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CFTC, Exchange Trade Funds & Post-trade Allocations

CFTC, Exchange Trade Funds & Post-trade Allocations

For the second time this yr, a Commodity Futures Buying and selling Fee-registered futures fee service provider and Nationwide Futures Affiliation member was sanctioned by each regulators for allegedly not supervising post-trade allocations of trades by a 3rd celebration the place the third celebration purportedly favored proprietary accounts over buyer accounts. Individually, the Securities and Exchange Fee denied the appliance of the Bats BZX change to listing and commerce shares of the Winklevoss Bitcoin Belief due to its considerations relating to potential fraudulent and manipulative acts and practices within the underlying bitcoin market. In consequence, the next issues are coated on this week’s version of Bridging the Weeks:

  • CFTC and NFA Sanction FCM for Dealing with of Publish-Trade Allocations by Buying and selling Supervisor (consists of My View and Compliance Weeds);

  • SEC Says “No” to Winklevoss Bitcoin Belief Whereas NFA Says “Yes” to Intermediaries’ Crypto Companies however Requires Disclosures (consists of My View); and extra.

Article Model: 


  • CFTC and NFA Sanction FCM for Dealing with of Publish-Trade Allocations by Buying and selling Supervisor: R.J. O’Brien & Associates LLC – a Commodity Futures Buying and selling Fee-registered futures fee service provider – agreed to pay US $750,000 in fines to the CFTC and the Nationwide Futures Affiliation associated to allegations that it didn’t adequately supervise the post-trade allocations of a buying and selling supervisor and permitted the buying and selling supervisor to commerce for his spouse’s account even after he was banned from buying and selling by NFA. RJO can also be a member of NFA.  

The CFTC stated that RJO’s supervisory breach occurred from January 2013 via February 2014.

As deduced from evaluate of each the CFTC and NFA settlement orders and different public paperwork, it seems that, in the course of the related time, RJO carried a number of accounts managed and managed by Jonathan Hansen and his agency, Newport Personal Capital LLC, which was registered with the CFTC as a commodity pool operator and commodity buying and selling advisor. Apparently, Mr. Hansen typically positioned orders for buyer accounts and proprietary accounts via RJO’s digital buying and selling platform and was assigned a Tag 50 identification by RJO to course of transactions executed by means of CME Group’s buying and selling platform. He additionally typically positioned orders by means of X-Change Monetary Entry LLC (“XCF”), one other CFTC registrant and NFA member, that have been given-up to RJO. Orders have been regularly positioned on a bunched foundation, and allotted later every day. In line with the CFTC, Mr. Hansen disproportionately allotted worthwhile trades to proprietary accounts and unprofitable or much less worthwhile trades to buyer accounts.

In September 2013, NFA issued a Member and Affiliate Duty Motion towards Mr. Hansen and his agency for causes unrelated to their post-trade allocation practices. The MRA prohibited Mr. Hansen and any individual appearing on his behalf from remitting funds from any buying and selling account he managed with out NFA’s authorization, and required Mr. Hansen to be suspended completely from buying and selling if he didn’t fulfill a monetary obligation by January 15, 2014. (Click on right here to entry the related MRA.) Mr. Hansen’s monetary obligation was not met, and, consequently, he was topic to a buying and selling ban starting on January 16.

Shortly after NFA’s MRA went into impact, RJO permitted an account to be opened for Mr. Hansen’s partner, though the Fee acknowledged that “RJO was not aware of the relationship” between Mr. Hansen and this account. Mr. Hansen entered orders for this account, however didn’t have a written energy of lawyer.

In accordance with the CFTC, in the course of the related interval, RJO didn’t comply with sure of its personal procedures in effectuating allocation directions on behalf of Mr. Hansen and ignored numerous purple flags that prompt wrongful post-trade allocations have been occurring. Furthermore, after the issuance of NFA’s MRA, RJO allegedly permitted transfers of funds from Mr. Hansen’s partner’s account with out NFA’s permission, as required. Lastly, even after his buying and selling ban went into impact, Mr. Hansen apparently managed buying and selling in his spouse’s account via Globex utilizing his Tag 50 identification that had not been instantly deactivated by RJO. The CFTC and NFA stated these issues constituted a failure to oversee by RJO.

In 2013, RJO settled an unrelated matter with the CFTC for an alleged breakdown in its oversight of post-trade allocations by a assured introducing dealer’s related individual. It resolved that matter by cost of a wonderful of US $300,000 and entry of a stop and desist order. The CFTC additionally claimed within the present matter that RJO violated its prior stop and desist order in failing to oversee Mr. Hansen’s post-trade allocations.

To resolve its present issues, RJO agreed to pay US $600,000 to the CFTC, and US $150,000 to NFA. In proffering its supply of settlements, RJO didn’t admit or deny any of the allegations of both regulator.

In Might 2018, XFA agreed to pay two fines totaling US $250,000 to the regulators to settle fees that, from at the very least January 2013 via January 2014, it additionally did not supervise the allocation of trades by Mr. Hansen and his agency. (Click on right here for particulars within the article “Former FCM Fined by CFTC and NFA for Processing CPO Client’s Unlawful Post-Trade Allocations Despite Red Flags” within the June three, 2018 version of Bridging the Week.)  XFA is at present registered with the CFTC as an introducing dealer, however from March 2013 by means of February 2016, it was registered as an FCM. The agency was additionally registered as an IB previous to its registration as an FCM.

My View and Compliance Weeds: As I wrote on the time of the X-Change settlements, 

“Although the CFTC charged XFA with failure to supervise under the general supervision requirement in its rules applicable to all Commission registrants (click here to access CFTC Rule 166.3), the CFTC said in the XFA settlement order that the CFTC regulation dealing with the post-execution allocation of bunched orders “places an affirmative obligation on FCMs to monitor for unusual allocation activity and to make a reasonable inquiry into the matter if an FCM had actual or constructive knowledge of fraudulent allocations.” Nevertheless, there isn’t a such categorical requirement within the related rule. The one two necessities for FCMs within the related rule (until they’re the eligible account supervisor partaking within the allocation) are (1) to take care of data to determine every order and account topic to a post-trade allocation and (2) to not settle for orders for post-trade allocation from an eligible account supervisor if the CFTC advises it accordingly. (Click on right here to entry the related CFTC regulation, Rule 1.35(b)(5).)

That being stated, underneath an NFA steerage, FCMs have an categorical, affirmative obligation to take “appropriate action” if they’ve precise or constructive information that allocations for its clients are fraudulent. (Click on right here to entry NFA Interpretive Discover 9029 to Compliance Rule 2-10.) The CFTC acknowledged this NFA steerage in its XFA settlement order, in addition to within the 2013 Federal Register launch the place the CFTC adopted its amended bunch order rule. (Click on right here to entry 68 Fed. Reg 34,790, 34,792 (June 11, 2003).)

In occasions of CFTC finances shortages – like now – it isn’t clear what’s the advantage of each the CFTC and NFA bringing parallel actions towards XFA for successfully the identical offense, notably the place NFA has an categorical steerage on an FCM’s obligations associated to its dealing with of bunched orders, the cited CFTC rule is silent on an FCM’s particular obligations, and the idea for the CFTC’s failure to oversee declare towards an FCM in reference to bunched orders finally derives from the NFA steerage.”

My similar evaluation and questioning applies to the CFTC’s present motion towards RJO.

That being stated, registrants that enact insurance policies and procedures in response to regulatory necessities should adhere to such inner necessities or their failure could possibly be used towards them in enforcement or different regulatory actions or personal litigation. Furthermore, if regulators expressly prohibit or situation dealings with sure individuals (e.g., via the Specifically Designated Nationals and Blocked Individuals Record publicized by the Workplace of Belongings Management of the US Division of Treasury – click on right here to entry background), registrants should guarantee they’ve procedures in place to concentrate on such prohibitions and restrictions, and take affordable measures to make sure compliance. Furthermore, relying on the categorical necessities of the prohibition or conditioning, it might be applicable to evaluate useful house owners of accounts, in addition to all approved merchants – as indicated by categorical buying and selling authorizations or permissioned buying and selling system entry – along with reviewing account names.

  • SEC Says “No” to Winklevoss Bitcoin Belief Whereas NFA Says “Yes” to Intermediaries’ Crypto Companies however Requires Disclosures: The Securities and Exchange Fee disapproved a proposed rule change by the Bats BZX Exchange, Inc. to allow its itemizing and buying and selling of shares of the Winklevoss Bitcoin Belief. The SEC denied BZX’s software, claiming that its proposed rule change was not in step with necessities of relevant regulation, primarily “to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest.” 

As proposed, the funding goal of the Belief was for its shares to trace the worth of bitcoin traded on the Gemini Exchange, a digital asset change owned by Gemini Belief Firm LLC, the Belief’s custodian that can also be a belief firm licensed by the New York Division of Monetary Providers. The Belief solely would maintain bitcoins as belongings.

Amongst different issues, the SEC claimed that, regardless of BZX’s assertions on the contrary, bitcoin and the bitcoin markets are usually not “uniquely resistant to manipulation.” In consequence, stated the SEC, BZX ought to have entered into “a comprehensive surveillance sharing agreement with a regulated market of significant size related to bitcoin” instead means to satisfy its requirement to stop fraudulent and manipulative acts and practices. Nevertheless, the SEC claimed BZX didn’t enter any such settlement. Though BZX pointed to its surveillance sharing settlement with the Gemini Exchange, the SEC stated that the Gemini Exchange was not a regulated market regardless of its supervision by the NYDFS. Furthermore, even when it the Gemini Exchange was adequately regulated, it was not a “significant” bitcoin-related market, the SEC noticed.

Lastly, BZX argued that even when its settlement with the Gemini Exchange was not passable, its conventional technique of figuring out and deterring fraud have been passable to satisfy its statutory obligations. The SEC rejected this argument too. BZX had proposed that, in keeping with different SEC approval orders, it will require change market makers to reveal their dealings within the underlying commodity (in addition to associated derivatives). Additionally, because it might with shares in different exchange-traded merchandise, BZX would be capable of get hold of info relating to buying and selling in shares of the Belief from Intermarket Surveillance Group members and affiliate members, in addition to from info on the blockchain and from the Gemini Exchange. The SEC stated, nevertheless, that these mechanisms have been unsatisfactory as they might not present perception into the underlying bitcoin or bitcoin derivatives holdings of all BZX market individuals or the id of market members buying and selling within the underlying bitcoin OTC market or different bitcoin buying and selling venues. (The ISG consists of a world group of exchanges, market facilities, and market regulators that carry out front-line market surveillance of their respective jurisdictions. Click on right here for particulars.)

BZX initially filed its software for a rule change on June 30, 2016. The SEC declined its request on March 10, 2017. (Click on right here to entry the SEC Order.) Thereafter, BZX promptly filed a petition requesting the SEC rethink its denial, which the Fee granted on April 24.

Commissioner Hester Peirce dissented from the Fee’s willpower. She claimed that BZX’s proposed rule change “satisfies the statutory standard” and that the SEC’s refusal to approve the rule “sends a strong signal that innovation in unwelcome in our markets, a signal that may have effects far beyond the fate of bitcoin [exchange-traded product].” In rejecting BZX’s software the SEC famous, nevertheless, that “its disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment.”

Purposes for different bitcoin-related exchange-traded merchandise stay pending on the SEC. (e.g., purposes by NYSE Arca – click on right here to entry background – and by CBOE BZX Exchange, Inc. – click on right here to entry background).

In different developments relating to digital belongings and fintech:

  • NFA Points Advisory to FCMs, IBs, CTAs and CPOs: The Nationwide Futures Affiliation proposed to undertake an Interpretive Discover that might require futures fee retailers, introducing brokers, commodity buying and selling advisors and commodity pool operators to affirmatively make sure disclosures to clients, counterparties or buyers that interact or might interact in actions associated to identify digital currencies or derivatives based mostly on digital currencies with or via them. 

NFA proposed very totally different disclosure obligations for FCMs and IBs as in comparison with CTAs and CPOs, and, usually, NFA will mandate totally different necessities in reference to actions associated to identify digital currencies versus digital foreign money derivatives. (Click on right here for particulars relating to the NFA Advisory within the article “National Futures Association Proposes Interpretive Notice Requiring FCM, IB, CTA and CPO Disclosures Regarding Virtual Currency Activity” within the July 27, 2o18 version of Between Bridges.)

  • OCC and Fintech Charters: The Workplace of the Comptroller of the Foreign money introduced it should start accepting purposes from monetary know-how corporations for particular objective nationwide financial institution (“SPNB”) charters. It’s meant that such corporations would interact in a number of of “core banking functions” of paying checks or lending cash, however wouldn’t take deposits. Sometimes, particular objective nationwide banks’ operations are restricted to sure actions, corresponding to fiduciary actions. Fintech corporations that search to turn into SPNBs can be evaluated on their “unique facts and circumstances” and if granted a constitution, will probably be supervised like “similarly situated” nationwide banks for capital, liquidity and monetary inclusion commitments. New York Division of Monetary Providers Superintendent Maria Vullo vehemently objected to OCC’s announcement. Based on Ms. Vullo, “a national fintech charter will impose an entirely unjustified federal regulatory scheme on an already fully functional and deeply rooted state regulatory landscape.” The NYDFS has beforehand challenged the authority of OCC to grant particular fintech charters. The US federal courtroom listening to the matter denied the NYDFS’s problem, claiming it was untimely on the time. (Click on right here for particulars within the article “Challenges to NY BitLicense and Potential OCC Fintech Charter Quashed” within the January 7, 2018 version of Bridging the Week.)

  • Token Alliance‘s Best Practices for Non-Securities Utility Tokens: The Token Alliance – an industry initiative of the Chamber of Digital Commerce – issued a comprehensive overview of the regulation of digital assets in the United States and other select jurisdictions, and proposed best practices for sponsors of digital tokens that are not intended to be securities or an instrument over which the Commodity Futures Trading Commission might have anti-fraud or anti-manipulation authority – i.e., utility tokens. To avoid unintended regulatory interactions, The Token Alliance recommended, among other things, that (1) sponsors fully develop their proposed system or application before distribution of a utility token, (2) utility tokens not be distributed before they can be used to access a proposed system or application; (3) utility token holders should not be permitted to sell the digital assets on credit; (4) utility tokens should be promoted for their utility purpose not the potential value of the token’s challenge; and (5) utility tokens shouldn’t be constructed in order that holders anticipate income from the underlying venture. White papers discussing utility tokens ought to embrace explanations of the know-how; use instances for the undertaking; traits and features of the token; and dangers. In its overview, The Token Alliance additionally offered rules and tips for token buying and selling platforms.

  • FINRA Seeks Feedback of Technological Innovation: The Monetary Business Regulatory Authority sought enter on the way it can help technological innovation to assist buyers and capital markets. Along with soliciting common feedback, FINRA is looking for perception on three particular areas: knowledge aggregation providers that may combination info from totally different monetary accounts right into a single location for buyers; supervisory processes associated to using synthetic intelligence; and the way to develop a machine-readable rulebook. Feedback are due by October 12. In January 2017, FINRA issued a report relating to digital ledger know-how and mentioned, amongst different subjects, regulatory issues for broker-dealers (click on right here to entry).

  • Comply with-up – Jon Montroll: Jon Montroll pleaded responsible to committing securities fraud in reference to the operation of a securities trade that traded shares in digital currency-related companies. He additionally pleaded responsible to obstruction of justice for making false statements to the Securities and Exchange Fee in reference to its investigation associated to his actions. In February 2018, each the SEC and the USA Division of Justice filed expenses towards Mr. Montroll in a federal courtroom in New York, and the SEC moreover filed fees towards BitFinder, Mr. Montroll’s purported securities trade. The SEC claimed that, from December 2012 by means of November 2013, Mr. Montroll misappropriated clients’ bitcoin; lied a few hack of the BitFunder ecosystem in the summertime of 2013 that resulted in a lack of 6,000 bitcoin; and raised funds for shares of a selected safety – Ukyo.Mortgage — and misappropriated funds from these investments too. (Click on right here for additional particulars relating to the SEC’s and DOJ’s allegations within the article “SEC Sues Bitcoin-Denominated Trading Platform for Operating an Unlicensed Securities Exchange; Principal Criminally Charged” within the February 25, 2018 version of Bridging the Week.)

  • Comply with-up – The Entrepreneurs Headquarters Restricted: A federal courtroom in New York ordered The Entrepreneurs Headquarters Restricted and Dillon Dean, its sole founder and principal, to pay over US $1.9 million in complete sanctions in reference to an enforcement motion introduced by the Commodity Futures Buying and selling Fee that charged that the defendants solicited bitcoin from clients to be able to pool their funds and spend money on monetary merchandise, together with binary choices traded on the Nadex, a CFTC-registered binary choices trade. In actuality, claimed the CFTC, the defendants misappropriated clients’ funds, together with utilizing belongings from some clients to pay different clients in a Ponzi scheme. Pursuant to a default order, the defendants should pay virtually US $1.5 million as a wonderful, and US $432,185 as restitution to clients.

My View: Commissioner Pierce’s dissent to the SEC’s denial of a proposed rule change by Bats BZX Exchange to allow the itemizing and buying and selling of shares of the Winklevoss Bitcoin Belief is spot on. There isn’t a language within the related statute that seems to require Bats BZX to deal with buying and selling in spot bitcoin, versus the exchange-traded product it proposed to accommodate, in a protection of its guidelines meant to preclude fraudulent and manipulative conduct. The language of the related statute is obvious:

An change shall not be registered as a nationwide securities change until the Fee determines that 

(5) The principles of the change are designed to stop fraudulent and manipulative acts and practices, to advertise simply and equitable rules of commerce, to foster cooperation and coordination with individuals engaged in regulating, clearing settling, processing info with respect to, and facilitating transactions in securities, to take away impediments to and excellent the mechanisms of a free and open market and a nationwide market system, and, typically, to guard buyers and the general public curiosity. 

(Emphasis added.)

Nothing on this provision means that an change should handle the potential for fraud or manipulation on one other change or buying and selling facility, not to mention within the over-the-counter market, to ensure that its guidelines associated to the itemizing of a selected safety to be accredited by the SEC.

Based on Ms. Pierce, BZX greater than adequately met its requirement beneath the plain language of the regulation.

Furthermore, in any case, even assuming the SEC’s studying of the related statute is right, the SEC offers brief shrift to the worth of the regulatory oversight of the NYDFS. Earlier this yr, NYDFS expressly required digital foreign money entities it licensed, together with the Gemini Exchange, to undertake measures designed to successfully detect, forestall and reply to fraud, tried fraud and comparable wrongdoing. (Click on right here for background within the article “NYS Financial Services Regulator Ups the Obligations of State-Licensed Virtual Currency Entities” within the February 11, 2018 version of Bridging the Week.)

As Apple achieved US $1 trillion in market worth this week, I recalled that, when the corporate was first listed in 1980, Massachusetts denied its residents entry to the inventory on the bottom it was too dangerous. This was a improper choice then, simply because the SEC’s determination now’s an incorrect consequence. (Click on right here for a related article from the December 12, 1980 version of The Wall Road Journal.)

As NFA demonstrates in allowing registrants beneath its oversight to transact in cryptocurrencies and cryptocurrency derivatives, the right strategy is to require applicable disclosure of dangers, to not preclude entry to new funding merchandise.

With applicable disclosure, buyers can decide on their very own whether or not any funding, together with an ETP based mostly on bitcoin, is just too dangerous as a result of the underlying market is or shouldn’t be particularly vulnerable to fraud or manipulation. Investor intermediaries’ software of suitability necessities will even assist function a examine on inappropriate investments by shoppers.

The SEC ought to, and solely has authority to, assess whether or not an change underneath its jurisdiction has guidelines to stop fraud or manipulation of the securities it lists, not the commodities underlying these securities. It shouldn’t, by itself, broaden its authority as a result of it doesn’t really feel snug with the underlying asset to an exchange-traded product.

Extra Briefly:

  • Alleged Spoofer Exonerated in Felony Trial Agrees in Precept to CFTC Settlement;Two Extra Purported Spoofers Criminally Charged: Andre Flotron, the previous UBS dealer accused of conspiracy to defraud in reference to purported spoofing‑sort buying and selling exercise involving valuable metals futures contracts listed on the Commodity Exchange, Inc., and located not responsible of legal fees by a jury listening to his case in Connecticut in April 2018, apparently agreed to settle associated civil fees initially introduced by the Commodity Futures Buying and selling Fee in January 2018. Though phrases on this settlement haven’t been finalized, each the CFTC and Mr. Flotron agreed to report again to the US federal courtroom listening to this matter by September 18 to report on developments. (Click on right here for a dialogue of the federal courtroom verdict relating to Mr. Flotron within the article “Former UBS Trader Found Not Guilty of Conspiracy to Defraud for Alleged Spoofing” within the April 29, 2018 version of Bridging the Week, and right here for a dialogue of the CFTC motion within the article “CFTC Names Four Banking Organization Companies, a Trading Software Design Company and Six Individuals in Spoofing-Related Cases; the Same Six Individuals Criminally Charged Plus Two More” within the February four, 2018 version of Bridging the Week.)

Individually, two further merchants previously related to Deutsche Financial institution – James Vorley and Cedric Chanu – have been named in felony complaints filed in a US federal courtroom in Chicago associated to alleged spoofing buying and selling actions on the Commodity Exchange, Inc. from at the very least December 2009 via November 2011. These two people – each non-US nationals – purportedly coordinated with one other former Deutsche Financial institution worker who pleaded responsible in June 2017 to partaking in spoofing, manipulation, and tried manipulation of gold and silver futures on the Comex from December 2009 by way of February 2012. (Click on right here for background on this plea settlement within the article “Former Newbie Bank Trader Pleads Guilty to Criminal Charges and Settles CFTC Civil Charges for No Fine for Spoofing, Attempted Manipulation and Manipulation of Gold and Silver Futures” within the June four, 2017 version of Bridging the Week.)

Unrelatedly, New York Mercantile Exchange and Comex enterprise conduct committees fined and barred a number of non-US nationals from accessing any CME Group marketplace for partaking in alleged disruptive buying and selling actions and never cooperating with trade disciplinary proceedings. The fines ranged from US $50,000 to US $100,000.

  • CFTC Proposes Simplifying Notification Necessities for Swap Sellers Associated to Segregated Funds for OTC Swaps: The Commodity Futures Buying and selling Fee proposed numerous rule amendments to offer extra flexibility in reference to the segregation of belongings held as collateral in uncleared swap transactions by swap sellers and main swap members. The proposed amendments tackle present notification necessities to counterparties relating to their option to have their preliminary margin segregated, in addition to preliminary margin funding and custody necessities, amongst different issues. Feedback on the CFTC proposals are due by September 28. The CFTC additionally proposed amendments to its place limits guidelines for safety futures merchandise, increasing the default degree for fairness SFP place limits and amending the standards to be utilized by designated contract markets for setting a better degree of place limits and accountability ranges. Feedback to this proposal are due by October 1.

  • IOSCO Recommends How Buying and selling Venues Ought to Monitor and Talk Excessive Volatility Occasions: The Worldwide Group of Securities Commissions issued eight suggestions to assist buying and selling venues higher cope with excessive volatility episodes and help orderly buying and selling. Among the many suggestions are that (1) buying and selling venues ought to implement and keep “appropriate” volatility management mechanisms throughout buying and selling hours to handle excessive volatility and help orderly buying and selling; (2) the mechanisms must be appropriately calibrated to, amongst different issues, the character of the monetary instrument or underlying asset, their liquidity or buying and selling profile and worth, in addition to volatility management mechanisms for associated devices; (three) the mechanism ought to be recurrently monitored to evaluate whether or not recalibration may be applicable; (four) the character of volatility mechanisms must be communicated to the general public; and (5) buying and selling venues’ buying and selling associated devices ought to talk as applicable when volatility mechanism are triggered.

  • FINRA Seeks Feedback on Membership Software Course of: The Monetary Business Regulatory Authority proposed amendments to its guidelines to expedite and make extra environment friendly the method to turn into a brand new member or for an present member to interact in new enterprise actions. Amongst different issues, the amended guidelines purpose to remove sure procedural redundancies between new and persevering with membership software processes; codify present follow to scale back the evaluate durations for membership software processes; and make clear occasions that might require a CMA. Feedback to FINRA proposed amendments are due by October 5.