Enforcement actions, private litigation and guidance regarding the criteria for regulatory investigations took center stage in developments impacting the financial services industry last week. In one disciplinary action brought by the Financial Industry Regulatory Authority, there were no fines – apparently in light of the “extraordinary cooperation” of the named broker-dealers. In the publication of “Enforcement Referral Criteria,” the UK Financial Conduct Authority provided insight into its deliberation process for commencing investigations for possible wrongdoing. As a result, the following matters are covered in this week’s edition of Bridging the Week:

• Alleged Fictitious Sales to Facilitate Improper Money Pass Prompts CFTC Injunctive Action and Asset Freeze (includes Compliance Weeds);

• Santander Holdings Agrees With Fed to Broad Plan to Address Alleged Governance, Risk Management and Capital Planning Deficiencies;

• Five Broker-Dealers to Pay Back More Than US $30 Million to Retirement Accounts and Charities Charged Too Much for Mutual Funds (includes My View);

• MF Global Investors Reach US $64.5 Million Settlement With John Corzine and Other MF Global Officers and Directors Related to Firm’s Collapse;

• ICE to Provide REMIT Reporting for Relevant Wholesale Energy Market Transactions Executed on ICE European Marketplaces;

• FCA Publishes Criteria Used for Formal Enforcement Investigations;

• G-IB Banned From Business by NFA While Principals Suspended for Charging Too Much to Customers (includes Compliance Weeds); and more

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Briefly:

• Alleged Fictitious Sales to Facilitate Improper Money Pass Prompts CFTC Injunctive Action and Asset Freeze: The Commodity Futures Trading Commission filed a lawsuit in a federal court in Illinois against Yumin Li and Kering Capital Ltd. – a company formed in November 2014 by Ms. Li’s mother – claiming that Ms. Li engaged in multiple illegal futures transactions from March 17 to May 6 of this year designed to transfer US $300,000 from an account of her employer to an account in the name of Kering Capital. Simultaneously, the CFTC obtained an ex parte asset freeze against Ms. Li and Kering Capital. According to the CFTC, Ms. Li entered multiple non-competitive buy and sell trades in her employer’s account meant to lose money and corresponding sell and buy trades in the Kering Capital account to make an equal amount of money, all in distant Eurodollar futures contracts traded on the Chicago Mercantile Exchange. The CFTC claimed Ms. Li chose these distant futures contracts and traded them on CME Group’s Globex platform outside of regular trading hours to ensure she could trade the two accounts opposite each other. The nature of the trades was a “money pass,” said the CFTC – “a form of non-competitive trading in which one traders loses money to another trader, typically where one trader buys a quantity of contracts at a high price opposite the other trader, and sells back the same quantity of contracts at a low price opposite the same trader, leaving neither trader with a resulting futures or options position.” The CFTC seeks disgorgement of funds allegedly transferred to Kering Capital, a prohibition of similar conduct, and fines, among other relief. 

Compliance Weeds: Many futures exchanges have express prohibitions against executing transactions designed to pass money between accounts (Click here, for example, to access CME Rule 432.G and here to access ICE Futures U.S. Rule 4.02(f).) Typically such transactions are executed non-competitively and may violate other exchange rules too (e.g., pre-execution communications. Click here to access the relevant CME Group Market Regulatory Advisory Notice.)

• Santander Holdings Agrees With Fed to Broad Plan to Address Alleged Governance, Risk Management and Capital Planning Deficiencies: The Board of Governors of the Federal Reserve System entered into an agreement with Santander Holdings USA, Inc., the bank holding company of Santander Bank, N.A. and various non-bank subsidiaries, for Santander Holdings to strengthen its board of directors’ oversight, risk management, capital planning and liquidity risk management. This agreement followed the Fed’s identification of deficiencies in these elements by Santander Holdings during a recent inspection. Under the agreement, Santander Holdings has 60 days to submit a written plan to the Fed outlining its proposed enhancements, and within 10 days of Fed approval, the firm must adopt the plan. Within 30 days of each calendar quarter, Santander Holdings must provide progress reports to the Fed.

• Five Broker-Dealers to Pay Back More Than US $30 Million to Retirement Account Charities Charged Too Much for Mutual Funds: Five broker-dealers agreed to pay back US $30 million to retirement accounts and charities for overcharging them mutual fund sales charges following disciplinary actions filed by the Financial Industry Regulatory Authority. The five broker-dealers are Wells Fargo Advisors, LLC, Wells Fargo Advisors Financial Network, LLC, Raymond James & Associates, Inc., Raymond James Financial Services, Inc. and LPL Financial LLC. According to the disciplinary actions filed against each broker-dealer, from at least July 1, 2009, through December 31, 2014, each firm offered mutual funds for retirement accounts and charities without sales charges, but failed to maintain adequate written supervisory procedures reasonably designed to prevent such entities from being assessed sales charges. As a result, the retirement accounts and charities s were wrongfully assessed sales charges at each of the broker-dealers, said FINRA. All the broker-dealers self-discovered and self-reported their issues to FINRA and were cited by FINRA for their “extraordinary cooperation.”

My View: There were no monetary sanctions other than disgorgement ordered by FINRA in connection with these disciplinary actions – and it appears that each broker-dealer was in the process of returning overcharged fees to the customers in any case after discovering and self-reporting their mistakes. This was a judicious application of FINRA’s discretion and hopefully can be repeated by FINRA and other regulators in other disciplinary proceedings where firms discover regulatory breaches on their own, fix them voluntarily, and make recompense to each detrimentally impacted customer (if any). To also assess civil penalties in such circumstances seems overkill. Unfortunately, inadvertent mistakes happen and responsible firms should be encouraged to correct them – not penalized!

• MF Global Investors Reach US $64.5 Million Settlement With John Corzine and Other MF Global Officers and Directors Related to Firm’s Collapse: John Corzine, the former chairman of the Board of Directors and chief executive officer of MF Global Holdings – the parent of the defunct futures commission merchant, MF Global Inc., and other officers and directors settled a lawsuit by former investors in the firm from May 2010 to November 2011. The investors claimed that MF Global Holdings had made false filings with the Securities and Exchange Commission related to the company’s controls and liquidity prior to the firm’s bankruptcy filing on October 31, 2011. The plaintiffs also claimed that MF Global’s and the defendants’ public statements “materially misstated and failed to disclose the significant liquidity risk posed by the Company’s proprietary investments in Euro sovereign debt through repurchase-to-maturity transactions … — a strategy designed to prop up the Company’s profitability.” (Click here to access the Consolidated Second Amended Securities Class Action Complaint (October 2014).) Subject to the US federal court in NY’s final approval (preliminary approval was granted), the defendants will cause their insurance carriers to pay US $64.5 million to resolve this matter. The plaintiffs previously settled claims against PricewaterhouseCoopers LLP for US $65 million and against underwriters (including Citigroup Global Markets, Inc., Deutsche Bank Securities Inc., Goldman Sachs & Co. and Merrill Lynch, Pierce, Fenner & Smith) for US $74 million. The lead plaintiffs in this action were The Virginia Retirement System and Province of Alberta, Canada. The defendants included, among others, J. Randy MacDonald, former chief financial officer of MF Global from April 2008 through March 2011, and Henri Steenkamp, the firm’s CFO from April through November 2011, in addition to Mr. Corzine. The Commodity Futures Trading Commission 2013 lawsuit against Mr. Corzine and Edith O’Brien, MF Global Inc.’s former assistant treasurer, related to the FCM’s implosion remains pending. 

• ICE to Provide REMIT Reporting for Relevant Wholesale Energy Market Transactions Executed on ICE European Marketplaces: ICE’s four European wholesale natural gas, electricity spot and derivatives markets will assist its clients to meet their obligations to report wholesale energy transactions to the Agency for the Cooperation of Energy Regulators (ACER) as required under the new European Union Regulation on Energy Market Integrity and Transparency (REMIT). Under REMIT such transactions (whether executed or unexecuted orders) must be reported via a registered reporting mechanism beginning October 7. ICE will report relevant transactions on ICE Endex Derivatives B.V., ICE Endex Gas B.V., ICE Endex Spot Ltd., and ICE Futures Europe via ICE Trade Vault Europe. Impacted market participants are required to obtain an ACER code and provide it and/or a legal entity identifier to the exchanges to enable them to submit required information to ACER. Market participants can opt out of the exchanges’ automatic reporting if they want. REMIT, adopted in 2011, was designed to enhance the transparency and stability of European energy markets while prohibiting insider trading and market manipulation.

• FCA Publishes Criteria Used for Formal Enforcement Investigations: The UK Financial Conduct Authority provided insight on when it decides to investigate possible wrongdoing in a published document entitled “Enforcement Referral Criteria.” Because an investigation is an “expensive and resource-intensive option for the subject of the investigation as well as for the FCA,” the agency said it exercises discretion in commencing inquiries “to ensure that in all the circumstances it is the appropriate course of action to take and the best use of our resources.” In determining to proceed, FCA said it considers (1) the weight of the evidence and the “proportionality and impact” of an investigation; (2) the purpose or goal achieved if the agency were to bring an enforcement proceeding; and (3) factors to determine whether the purpose or goal of an enforcement proceeding will likely be met. These factors include whether a proceeding will deter wrongdoers from repeating their infractions; improve behavior and raise standards in the industry; result in proportionate penalties for those charged with serious offenses; and remove malefactors from the industry or impose restrictions, where appropriate.

• G-IB Banned From Business by NFA and Principals Suspended for Charging Too Much to Customers: Edgevalencia, LLC, a guaranteed introducing broker, agreed to be permanently barred from National Futures Association membership in response to NFA charges in an administrative process that the firm assessed excessive commissions on its customers in connection with recommended gold bull-call option spreads, and failed to help their customers mitigate losses on their trades when their positions were losing money. According to NFA, between February 2012 and 2014, ELV had 28 customer accounts, none of which ever achieved a profit. During the period, ELV’s customers lost over US $700,000 while the firm collected over US $225,000 in commissions. Both Stephen Edge and Joseph Valencia, co-owners, principals and associated persons of ELV, agreed to be barred from NFA membership for five years, among other sanctions. The futures commission merchant that guaranteed ELV was not named in the NFA action.

Compliance Weeds: Under guarantee agreements that futures commission merchants are required to enter into with a guaranteed introducing broker to excuse such IB from complying with minimum CFTC capital requirements, a guarantor FCM must agree to be jointly and severally liable with the G-IB for all violations by the G-IB under relevant law “with respect to the solicitation of and transactions” involving all customer accounts introduced by the G-IB. (Click here to access form of guarantee agreement.) Under National Futures Association rule, an FCM is similarly responsible for all “acts and omissions” of a G-IB which violate NFA requirements. (Click here to access NFA Rule 2-23.) To help minimize potential liability, guarantor FCMs must effectively monitor G-IBs like branch offices. Although at least one annual on-site audit is required to be conducted by the guarantor FCM of its G-IB, more frequent inspections and monitoring should be undertaken. (Click here for an NFA interpretive notice regarding the supervision of G-IBs and branch offices.)

And more briefly:

• CFTC Seeks Public Comment on Increased Electricity Position Limits Proposed by ICE Futures U.S.: The Commodity Futures Trading Commission seeks public comment on how to best estimate deliverable supply in connection with certain electricity contracts traded on ICE Futures U.S. IFUS previously had proposed to self-certify an increase in speculative position limits. However, the CFTC rejected IFUS’s self-certification and opened its proposed position limits increase to public scrutiny, claiming that IFUS’s submission “contains an inadequate explanation of the subject of the rule amendment and is potentially inconsistent with [applicable law].” (Click here for further background) Comments will be accepted through August 6.

• NFA Enhances CPO Form PQR and CTA Form PR: The National Futures Association claims to have enhanced required quarter-ending reporting by commodity pool operators on Form PQR and commodity trading advisors on Form PR. The new forms are effective for the quarter ending June 30. CPOs are required to file Form PQR each quarter to provide NFA information about their operations and the operations of pools they operate. CTAs are required to file Form PR each quarter similarly to provide NFA information about themselves, their trading programs, the pool assets it directs and principal-carrying broker relationships, among other information.

• CME Group Updates Block Trade MRAN and TAS Rules: CME Group updated its proposed consolidated Market Regulation Advisory Notice related to block trades to reference certain minimum quantity thresholds for certain intra-commodity futures spreads and combinations (these were not included in a prior version). CME Group also proposed to amend exchange rules related to trading at settlement transactions, and on the New York Mercantile Exchange and the Commodity Exchange, Inc., trading at marker transactions too, and consolidate into one MRAN its current multiple MRANs dealing with these transactions. (TAS transactions permit trades to be executed at the current day’s settlement price or in designated price increments above or below such price. TAM trades are similar to TAS trades and permit trading at a differential to a not-yet-known marker price.) TAS and TAM orders are limited to when they may be placed on Globex and other conditions (e.g., TAS and TAM transactions may not be used to disrupt orderly trading. Also, traders cannot manipulate or attempt to manipulate a settlement or market price to benefit a pending TAS or TAM order). The new TAS and TAM MRAN is anticipated to be effective July 24.

• Basel Committee Updates Leverage Ratio Framework FAQs: The Basel Committee on Banking Supervision updated its Frequently Asked Questions related to the Basel III leverage ratio framework. This framework, initially adopted in January 2014, is designed to encourage banks to maintain sufficient levels of liquidity to respond to market stress situations, and not overly rely on short-term funding to support less liquid assets (click here to access the framework). Among other matters, the new FAQs address netting of securities financing transactions with no explicit ending dates (they are not eligible for Basel III netting) and the treatment of long settled transactions and failed trades (they should be treated according to their accounting classification).

• Public Comment Sought by CFTC for OTC Clearing Hong Kong Request to Be Exempted From Registration as DCO: The OTC Clearing Hong Kong Limited is seeking exemption from the Commodity Futures Trading Commission from a requirement to register as a derivatives clearing organization. The CCP, which clears swaps, claims that it is subject to comparable and comprehensive supervision by a regulator in its home country, as it would be if it were under the oversight of the CFTC. Comments will be accepted through July 23.