Last week, Navinder Singh Sarao – accused by both the Department of Justice and the Commodity Futures Trading Commission of engaging in spoofing-type conduct that contributed to the May 6, 2010, “Flash Crash” – pleaded guilty to his DOJ criminal charges and proposed to settle his CFTC civil action, following his extradition to the United States from the United Kingdom. In addition, ICE Futures U.S. once again proposed revisions to its Frequently Asked Questions related to the possible pre-execution hedging by principals to a futures block trade. And of course, Donald J. Trump won the election to be the next United States president. As a result, the following matters are covered in this week’s edition of Bridging the Week:

• Alleged Flash Crash Spoofer Pleads Guilty to Criminal Charges and Agrees to Resolve CFTC Civil Complaint by Paying Over $38.6 Million in Penalties (includes Legal Weeds and My View);

• One More Time – ICE Futures U.S. Proposes Revision to Futures Block Trade Guidance to Permit Pre-Hedging (includes My View);

• Where, Oh Where Is the CFTC New Form 40 Portal? (includes My View);

• Additional Musings on the CFTC’s Supplemental Proposal Regarding Regulation AT (My View);

• The Sun Did Come Out Tomorrow – Conjecture on Financial Services Regulation in the Trump Years (My View); and more.

Briefly:

• Alleged Flash Crash Spoofer Pleads Guilty to Criminal Charges and Agrees to Resolve CFTC Civil Complaint by Paying Over $38.6 Million in Penalties: Navinder Singh Sarao pleaded guilty last Wednesday in a US federal court in Chicago to criminal charges previously brought against him by the Department of Justice for allegedly engaging in manipulative conduct through spoofing-type activity involving E-mini S&P futures contracts traded on the Chicago Mercantile Exchange between April 2010 and April. 2015, including illicit trading that contributed to the May 6, 2010, “Flash Crash.” On the same day, the Commodity Futures Trading Commission announced that Mr. Sarao and Nav Sarao Futures Limited PLC, a company he controlled, settled civil charges it had brought against the two defendants related to the same essential conduct. Mr. Sarao and his company both were publicly charged by the DOJ and CFTC in April 2015. (Click here for details.) Following the filing of the criminal and civil actions against him, Mr. Sarao fought extradition to the United States from his home in the United Kingdom, but recently lost his last appeal before the UK High Court. He was physically extradited on November 7. (Click here for details.) Among other things, the CFTC and DOJ claimed that, during the relevant time, Mr. Sarao principally employed two automated trading programs to effectuate his spoofing-type trading activities. The federal regulators alleged that, on the day of the "Flash Crash," Mr. Sarao entered numerous spoofing orders “that represented well over 20 percent of all E-mini sell orders visible to the market” in E-mini S&P Futures. (The “Flash Crash” refers to events on May 6, when major US-equities indices in the futures and securities markets suddenly declined 5-6 percent in the afternoon in a few minutes before recovering within a similarly short time period.) To resolve his CFTC charges, Mr. Sarao proposed to disgorge profits of over US $12.87 million, and pay a fine of over US $25.74 million, among other sanctions; the US federal court in Chicago must formally approve the CFTC settlement. A status hearing on Mr. Sarao’s criminal action is scheduled for February 9, 2017, while Mr. Sarao and the CFTC are formally scheduled to present his settlement agreement to the court for its approval this week.

Legal Weeds: In his proposed CFTC settlement, Mr. Sarao admitted that, in order to effectuate his spoofing activity, he arranged customization of an unnamed “off-the-shelf” trading platform. The CFTC had charged that, in working with computer programmers on this customization, Mr. Sarao evidenced “an intent to use two algorithmic trading programs to place orders (1) with no intention of executing those orders; and (2) with an intention to affect E-mini S&P market prices.” Importantly, in charging Mr. Sarao and his company, the CFTC did not reference the actual source code underlying his customization; rather, it quoted from email between Mr. Sarao and his programmers to show instructions for them to develop functionality to allow him to engage in his illicit layering and spoofing activity. The CFTC also described the behavior of the two trading programs principally employed by Mr. Sarao. This is consistent with how the CFTC approached its settlement with Michael Coscia, who ultimately was also convicted of spoofing by a jury in a federal court and sentenced to three years imprisonment following the filing of a criminal action by the US Attorney’s Office in Chicago. (Click here for details.) In its Order Instituting Proceedings and Making Findings against Mr. Coscia, the CFTC described the behavior of an algorithm he used “designed to rapidly place bids and offers in the market and to cancel those bids and offers prior to execution.” There was no reference to source code. (Click here for a copy of the CFTC’s Order against Mr. Coscia and Panther Energy Trading LLC, a company he owned and controlled.)

My View: It appears that the CFTC is well-equipped using its existing arsenal of current laws and regulations to investigate potential market manipulation and other disruptive trading, including potential spoofing, without any greater access to source code as it currently seeks under proposed Regulation AT.

• One More Time – ICE Futures U.S. Proposes Revision to Futures Block Trade Guidance to Permit Pre-Hedging: ICE Futures U.S. proposed amending its Frequently Asked Questions regarding pre-hedging futures block trades less than two weeks after its latest guidance became effective on November 1. IFUS’s current block trade FAQ permits certain pre- or anticipatory hedging by a counterparty to a potential block trade prior to the block transaction being formally executed. However, this ability does not exist for “an intermediary that takes the opposite side of its own Customer order.” In addition, it is currently prohibited under the IFUS guidance for a person to engage in front running of a block trade when acting on material nonpublic information regarding an impending transaction by another person “obtained through a confidential employee/employer relationship, broker/customer relationship or in breach of a fiduciary responsibility.” As proposed to be amended, the phrase “fiduciary responsibility” would be replaced by the phrase “pre-existing duty.” It appears that the new phrase is broader than the prior phrase, although it is not clear what is contemplated by the new phrase or that it has any applicability in connection with principal transactions. Absent objection by the Commodity Futures Trading Commission, IFUS’s new FAQ should be effective November 28. ICE Futures U.S. initially proposed its revised block trade FAQ during June 2016; amended its proposal in October 2016 (which is the version currently in effect); and now has proposed a third version.

My View: Currently, there are three very similar but slightly different variations of block trade guidances outstanding that address what is permissible pre-hedging of block trades by principals to a transaction: what ICE Futures U.S. has just proposed; what CME Group has adopted based on IFUS language currently in place; and what NASDAQ Futures has adopted (Click here for details.) The three exchanges should, as soon as possible, provide clarification regarding the meaning of their guidances and the significance of any subtle differences in language. My expectation is that this will happen in some form shortly.

And more briefly:

• CFTC Approves Final Rule Regarding Timing of CCO Annual Reports for FCMs, SDs and MSPs: The Commodity Futures Trading Commission adopted amendments to existing rules to permit futures commission merchants, swap dealers and major swap participants to file mandated chief compliance officer annual reports with it by no later than 30 days following such entities’ filing of mandated annual financial reports (90 days after their fiscal year-end). Under existing rules, such CCO annual reports must be filed within 60 days after a registrant’s fiscal year-end; however, such reports may now be filed later under a staff no-action letter (click here to access the relevant no-action letter). In addition, the CFTC amended its rules to permit FCMs relying on substituted compliance with a foreign jurisdiction’s equivalent CCO requirements to file a comparable CCO annual report with it 15 days after the date such comparable report must be completed locally, and to delegate to CFTC staff the authority to grant extensions in time for the filing of CCO annual reports.

• CME Fines Two Non-Members for Prearranging Transactions to Transfer Equity Between Accounts: Jun Jin and Diego Di Stefano, two non-members of the Chicago Mercantile Exchange, were found to have admitted violations of the exchange’s prohibition against prearranging transactions for the purpose of transferring equity between accounts (click here to access CME Group Rule 432.G). CME had charged that Mr. Jin had engaged in such conduct involving CME FX option contracts between May and June 2014, while Mr. Stefano had transacted in such manner in E-mini S&P futures between September and November 2014. Neither individual answered CME charges filed against them. Mr. Diego was assessed a fine of US $75,000 and Mr. Jun, US $50,000, as well as trading prohibitions, for violating CME prohibitions.

Follow-up:

• Where, Oh Where Is the CFTC New Form 40 Portal?: Last week I wrote that, beginning November 18, persons owning or controlling reportable positions in futures or swaps and subject to a special call by the Commodity Futures Trading Commission must file electronically a revised CFTC Form 40 or 40S with the CFTC. Moreover, these new forms ask different questions than the legacy Form 40 and have different obligations regarding affirmative updates. (Click here for background.) Persons wishing prior to November 18 to test the new CFTC portal that will be used to prepare and submit the new Form 40, or submit it via a secure FTP data feed may do so by starting the registration process here. For technical guidance to assist in preparing files for SFTP transmission, click here. Finally, for a copy of the new Form 40, click here (unfortunately, you will not find a standalone version of the new Form 40 at www.cftc.gov as of this time).

My View: Due to the difficulty navigating the CFTC’s website to find the portal used to input the revised Forms 40 and 40S (in order to test the process of submitting the new forms); the lack of a standalone draft new Form 40 easily identifiable on its website; and the ambiguity of some of the new questions on the Form 40, it seems only fair and reasonable for the CFTC to delay the effective date of new Forms 40 and 40S requirements. Reportable traders should make a request for such delay urgently.

• My View: Additional Musings on the CFTC’s Supplemental Proposal Regarding Regulation AT: As I wrote here last week, the Commodity Futures Trading on November 4 approved a supplemental notice of proposed rule-making (SNPRM) regarding Regulation Automated Trading, initially proposed during November 2015. The supplemental proposal includes a volumetric threshold designed to reduce the potential number of possible AT Persons; a change to the definition of direct electronic access; a new process for the CFTC to request access to source code through special calls; and a methodology for AT Persons to delegate somewhat the of testing algorithmic trading systems to third parties that control such systems. (Click here for details.) Under the volumetric test as proposed, an existing registrant would not be considered an AT Person (and thus subject to most of the pre-trade risk controls and systems development and testing requirements), or a non-registrant required to register as a Floor Trader (and thus become an AT Person) unless they engaged in 20,000 contracts for such person’s own account, the account of customers, or both, on average during each trading day during the prior six-month counting period. However the daily volume appears to be computed, as proposed, on the basis of total contracts traded on the electronic trading facilities of designated contract markets regardless of whether they originated through algorithmic trading or otherwise. This does not seem consistent with the purpose of the proposed limitation. Likewise, because of the revised definition of DEA, it appears possible that affiliates (e.g., foreign brokers) of certain existing registrants that might be deemed AT Persons (e.g., futures commission merchants) might have to register as Floor Traders (and also be AT Persons) if they engage in algorithmic trading for their own account and route orders through FCMs electronically to DCMs even if they exceed the volumetric threshold only because the combination of their customer and proprietary orders exceed the volumetric threshold. This also, hopefully, is a drafting ambiguity. Bottom line: it’s important for persons that may have issues with specific provisions of the SNPRM to file timely comment letters with the CFTC and not simply assume that, because of the pending inauguration of Donald Trump, that Regulation AT will simply go away. It likely won’t – at least not in full!

And finally:

• My View: The Sun Did Come Out Tomorrow – Conjecture on Financial Services Regulation in the Trump Years: Many people were stunned last Tuesday night when Donald J. Trump became the president-elect of the United States, and many were afraid that the sun might never shine again. It did – as the Broadway musical Annie predicted – beginning Wednesday. Pundits far more insightful than I am will wax eloquently for weeks and months, if not years, as to what happened and why. However, one consequence of Mr. Trump’s election is that it seems more likely than not that at least some provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010 will be substantially modified if not repealed – although the entire law is not likely to be eliminated. This is suggested by criticism of Dodd-Frank that was posted on Mr. Trump's President-Elect website last week. (Click here to access the section “Financial Services” on the new President-Elect Donald J. Trump website.) A provision on the radar for possible elimination likely includes the so-called “Volcker Rule” that prohibits banks from making certain types of speculative investments – although it’s no sure bet. As recently as August, Mr. Trump indicated that he wanted to bring back the Glass-Steagall Act’s barriers between commercial and investment banking – consistent with the 2016 platform of the Republican Party (click here to access; see page 28). He also observes on his new President-Elect website that “taxpayers [still] remain on the hook for bailing out financial firms deemed ‘too big to fail.’” This is not verbiage consistent with eliminating the Volcker Rule, and as a result nothing can be predicted for certain. Mr. Trump has also called for a federal regulation freeze immediately after he becomes president, and a reduction in existing federal regulations afterwards. Although he will not be able to order this directly at independent federal agencies like the Commodity Futures Trading Commission and Securities and Exchange Commission, he would be able to accomplish this indirectly by appointing new chairs and commissioners at each agency. It is expected that both Timothy Massad and Mary Jo White will resign as chairs of the CFTC and SEC, respectively, on or prior to January 20, enabling the appointment of agency heads more sympathetic to his agenda. As a result, CFTC and SEC pending rules (such as proposed Regulation Automated Trading) that are not finalized by January 20 are at best likely to be delayed, substantially modified or even killed, but final rules implemented by January 20 will stay on the books for now – although effective dates could be delayed, or revisions proposed and subsequently adopted. It is likely that both agencies will do less to hinder business through new regulations generally, but violations of law will continue to be prosecuted – even aggressively if the matter is reactive to an incident that garners populist outcry. The fact that many banking sector stocks generally hit multi-year highs since Mr. Trump’s election reflects investor sentiment that constraints on the banking sector will soon be diminished and their performance should excel. We’ll see!