January 18, 2022

Volume XII, Number 18


MiFID II, MiFIR, Block Trade Washes, AlphaMetrix, Charges for Cash, Bitcoin Options Exchange, Trading System Failures - Bridging the Week: December 15 to 19 and 22, 2014

An inadvertent system logic flaw caused two affiliated broker-dealers not to perform required anti-money laundering obligations and resulted in sanctions by the Financial Industry Regulatory Authority, while automated trading system malfunctions resulted in fines to three firms by the CME Group. In addition, one clearinghouse says that posting cash with it may soon be more costly, while another entity seeks designation with the Commodity Futures Trading Commission to trade and clear options on Bitcoin. Meanwhile, MiFID II and MiFIR inch their way towards implementation in Europe. As a result, the following matters are covered in this week’s Bridging the Week:

  • ESMA Publishes Implementing Rules for MiFID II;


  • Coscia Files Motion to Dismiss Criminal Spoofing Indictment (includes My View);


  • LedgerX Seeks CFTC Designation as a Clearinghouse and Swap Execution Facility for Bitcoin Options;


  • Two Wells Fargo Entities Settle With FINRA for AML Customer Identification Program Breakdown;


  • ICE Clear U.S. Alerts Clearing Members That Cash Deposits May Result in Negative Returns;


  • System Failures Result in Three Firms Being Sanctioned US $145,000 by CME Group Exchanges (includes Helpful to Getting the Business Done);


  • CME Explicitly Prohibits Block Trades Between Accounts With the Same Beneficial Ownership (includes Compliance Weeds);


  • CFTC Excuses CTA Members of DCMs From Recording Oral Communications; Will Not Require Other Market Participants to Link Certain Oral and Written Communications;


  • Registrations of AlphaMetrix, LLC and Aleks Kins, Former CEO, Revoked by CFTC;


  • Fed Grants One-Year Delay for Banks to Conform Ownership Interests With Legacy Covered Funds; Another One-Year Delay on the Horizon;


  • NFA Proposes to Amend Interpretive Notice to Exclude Certain Additional Transactions From Prohibition Against Loans by Commodity Pools to CPOs and Related Entities;


  • Former Managing Director of Asset Manager Prohibited by FCA From Performing Any Regulated Activity Because of Train Fare Payment Evasion (includes Culture and Ethics); and more.

ESMA Publishes Implementing Rules for MiFID II

The European Securities and Markets Authority issued its final technical advice and initiated a consultation regarding proposed regulatory and technical standards regarding the roll-out of the Markets in Financial Instruments Directive (MiFID II) and Regulation (MiFIR).

Among other matters, ESMA proposes: (1) pre- and post-trade transparency requirements for equity and equity-like financial instruments by trading venues and investment firms; (2) enhanced transparency regarding non-equity instruments, particularly bonds, derivatives, structured finance products and emission allowances; (3) trading of derivatives only on certain venues in line with G20 requirements such as on regulated markets and multilateral or organized trading facilities; (4) position limits and reporting requirements for commodity derivatives; (5) rules impacting algorithmic and high-frequency trading, including definitions and organizational requirements; and (6) non-discriminatory access requirements to trading venues, clearinghouses and benchmarks.

ESMA’s technical advice also has a number of provisions aimed at enhancing customer protection. These include provisions related to when portfolio managers can receive research from third parties; when investment firms can receive or pay inducements; and disclosure of costs and charges.

ESMA also proposes that investment firms “establish and maintain a permanent and effective compliance function that operates independently” and has certain enumerated responsibilities. These tasks include assessing on a “regular basis” a firm’s compliance with its MiFID obligations; assisting staff providing investment services to comply with the firm’s MiFID II obligations; reporting at least annually to the firm’s management body regarding the “implementation and effectiveness of the overall control environment for investment services and activities,” among other matters; and to monitor the firm’s complaints handling process.

Firms are also required to appoint a “single officer” responsible for matters related to the safeguarding of client assets, although this person may have other responsibilities.

The technical advice will now be sent to the European Commission for approval, while comments will be accepted by ESMA on its consultation through March 2, 2015. MiFID II and MiFIR are scheduled to go into effect on January 3, 2017.

And briefly:

  • Coscia Files Motion to Dismiss Criminal Spoofing Indictment: Michael Coscia filed papers in a US federal court in Chicago last week to have his indictment for spoofing dismissed as a matter of law. In October 2014, Mr. Coscia was indicted for spoofing and commodities fraud related to trading activities from August to October 2011 in 17 different CME Group contracts, and three ICE Futures Europe contracts. In his court papers, Mr. Coscia claimed that the prohibition against spoofing in federal law is “hopelessly vague, and its criminal enforcement would violate [his] right to due process of law.” Among his other arguments, Mr. Coscia noted that only after more than 18 months following his alleged wrongful conduct did the Commodity Futures Trading Commission issue a final interpretive guidance regarding the nature of conduct that might constitute prohibited spoofing. The delay, claimed Mr. Coscia, reflected public debate and even some CFTC’s commissioners’ acknowledgement that the definition of spoofing was unclear and could, on its face, prohibit legitimate conduct. As a result, Mr. Coscia said his indictment should be dismissed because “[b]asic principles of due process … do not permit a statute to sweep in a broad swath of conduct without a standard for separating the lawful from the unlawful.” (Click here to see details regarding Mr. Coscia’s indictment in the article “NJ-Based Trader Previously Sanctioned by UK FCA, CFTC and CME Indicted in Chicago for Same Spoofing Offenses,” in the September 29 to October 3 and 6, 2014 edition of Bridging the Week.)

My View: It was an unusual experience to review Mr. Coscia’s memorandum of law to support his motion to dismiss, and find my own public writings and statements referenced three times—particularly one writing from January 2011 where I warned that the “lack of clarity is particularly troubling since certain violations [of the anti-spoofing provision of law] could potentially result in criminal action.” Then, as now, I believe that “bidding or offering with the intent to cancel the bid or offer before execution” (the statutory definition of spoofing) might be wrongful under certain circumstances, but under other circumstances has another name other than spoofing—it’s called ordinary, legitimate trading!

  • LedgerX Seeks CFTC Designation as a Clearinghouse and Swap Execution Facility for Bitcoin Options: The Commodity Futures Trading Commission is seeking comments on the application of LedgerX, LLC for registration as a swap execution facility and a derivatives clearing organization in order to list and clear fully collateralized, physically settled options on Bitcoin—a type of virtual currency. As proposed, all of LedgerX’s participants will solely be self-clearing members that qualify as so-called “eligible contract participants.” No intermediated clearing through a futures commission merchant will be permitted. Before any order of a participant is effectuated, the participant must have all necessary funds in an approved depository account or collateral in the form of the commodity underlying the contract in an account controlled by LedgerX—presumably Bitcoin. Initially, LedgerX does not propose to accept deposits in the form of US government securities, foreign currency, checks or monetary instruments in its settlement bank accounts, but may do so in the future. Among the ultimate owners of LedgerX are Google Ventures 2014, LLP, Lightspeed Venture Partners IX, LP, Paul Chou (also chief executive officer), Juthica Chou, Ethan Rigel, Zach Dexter and James Newsome, former chairman of the CFTC. Comments are due by January 30, 2015.
  • Two Wells Fargo Entities Settle With FINRA for AML Customer Identification Program Breakdown: Two Wells Fargo entities registered as broker dealers—Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC—agreed to pay a joint and several fine of US $1.5 million related to a breakdown in its customer identification program from October 1, 2003, through October 19, 2012.  During this period the firms did not verify the identity of all customers opening a new account, as required by law. This is because the firms sometimes used recycled identifiers of old accounts that previously had been closed for new customers. However, the firms’ CIP system recognized the new customers’ identifiers as existing accounts, and did not verify their identity. Approximately 220,000 accounts were impacted by this breakdown. FINRA acknowledged that the two Wells Fargo entities self-discovered and remediated this issue on accounts that were still open when the error was caught, fixed their CIP system, and self-reported the violations to FINRA.
  • ICE Clear U.S. Alerts Clearing Members That Cash Deposits May Result in Negative Returns: ICE Clear U.S., Inc. advised its clearing members that beginning February 1, 2015, because of charges it will assess on cash balances, “in a low or negative interest rate environment, these charges may result in negative return on cash deposits held by ICUS.” Currently, ICUS assesses an annualized fee on cash balances equal to fees charged by external managers plus additional basis points based on a sliding scale related to investment return. However, beginning February 1, ICUS will pay a return on US dollar deposits equal to the net interest income earned on the balances less an external investment management fee less a flat charge of five basis points. This fee will be calculated daily, accrued monthly and charged or credited on a monthly basis. ICUS will no longer pay any interest on non-USD balances and will pass along any charges for negative interest that ICUS is assessed on clearing member balances.
  • System Failures Result in Three Firms Being Sanctioned US $145,000 by CME Group Exchanges: Three firms were sanctioned by the CME Group related to breakdowns in their automated trading systems. 303 Proprietary Trading, LLC, agreed to pay a fine of US $75,000 related to excessive messages sent by its proprietary trading system during two seconds on May 8, 2013. According to CME, 303’s system failure resulted in over 27,000 resend messages, CME’s initiation of a port closure and the failure of a Globex gateway. Also, “the excessive messaging affected up to 437 separate customer sessions, causing the cancellation of approximately two thousand orders, and resulted in the loss of customer priority.” CME claimed that 303’s failure was cause by its failure to conduct sufficient testing or simulation on its ATS “to ensure its suitability for sending administrative messages on Globex.” Likewise, Allston Trading LLC was fined US $35,000 because its ATS entered an “excessive number of order and cancellation messages” during one hour on October 23, 2012. According to the CME, “[t]his repetitive pattern of order entry and cancellation occurred after a software failure which caused one of Allston’s several safeguards against excessive messaging to not function as intended.” Finally, Traditum Group LLC was sanctioned US $35,000 because of the failure of an ATS purchased from a third-party vendor that malfunctioned and caused 3,540 one-lot round turn transactions in December Canadian dollar futures contracts during approximately two minutes on November 10, 2011. This represented, said CME, “a significant volume spike in Canadian Dollar during this time period.”

Helpful to Getting the Business Done: Each of the respondents in these matters was charged for its system breakdown with violating the CME Group general prohibition against committing acts detrimental to the interest or welfare of the exchange and, in one case, failure to supervise too. Although CME Group and ICE Futures U.S. have some specific requirements regarding ATS (e.g., electronic audit trail requirements: click here to access the relevant CME Group MRAN, and identification of Globex operators: click here to access a relevant CME Group publication), most of the best guidance is voluntary, with some issued by the Principal Traders Group of the Futures Industry Association (e.g., “Recommendations for Risk Controls for Trading Firms:” click here to access, and “Software Development and Change Management Recommendations:” click here to access). However, adherence to the voluntary standards might help trading firms avoid ATS breakdowns and adverse financial consequences, including exchange and other regulator fines.

  • CME Explicitly Prohibits Block Trades Between Accounts With the Same Beneficial Ownership: The CME Group is proposing to update a market regulatory advisory notice that addresses wash trades (last issued in November 2013) to make clear that block trades between accounts with identical ownership or accounts of wholly-owned affiliates with the identical owner—accounts deemed to be with the same beneficial owner—are prohibited. The revised MRAN also cautions against engaging in wash trades to freshen position dates in physically delivered futures contracts (see story below entitled “CME Freshens Rule Prohibiting Cattle Futures Freshening”) and reflects changes in the CME Group’s self-match prevention (SMP) functionality on CME Globex being rolled out by January 11, 2015. Currently, the applicable wash trades MRAN states that block trades between accounts with the same beneficial owner and accounts with common beneficial ownership that is less than 100% are prohibited unless each account’s decision to enter into the transaction is made by an independent decision maker, is the result of a “legal and bona fide business purpose,” and the block trade is executed at a “fair and reasonable price.” The proposed revised MRAN will permit block trades meeting these requirements among commonly owned accounts, but only if the amount of beneficial ownership is less than 100%. Separately, CME Group’s SMP functionality, when used, prevents the matching of buy and sell orders for commonly owned accounts. By January 11, 2015, CME Group is enhancing its SMP functionality to permit customers to determine whether a resting or new order should be cancelled in the case of a self-match. The CME Group’s revised wash trades MRAN is scheduled to be effective January 2, 2015. 

Compliance Weeds: Even within the CME Group, there is a difference in permissible transactions between affiliates in the case of block trades and exchange of futures for related positions. As clarified by the CME Group’s new wash trades MRAN, block trades between accounts with the same beneficial owner are now always prohibited (CME Group staff states this always has been the case). However, EFRP trades between independently controlled accounts with common beneficial owners (i.e., the same beneficial owner orwhere the amount of beneficial ownership is less than 100%) are permitted, as well as between independently controlled accounts within the same legal entity—provided the accounts are in separate business units (click here for the relevant CME Group MRAN regarding EFRPs). ICE Futures U.S., on the other hand, permits block trades between accounts of affiliated persons—without regard apparently to the percentage of ownership—provided that the block trade is executed at a “fair and reasonable price,” that each party has a “separate and independent bona fide business purpose for engaging in the trades” and that the transactions are undertaken by a “separate and independent decision-maker.” (Click here for the relevant ICE Futures U.S. FAQ regarding block trades.) The devil is in the details!

  • CFTC Excuses CTA Members of DCMs From Recording Oral Communications; Will Not Require Other Market Participants to Link Certain Oral and Written Communications: The Commodity Futures Trading Commission’s Division of Market Oversight granted no-action relief to commodity trading advisors who are members of designated contract markets or swap execution facilities in connection with their regulatory requirement to record all oral communications related to futures, options on futures, and swaps—so-called commodity interest transactions—and related cash and forward transactions. Going forward, such CTAs will not have to record oral communications related to any commodity interest transactions. CFTC staff had previously granted relief to such CTAs from recording conversations that led to the execution of swaps only. In addition, the CFTC staff has granted relief to all market participants covered by its recordkeeping rule from the Commission’s requirement that they be able to link records of oral and written communications to particular commodity interest transactions. This relief will expire December 31, 2015, or the earlier date of a relevant amendment to the CFTC’s recordkeeping rule. 
  • Registrations of AlphaMetrix, LLC and Aleks Kins, Former CEO, Revoked by CFTC: Last week, AlphaMetrix, LLC’s registration as a commodity pool operator and commodity trading advisor, and Aleks Kins, AlphaMetrix’s former president and chief executive officer’s registration as an associated person were revoked by the Commodity Futures Trading Commission. In November 2013, the CFTC filed an enforcement action against AlphaMetrix claiming that the firm misappropriated over US $2.8 million of funds belonging to various commodity pools it operated, and hid its fraud by issuing false account statements to pool investors. Specifically, pursuant to various side letters between AlphaMetrix and pool participants, the firm was required to reinvest certain fees otherwise owed to pool participants. Instead, the firm transferred the fees to the parent company of the firm, AlphaMetrix Group, which was experiencing financial difficulty. Both AlphaMetrix and Kins voluntarily consented to the revocations of their registrations. (Click here to see further details regarding the CFTC’s original allegations against AlphaMetrix in the article “CFTC Commences Three Litigations on Diverse Themes: Customer Protection, Alleged Manipulation, and Alleged Speculative Limits Violations,” in the November 4 to 8 and 11, 2013 edition of Bridging the Week.)
  • Fed Grants One-Year Delay for Banks to Conform Ownership Interests With Legacy Covered Funds; Another One-Year Delay on the Horizon: The Board of Governors of the Federal Reserve has given banking entities until July 21, 2016, to conform legacy investments in hedge funds, and private equity funds—so-called “covered funds”—and foreign funds (legacy investments include those that were in place prior to December 31, 2013). Banking entities are prohibited from acquiring or holding an ownership interest in, sponsoring, or having certain relationships with covered funds and foreign funds under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Board also announced its intent to grant an additional one-year extension next year to July 21, 2017. During these extension periods, banking entities are expected to engage in “good faith efforts” to conform to Dodd-Frank requirements regarding the relevant legacy investments by the end of conformance period. These extensions do not relate to proprietary trading activities that still must be conformed to by July 21, 2015. This relief was granted within days of the passage by Congress of the Consolidated and Further Continuation Appropriations Act 2015 which significantly narrowed the so-called “Push-Out” rule of Dodd Frank—which would have required all government-insured bank swap dealers to transfer all or part of their swaps portfolios to non-bank affiliates. 
  • NFA Proposes to Amend Interpretive Notice to Exclude Certain Additional Transactions From Prohibition Against Loans by Commodity Pools to CPOs and Related Entities: The National Futures Association has proposed amendments to its interpretive notices entitled “Prohibition of Loans by Commodity Pools to CPOs and Related Entities.” Ordinarily, NFA prohibits a commodity pool from directly or indirectly making a loan or advance of pool assets to the entity’s commodity pool operator or any other affiliated party or entity. However, NFA has previously excluded certain transactions from this prohibition, including those associated with short securities sales and reverse-repurchase transactions. The amended interpretive notice will add certain new transactions to the exclusion, including loans from a pool to a wholly-owned subsidiary that was formed solely to benefit the pool, or loans to a wholly-owned subsidiary that is a registered broker-dealer and/or registered futures commission merchant that was formed solely to provide clearing and other prime brokerage services to the pools that made the loan. Other conditions apply. The NFA proposes that this rule will be effective on December 22 unless the CFTC objects. 

And even more briefly:

  • ESMA Issues Report on HFT Trading in EU Equity Markets: The European Securities and Markets Authority issued a report on high-frequency trading in EU equity markets. Using two measures—one based on the identification of HFT firms (flag approach), and the other based on statistics including lifetime of orders or order to trade ratio (lifetime of orders)—ESMA estimated that, applying the flag approach, HFT transactions account for 30% of all trades and 58% of all orders, while applying the lifetime of orders approach, 49% of all trades and 76% of all orders. ESMA plans next to evaluate the drivers of high-frequency trading, how HFT contributes to liquidity, and HFT’s potential benefits and risks. 
  • FSOC Seeks to Understand Potential Risks to the US Financial System Posed by the Asset Management Industry: The Financial Stability Oversight Council is seeking public comment to assess whether any asset management products or activities (including individually managed accounts or pooled investment vehicles) may pose potential risks to the US financial system because of liquidity and redemptions, leverage, operational risk, and the failure or closing of an entity, among other matters. Comments must be received by 60 days after publication of the FSOC notice in the Federal Register.
  • CME Updates Crossing Rules and Pre-Execution Communication Rules to Account for Swaps: CME Group has updated its rules related to simultaneous buy and sell orders for different beneficial orders, trading against customer orders, and pre-execution communications, as well as the associated market regulatory advisory notices, to apply to swap contracts, in addition to futures and related options.
  • LCH.Clearnet Ltd Authorized to Clear Swaps, Futures and Options on Futures; Four Non-US Clearinghouses Receive Extensions of Previously Granted No-Action Relief to Transact With Certain US Persons: LCH.Clearnet Ltd. was approved by the Commodity Futures Trading Commission as a derivatives clearing organization to clear swaps, futures and options. Separately, four non-US clearing houses—ASX Clear (Futures) Pty Limited, Clearing Corporation of India Ltd., Korea Exchange, Inc., and OTC Clearing Hong Kong Limited—had their no-action relief extended by CFTC staff, which allows them to continue to clear certain interest rate swaps for US clearing members. 
  • NFA Updates Regulatory Guide for FCMs, IBs, CPOs and CTAs: The National Futures Association has updated its helpful manual “NFA Regulatory Requirements,” which provides a succinct summary of material regulatory requirements for futures commission merchants, introducing brokers, commodity pool operators and commodity trading advisors. The current version addresses new CFTC regulatory requirements that have recently gone into effect.

Compliance Weeds: Every FCM, IB, CPO and CTA should compare the contents of this guide to their existing compliance manual to ensure that sections considered important by NFA are not missing.

  • CME Freshens Rule Prohibiting Cattle Futures Freshening: Effective January 2, 2015, the Chicago Mercantile Exchange will permit freshening of delivery dates in live cattle futures. Currently, purchases and sales by a long position holder following the first date on which holders of long position may be assigned for delivery must first be netted out, before any excess is applied against an existing position. Beginning January 2, sell transactions may close out existing long positions, and buy transactions may establish new positions. The CME cautions, however, that freshening may not occur through illegal pre-arranged trades.
  • FINRA Files Complaint Against Broker-Dealer and Three Employees for Alleged Submission of Falsified Documents: Wedbush Securities Inc. and three employees were charged by the Financial Industry Regulatory Authority with creating and producing to its staff “falsified and misleading documents” in connection with FINRA’s review of Wedbush’s reporting of municipal securities transactions from October 1 and December 31, 2011. According to FINRA, the respondents admitted that reports submitted to FINRA had been altered.

And finally:

  • Former Managing Director of Asset Manager Prohibited by FCA From Performing Any Regulated Activity Because of Train Fare Payment Evasion: The UK Financial Conduct Authority barred Jonathan Burrows, a former managing director of Blackrock Asset Management Investor Services Limited, from engaging in any regulated activities because he failed to pay train fares in connection with his commuter rail transport to London for an unspecified time period, prior to the time he was caught by an officer on November 19, 2013. According to the FCA, Mr. Burrows was banned because he “is not fit and proper” to carry on regulated entities “because he lacks honesty and integrity.” Mr. Burrows apparently admitted to the relevant transit authority that” he had evaded his train fare on a number of occasions and had done so in the knowledge that he had been breaking the law,” and paid a fine which he claimed exceeded the amount of fare he evaded paying. However, Mr. Burrows apparently did not advise his employer of his misconduct—although the FCA did not charge him related to this. Mr. Burrows consented to the sanction.


Culture and Ethics: This much-reported episode has engendered quite a few raised eyebrows and a fair amount of head shaking by those reading about it. That being said, I am still surprised at the harshness of Mr. Burrows’ penalty in light of the scope of his malfeasance and the seemingly unrelated nature of his actual misconduct to his regulated activity. Few would disagree that those who engage in unscrupulous behavior in our industry, or even unrelated felonies, major crimes, or even certain crimes of moral turpitude are appropriate subjects of harsh sanctions including registration or trading suspensions, let alone prohibitions. However, at some point enough is too much. Frankly, as much as what Mr. Burrows did to evade payment of his transit fares was very wrong (and seems quite arrogant too), it’s a credit to him that he consented to this seemingly disproportionate sanction. Anyone, besides me, humming Arlo Guthrie's 1967 hit song Alice's Restaurant (released by Warner Bros./Reprise)?

©2022 Katten Muchin Rosenman LLPNational Law Review, Volume IV, Number 356

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...