margin with a UK-based foreign broker for use on the customer’s behalf at a UK-based clearinghouse after recent changes in European law. Under the updated no-action relief, a US FCM can continue to post its customers’ securities with a UK-based broker authorized as an investment firm under UK law subject to certain conditions, including that the UK-based broker maintain the customers' securities in a gross omnibus segregated account at an authorized UK clearinghouse. 

Previously, CFTC staff had granted this relief contingent on the UK broker maintaining the US FCM's customers' securities in an individual client segregated account at a UK clearinghouse; however, since January 3, 2018, because of changes in EU law, authorized clearinghouses have elected not to offer ISAs to indirect clients in indirect clearing arrangements.

This no-action relief was obtained because of concerns that CFTC rules might preclude a US FCM from posting customer securities with a UK-based broker for deposit with a UK clearinghouse because UK clearinghouses generally accept securities from their clearing members subject to title transfer or a limited right of reuse. Under CFTC rules, an FCM may not commingle customer funds with its own money, securities or property. (Click here to access no-action letter previously granted by the CFTC’s Division of Swap Dealer and Intermediary Oversight and here to access CFTC Rule 30.7(e))

  • Broker-Dealer Fined US $2.75 Million by FINRA for Breakdowns in AML Program and Customer Complaint Reporting: The Financial Industry Regulatory Authority fined LPL Financial, LLC, a broker-dealer, US $2.75 million for not reporting as suspicious activities to the Financial Crimes Enforcement Network unsuccessful attempts by third parties to gain unauthorized access to customers’ email or brokerage accounts, as well as for not amending individual registrants’ Form U4s and U5s to report certain customer complaints. According to FINRA, LPL mistakenly believed that only successful hacking incidents were subject to SAR reporting and advised its employees accordingly; however, this conclusion was incorrect. As a result, FINRA concluded that LPL failed to investigate and file over 400 SARs with FinCEN from January 1, 2013 through May 31, 2016. 

Additionally, FINRA alleged the firm took the view that the requirement on Forms U4 and U5 to identify “a claim for compensatory damages of $5,000 or more” only required disclosure if a customer expressly requested reimbursement in that amount. In response, the firm did not report incidents where a customer did not per se request such amount, but from the totality of the complaint, it was clear this is what the customer wanted. Relying on this incorrect view, FINRA stated the firm failed to file at least 31 reportable customer complaints from March 2013 through November 2017.

Form U4 is used to register individuals with FINRA (or transfer individual registrations from one FINRA member to another), while Form U5 is used to terminate individuals’ licenses.

  • Treasury Updates OFAC Sanctions List: The US Department of the Treasury’s Office of Foreign Assets Control amended its Specially Designated Nationals List to include certain individuals and entities affiliated with North Korea. Generally, US persons are prohibited from dealing with SDNs.
©2022 Katten Muchin Rosenman LLPNational Law Review, Volume VIII, Number 309

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...