Spoofing; Post-Trade Allocations; Wash Trades & Cryptocurrency

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Bridging the Week by Gary DeWaal: August 6 to 10 and August 13, 2018 (Spoofing; Post-Trade Allocations; Wash Trades; Supervision; Cryptocurrency Activities)

by: Gary De Waal of Katten - Bridging the Week

Monday, August 13, 2018

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A trader who was summarily banned in August 2016 from all CME Group exchanges for 60 days on an emergency basis agreed to pay a fine and be banned for an additional 45 days to resolve disciplinary charges that he purportedly designed and used an algorithmic trading system for spoofing. Separately, one CME Group exchange settled with a non-US trading firm for wash trades and, in the process, further articulated some minimum standards of supervision it expects. In addition, NFA formally issued its Interpretive Notice on certain members’ enhanced disclosure obligations regarding their cryptocurrency activities, including important compliance dates. As a result, the following matters are covered in this week’s edition of Bridging the Week:

COMEX and NYMEX Non-Member Settles Disciplinary Actions for Allegedly Operating Trading System Designed to Mislead Market Participants by Spoofing;
NFA Sets October 31 as Compliance Date for New Interpretive Notice Requiring Enhanced Disclosures for Cryptocurrency Activity; and more.

Article Version:

Briefly:

COMEX and NYMEX Non-Member Settles Disciplinary Actions for Allegedly Operating Trading System Designed to Mislead Market Participants by Spoofing: Andrei Sakharov, a nonmember, agreed to pay a collective fine of US $80,000 and be banned from all direct and indirect access to CME Group exchanges for 45 days to settle charges that he engaged in spoofing conduct. This allegedly wrongful activity occurred on “one or more occasions” from July 1 through July 7, 2016, and involved gold futures traded on the Commodity Exchange Inc. and natural gas futures on the New York Mercantile Exchange Inc.

According to the exchanges’ business conduct committees, Mr. Sakharov’s problematic orders were placed without an intent for execution pursuant to an algorithmic trading system that he purposely programmed and operated to “mislead other market participants through spoofing activity.”

The BCCs also claimed that Mr. Sakharov traded a customer’s account without a proper written authorization, and from January 1 through July 7, 2016, traded orders for multiple trading accounts while using the Globex identifications registered to the owners of such accounts and not his own, contrary to CME Group requirement (Click here to access CME Group Rule 576).

In August 2016, Mr. Sakharov was summarily banned from trading on all CME Group exchanges for 60 days by the CME Group’s chief regulatory officer on an emergency basis on the grounds that such action was necessary to “protect the best interests of the Exchanges and the marketplace.” (Click here for background in the article “Nonmember Banned From Trading All CME Group Products for 60 Days Without a Hearing for Alleged Suspicious Trading Activities” in the August 28, 2016 edition of Bridging the Week. )

ICE Futures U.S. Summary Action

Unrelatedly, ICE Futures U.S. summarily denied Craig Cowell access to all IFUS markets for a maximum of 60 days on an emergency basis for purportedly engaging in spoofing-type conduct. The exchange indicated that on numerous occasions, Mr. Cowell placed a small resting order on one side of the market and numerous, large orders on the other side of the market. Once the small lot was executed, charged IFUS, the large orders were canceled.

CFTC Fines Post-Trade Allocator

Additionally, the Commodity Futures Trading Commission agreed to accept payment of a fine of US $100,000 from Christian Mayer, a former associated person with Northstar Commodity Investment Co., a CFTC-registered introducing broker, for impermissibly transferring winning trades after the fact to his personal account from customer accounts. Mr. Mayer allegedly engaged in such conduct from October 29, 2014, to September 28, 2016.

According to the CFTC, during the relevant time, Mr. Mayer entered 186 unauthorized day trades in two client accounts,and later transferred 113 transactions to his personal account. He left the remainder of the trades in the clients’ accounts. As a result, Mr. Mayer transferred gains totaling almost US $39,000 to his account, while leaving losses of over US $66,000 with his customers.

After discovering Mr. Mayer’s conduct, Northstar reimbursed the customers and terminated Mr. Mayer’s employment. Following this, Mr. Mayer reimbursed Northstar US $150,000.

In addition to paying a fine to the CFTC, Mr. Mayer agreed to be permanently barred from trading on any CFTC-registered exchange to settle this matter. In August 2017, Mr. Mayer agreed never to be registered or associated as a principal with any National Futures Association member in connection with related charges brought against him by NFA. (Click here for background in the article “NFA Bars Former Broker From Membership for Unauthorized Trading and Transferring Winning Trades From Customers to Himself” in the August 20, 2017 edition of Bridging the Week.) Northstar agreed to pay a fine of US $15,000 to NFA in August 2017 related to this matter for failing to adequately monitor intraday transfers by its APs. (Click here to access the relevant NFA complaint, and here to access the decision.)

Failure to Supervise

Separately, Abans Middle East DMCC agreed to resolve a COMEX disciplinary action by paying a US $70,000 fine for failing to supervise its traders who purportedly entered a series of prohibited wash trades between February 11 and July 14, 2016. The COMEX BCC said that Abans did not provide its traders “adequate training” in exchange rules and did not monitor their trading activity. The exchange’s BCC also said that Abans did not adequately supervise its traders’ use of unique Globex identifications.

Finally, Quest Partners, LLC consented to pay fines of US $15,000 to each of COMEX, NYMEX, Chicago Mercantile Exchange and the Chicago Board of Trade because of a malfunction in its trading system that caused unintended orders to be placed in marketplaces. According to the BCCs, “[t]he orders resulted in the unintended execution of trades, sharp price movements and volume aberrations.” The four exchanges said that Quest had tested some updates to its trading system and then attempted to disengage the updates, but failed to roll back all the changes. It was this failure, alleged the exchanges, that caused the firm’s problem.

Compliance Weeds: In October 2017, the CFTC and COMEX brought and resolved charges against Arab Global Commodities DMCC for alleged spoofing-type trading by one of the firm’s unnamed traders in 2016.

Although these two actions against AGC broke no new ground regarding the CFTC’s or CME Group’s view regarding spoofing, they did provide clear articulation by the regulators of at least some elements of what they expect as the components of an effective compliance program regarding disruptive trading: (1) a written policy prohibiting spoofing; (2) training; (3) monitoring tools and monitoring; and (4) follow-up on red flags emanating from such monitoring or otherwise. Moreover, potential violations are expected to be elevated within a company and appropriate action taken. (Click here for further details, in the article “Proprietary Trading Firm Charged by CFTC With Spoofing Based Solely on the Alleged Wrongful Trading of One Employee” in the October 15, 2017 edition of Bridging the Week.)

In the Abans disciplinary action reported on in the above article, the COMEX BCC made clear that it expects trading firms to train their employees regarding exchange rules and monitor their trading activity for possible violations.

On two occasions, most recently in a disciplinary action involving Continental Energy Group LLC, the NYMEX BCCs suggested that persons have an obligation to have block trade procedures that incorporate the exchange’s requirements, train its employees regarding the exchange’s block trade rules and monitor block trade submissions to help ensure block execution times are accurate. (Click here for background in the article “Four CME Clearing House Members Sanctioned for Setting Aside Insufficient Funds for Customers; CME Ends Emergency Suspension of Korean Broker to Access CME Group Markets” in the July 15, 2018 edition of Bridging the Week.)

Persons trading on CME Group exchanges should take heed of the BCCs’ guidance in disciplinary action settlements, and adopt procedures, train staff, and monitor trading, as appropriate, even if not located in the United States. (Click here for a CME Group advisory notice regarding the duty of supervision of employees and agents.)

Legal Weeds: Designated contract markets are required by the CFTC rule to have a disciplinary process that includes certain required elements that promote fairness, but may include an emergency process that permits a DCM to “impose a sanction, including suspension, or take other summary action against a person or entity subject to its jurisdiction upon a reasonable belief that such immediate action is necessary to protect the best interest of the marketplace.” (Click here for further background in the Legal Weeds section associated with the article “Nonmember Banned From Trading All CME Group Products for 60 Days Without a Hearing for Alleged Suspicious Trading Activities” referenced above.)

More Briefly:

CFTC Proposes Rules to Codify DCO Registration Exemption for Non-US Clearinghouses Subject to Comparable Oversight: The Commodity Futures Trading Commission sought to formalize ad hoc procedures to exempt non-US-based clearinghouses from registration as a derivatives clearing organization for swaps, provided that the clearinghouse is subject to “comparable, comprehensive supervision and regulation” by an oversight government regulator in the clearinghouse’s home country. To date, the CFTC has exempted four non-US clearinghouses from such registration using ad-hoc standards: ASX Clear (Futures) Pty Limited, Japan Securities Clearing Corporation, Korea Exchange, Inc., and OTC Clearing Hong Kong. The CFTC’s proposed rules seek to codify these standards. Comments are due on the CFTC’s proposal by 60 days after their publication in the Federal Register.
IOSCO Study Highlights Concentration of Clearing Members and Their Interdependence Across CCPs: The International Organization of Securities Commissions issued a report finding that, in connection with a 2017 analysis, there continues to be great interdependencies in central clearing compared to its 2016 data analysis. Among other things, two unnamed CCPs accounted for 40 percent of all prefunded resources, while 10 CCPs accounted for 90 percent. (Prefunded resources included collected initial margin, contributions to a prefunded default arrangement and a CCP’s skin in the game.) Moreover, the largest 11 out of 306 clearing members were connected to between 16 and 25 CCPs. This suggests, says IOSCO, that the default of a single clearing member could result in defaults by the same entity or affiliates in up to 24 other CCPs. Although IOSCO said that its analysis measured interconnectedness, it observed that it was not endeavoring to measure contagion or related risks.

Follow-up:

NFA Sets October 31 as Compliance Date for New Interpretive Notice Requiring Enhanced Disclosures for Cryptocurrency Activity: The National Futures Association formally issued its Interpretive Notice on disclosure obligations by futures commission merchants, introducing brokers, commodity trading advisors, and commodity pool operators related to activities involving cryptocurrencies and derivatives based on cryptocurrencies on August 9. (Click here for details on the contents of the Interpretive Notice in the special edition of Between Bridges on July 26.)

Compliance dates for requirements in the Interpretive Notice are as follows:

FCMs (or FCMs or IBs for introduced accounts)

Spot Cryptocurrencies

Provide relevant customers with mandatory disclosure language and prominently display the language in all promotional literature related to spot market virtual currencies: beginning October 31.

Cryptocurrency Derivatives

Provide relevant customers with required CFTC and NFA advisories by the relevant required method: beginning October 31.
Provide existing customers as of October 31 with required CFTC and NFA advisories by the relevant required method: by November 30.

CTAs and CPOs

Spot Cryptocurrencies

If relevant,

Address applicable risks in promotional material related to virtual currencies and include mandatory disclosure language: by October 31.
Address applicable unique risks in disclosure documents and offering documents related to virtual currencies and include mandatory disclosure language: by November 21. Provide to existing clients by and new clients beginning November 21.
If disclosure document must be filed with NFA (and accepted prior to first use), file with NFA: by November 21.

Cryptocurrency Derivatives

If relevant,

Address applicable unique risks in promotional material related to virtual currencies: by October 31.
Address applicable risks in disclosure documents and offering documents related to virtual currencies: by November 21. Provide to existing clients by and new clients beginning November 21.
If disclosure document must be filed with NFA (and accepted prior to first use), file with NFA: by November 21.

In other developments related to crypto assets:

SEC Punts on Cboe BZX: The Securities and Exchange Commission extended the 45-day time period it had to consider the request for a rule change by the Cboe BZX Exchange, Inc. to list and trade shares of the SolidX Bitcoin Shares issued by VanEck SolidX Bitcoin Trust. Cboe filed for the rule change on June 20, 2018. The new deadline is September 30, 2018. Recently, the SEC declined a rule change proposed by the Bats BZX Exchange, Inc. to permit its listing and trading of shares of the Winklevoss Bitcoin Trust. The SEC denied BZX’s application, claiming that its proposed rule change was not consistent with requirements of applicable law, mainly “to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest.” (Click here for details in the article “SEC Says 'No' to Winklevoss Bitcoin Trust While NFA Says 'Yes' to Intermediaries’ Crypto Businesses but Requires Disclosures” in the August 5 edition of Bridging the Week.)

Legal Weeds: Decisions in response to motions to dismiss are still outstanding in two important enforcement actions involving cryptocurrencies where defendants challenge the jurisdiction of the Commodity Futures Trading Commission and Securities and Exchange Commission over certain crypto tokens.

A federal court in Massachusetts is expected to rule soon on a motion to dismiss made by Randall Crater and the relief defendants in the CFTC’s My Big Coin Pay, Inc. enforcement action filed earlier this year. In that action, the CFTC claimed that My Big Coin Pay, Inc. and two persons closely involved with the company – Mr. Crater and Mark Gillespie – allegedly engaged in a virtual currency scheme that misappropriated approximately US $6 million from 28 or more persons from at least January 2014 through January 2018.

Mr. Crater and the relief defendants argued in papers to support a motion to dismiss that the CFTC has no jurisdiction to bring its enforcement action alleging fraud in connection with the sale of the virtual currency known as “My Big Coin,” because the virtual currency was not a commodity under applicable law. This is because, said the defendants, the virtual currency was neither a good nor an article, service, right or interest in which contracts for future delivery are dealt in. If My Big Coin is not a commodity, the CFTC had no authority to prosecute a fraud case against them under applicable law, claimed the defendants.

Moreover, the defendants argued that the CFTC had no standing to bring a general anti-fraud case against them relying on a fraud-based manipulation prohibition adopted as part of Dodd-Frank. (Click here for background in the article “CFTC Sues Unregistered Company and Promoters of Fake Virtual Coin for Alleged Fraud and Operating Purported Ponzi Scheme” in the January 28, 2018 edition of Bridging the Week.)

Separately, Maksim Zaslavskiy moved to dismiss a criminal complaint that had been filed against him in November 2017, charging that he engaged in illegal unregistered securities offerings and securities fraud in connection with the offering of digital tokens through initial coin offerings organized by two of his companies, REcoin Group Foundation, LLC and DRC World, Inc. Among other things, Mr. Zaslavskiy claimed in his motion that the digital tokens he tried to create were not securities but cryptocurrencies, and that all currencies – fiat and otherwise – are not securities under applicable law. (Click here for background in the article “Federal Court, Treasury and SEC Provide Further Guidance on Cryptocurrencies; Subject of Criminal Complaint for ICO Asks Court to Dismiss Prosecution Claiming Cryptocurrencies Are Not Securities” in the March 11, 2018 edition of Bridging the Week.)

For further information:

CFTC Proposes Rules to Codify DCO Registration Exemption for Non-US Clearinghouses Subject to Comparable Oversight:
https://www.cftc.gov/sites/default/files/2018-08/federalregister080818.pdf

COMEX and NYMEX Non-Member Settles Disciplinary Actions for Allegedly Operating Trading System Designed to Mislead Market Participants by Spoofing:

IOSCO Study Highlights Concentration of Clearing Members and Their Interdependence Across CCPs here.

NFA Sets October 31 as Compliance Date for New Interpretive Notice Requiring Enhanced Disclosures for Cryptocurrency Activity:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 11, 2018. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article.