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Gary DeWaal's Bridging the Week: November 4 to 8 and 11, 2013

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Published Date : November 11, 2013

It was fitting that the 29^th annual Futures Industry Association Expo occurred last week following the completion of the New York City Marathon on November 3. Like the many runners who staggered across the finish line in NYC's Central Park the prior Sunday after their grueling 26.2 mile race, attendees at the FIA's Chicago conference seemed very weary and resigned to accept that it is now past time to argue any more about the merits of Title VII of Dodd Frank and the various regulations of the Commodity Futures Trading Commission to implement it. Instead, now is the time to deal with the reality: soon the first swaps contracts will be designated as made available to trade, and the full architecture of the new regulatory environment mostly will be installed. Industry participants either will survive in the new world or not.

Efforts now must be directed to finalizing the implementation of the new regulatory architecture, navigating the challenging capital and liquidity rules proposed by international bank regulators (and an unexpected bias by the Federal Reserve Board against clearing houses accepting US Treasury securities), and adapting infrastructure and personnel to distinguish each player from its competitors.
But on the landscape still remains the challenge next year of the roll out of EMIR in Europe and other central clearing initiatives in each of the other of the G-20 jurisdictions.

No wonder FIA Expo participants seemed so weary: the end of their marathon constituted just a short pause before the start of the longer triathlon on the horizon!
However, in addition to the events at FIA Expo, there were many noteworthy regulatory news items last week that are covered on this week's Bridging the Week, including:

the CFTC proposes new position limit and aggregation rules;
the CFTC commences three enforcement actions on diverse themes: customer protection (AlphaMetrix), alleged manipulation (Don Wilson and DRW), and alleged speculative position limit violations (James Yadgir);
MF Global customers to be paid in full;
ESMA approves four trade repositories; reporting under EMIR to begin February 12, 2014;
FCA comments on LME Approved Warehouses' Delivery Delays;
FINRA fines two firms (TD Ameritrade and SG Americas Securities) US $1.8 Million for large options position reporting and supervisory infractions;
ICE Clear US will increase guaranty fund size and disallow use of money market mutual funds;
the Singapore Exchange proposes changes to its default fund structure and OTC financials' default management process;
SAC Capital Management pleads guilty to criminal insider trading charges; and more.

Video Overview:

Article Overview:

CFTC Proposes New Position Limit Rules:

Last week the US Commodity Futures Trading Commission proposed new rules related to derivatives speculative position limits, addressing (1) absolute levels regarding 28 so-called "core referenced futures contracts" involving various agricultural commodities, energy products and metals, (2) aggregation of related accounts, and (3) what constitutes bona fide hedging positions. The proposed rules are meant to replace final rules adopted by the CFTC on October 18, 2011, that were vacated by a US District Court during September 2012.

Each CFTC proposed speculative limit limit applies to the total of a trader's futures and options, and economically equivalent swaps, across all trading venues (and OTC), to the extent that the derivative products are under the jurisdiction of the CFTC. They do not apply to financial instruments under the jurisdiction of the SEC, such as exchange-traded funds. Different limits will apply to spot month and non-spot month positions. Ultimately the Commission will expand the list of core referenced futures contracts in physical commodities.

Spot month limits generally are proposed to be set at 25% of estimated deliverable supply, and be applied separately to physical delivery and cash-settled referenced contracts. However a trader only transacting in cash-settled contracts will be eligible for an exemption to trade up to five times the cash-settled spot month limit.

Non-spot month limits generally are proposed to be set as a function of open interest using a 10/2.5 formula – 10% of a contract's first 25,000 of open interest plus 2.5% of the remainder. There will be single-month and all-months-combined limits.

There will be exemptions from the speculative position limits solely for bona fide hedging positions. In general, all bona fide hedge positions must be to offset price risks "incidental to commercial cash operations" and must be acquired and liquidated in "an orderly manner in accordance with sound commercial practices."

The proposed rules also address aggregation requirements for affiliated entities but permit exemptions, among other circumstances, where ownership

is not greater than 50% in an affiliate whose trading is independently controlled;
is greater than 50% in a non-consolidated entity whose trading is independently controlled and where the entity's positions either are bona-fide hedges or do not exceed 20% of any position limit; and
results from broker dealer activities as a dealer.

Comments will be due on the new proposed rules by 60 days after their publication in the Federal Register.

(A more complete summary of these new proposed was published on this website on November 5: http://www.garydewaalandassociates.com/?p=1347.)

CFTC Commences Three Litigations on Diverse Themes: Customer Protection, Alleged Manipulation, and Alleged Speculative Limits Violations

Last week the CFTC brought three enforcement actions on diverse themes: one related to customer protection, one related to alleged manipulation and the third related to alleged speculative limits violations.

AlphaMetrix

In the first matter, following the Member Responsibility Action filed by the National Futures Association on October 21, the CFTC on November 4 filed an enforcement action against AlphaMetrix LLC (AlphaMetrix) in the US District Court in Chicago 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 in the pools. Instead the Firm transferred the fees to the parent company of the firm, AlphaMetrix Group, which allegedly was experiencing financial difficulty.

As of August 21, 2013, AlphaMetrix operated 90 separate funds with over US $700 Million under management.

Separately, AlphaMetrix consented to a CFTC-requested Order requiring it to return at least 95% of all of its operated funds' assets to its customers within 15 days of the formal entry of the Court Order as well as other prophylactic relief.

(For a discussion of the NFA's MRA against AlphaMetrix, view, see Bridging the Week – October 21 to 25 and 28: http://www.garydewaalandassociates.com/?p=1229.)

Don Wilson and DRW

In the second matter, 0n November 6, seemingly timed for the opening of FIA Expo, the CFTC commenced an enforcement action against DRW Investments LLC and its principal, Don Wilson, in the US District Court in NY for the alleged manipulation of the settlement prices of the IDEX USD Three-Month Interest Rate Swap Futures Contract listed on the NASDAQ OMX Futures Exchange and cleared by the International Derivatives Clearing House.

According to the Commission, DRW established a long position in the Three Month Contract beginning in August 2010. Afterwards, beginning in December 2010, the respondents placed bids "that DRW knew would never be accepted" artificially to influence the settlement prices in their favor during the 15-minute period that most influenced settlement prices on at least 118 trading days, in a "banging the close" type-scheme.

Previously, on September 21, the respondents had filed a lawsuit against the CFTC, in the US District Court in Chicago, seeking to prohibit the CFTC to file an enforcement action against them. In that prior action, the respondents acknowledged many of the facts alleged by the CFTC in its current enforcement action. However, the respondents argued that IDCH had no obligation in its rules to reference DRW's orders to calculate settlement prices, but in any case, its orders (1) reflected its analysis of what it perceived to be a flawed contract (i.e., the Three Month Contract was not economically equivalent to a comparable uncleared three month swap); (2) were orders it was willing to execute; and (3) were posted for sufficient time for an execution to occur.

(For a discussion of Don Wilson's and DRW's lawsuit against the CFTC, see Bridging the Week – September 16 to 20 and 23: http://www.garydewaalandassociates.com/?p=954)

James Yadgir

In the third matter, on November 5, the CFTC filed an enforcement acting naming James Yadgir for violating speculative position limits of the Chicago Mercantile Exchange in connection with his trading of live cattle futures contracts in April 2011 and feeder cattle futures contracts during May 2012.

In the Complaint, the CFTC alleges that Yadgir violated the Live Cattle spot limit on one day, on April 6, 2011, through positions in two accounts. He reduced his positions on April 7, and was issued a warning letter by the CME on September 19, 2011, for this offense. He is alleged to have violated the spot limit for Feeder Cattle on two days, May 23-24, 2012, including on the second day by .152 of one contract.

And briefly:

MF Global Customers To Be Paid in Full. The Bankruptcy Court hearing the MF Global bankruptcy matter approved a motion to reimburse customers 100% of their allowed claims -- both in connection with their US and non-US trading. This required the judge to approve a loan of funds from the general property of the debtor (i.e., funds that never were part of customer protected funds).

ESMA Approves Four Trade Repositories; Reporting to begin February 12, 2014: The European Securities and Markets Authority announced that mandatory trade reporting under the European Market Infrastructure Regulation will be effective February 12, 2014. In connection with this, ESMA approved four trade repositories, including DTCC Derivatives Repository Ltd and UnaVista Ltd. located in London. The registration of other trade repositories is pending.
FINRA Fines Two Firms US $1.8 Million for Large Options Position Reporting and Supervisory Infractions: SG Americas Securities, Inc. was fined US $675,000 and TD Ameritrade Clearing, Inc. was fined US $1.15 Million related to their failure to report or accurately report various large option positions (LOPR) as well as for not having adequate supervisory oversight. SG America's LOPR violations occurred during various intervals from December 2007 through January 2013, while TD Ameritrade's violations happened from May 2007 through May 2013.
ICE Clear US Will Increase Guaranty Fund Size and Disallow Use of Money Market Mutual Funds: In order to retain its status as a so-called Qualified Central Counterparty, ICE Clear US will increase the size of its guaranty fund from US $300 Million to US $450 Million as of January 1, 2014, to cover the potential default of two clearing members with the largest aggregate credit exposure in extreme but plausible market conditions. This will require an increase in the amount funded by clearing members to US $400 Million, as ICE will cover US $50 Million itself. Also, as of January 1, clearing members can no longer post money market mutual funds to satisfy their original margin or guaranty fund requirements. Previously ICE announced that as of the new year, at least 50% of a member's guaranty fund requirement must be posted in cash. (Members pay Guaranty fund deposits as a function of their open interest and volume. For notice of ICE Clear's prior announcement regarding guaranty fund deposits and cash, see Bridging the Week – September 16 to 20 and 23: http://www.garydewaalandassociates.com/?p=954.)
FCA Issues Statement Regarding LME Warehouses: The UK Financial Conduct Authority last week stated its expectation that the London Metal Exchange ensure that its approved warehouses "provide effective and efficient services for the receipt, holding, and delivery of metal related to the trading of LME contracts, to support the LME in meeting its regulatory obligations as a recognised investment exchange." This statement was issued following recent criticism regarding delivery delays from LME approved warehouses. According to the FCA, "[t]he LME has recently instigated a number of initiatives in relation to its warehousing arrangements, to manage potential conflicts of interest arising from the ownership of warehouses and to reduce queue lengths." The FCA indicated that while it has no direct regulatory authority over LME warehouses, it will continue to monitor developments.
SEC Brings an Enforcement Action for Subprime Fraud: The US Securities and Exchange Commission brought and settled an enforcement action against RBS Securities Inc. for allegedly misleading investors in connection with a 2007 subprime residential mortgage-backed security offering. It mislead investors, claimed the SEC, when the Firm said that loans underlying the security "generally" met the lender's underwriting guidelines, when in fact, 30% of the loans did not. RBS settled this matter by paying over US $150 Million, including US $80.3 Million and pre-judgment interest to its former investors, and a civil fine to the SEC.

SGX Proposes Changes to its Default Fund Structure and OTC Financials Default Management Process: The Singapore Exchange Derivatives Clearing Limit proposes changes to the waterfall related to its clearing fund structure, and its procedures for managing the default of a member who clears over the counter financial derivatives. First SGX proposes to continue to contribute at least 25% of the Clearing Fund at all times. However, in an effort to be more equitable to clearing members that do not clear all contract classes, SGX proposes to apply 15% before member contributions in the case of a first member default, and the second 10% before a subsequent member default in a different contract class. Also instead of relying on compulsory assignment of a defaulted clearing member's OTCF position to all the bidders in the case of an unsuccessful auction, the SGX proposes to utilize each member's Clearing Fund contributions to cover losses in relation to the member's distance from the successful bid. Comments are due by November 27.
SAC Capital Management Pleads Guilty to Criminal Insider Trading Charges Brought by the US Attorney. Various SAC Capital Management companies pled guilty last week to charges of securities and wire fraud in connection with various allegations of insider trading by various employees from 1999 through at least 2010. The allegations relate to trading in securities of more than 20 public companies. According to the US Attorney, various corporate failures led to the violations, including hiring employees with "networks of public company insiders;" failure to question employees about trades that seemed to be based on inside information; and failure to maintain effective compliance programs to prevent or detect problematic such trades. As part of its plea, the SAC companies agreed to pay a fine of US $1.184 Billion in addition to US $616 Million previously paid to the SEC in connection with similar civil charges. The terms of this settlement are subject to approval by the US District Court which apparently will not happen prior to March 2014, if at all.

For further information, see:

CFTC v. AlphaMetrix
Complaint:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfalphametrixcomplaint110413.pdf
Order:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfalphametrixorder110513.pdf
CFTC v. Don Wilson and DRW:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfdrwcomplaint110613.pdf
(Note: in the Complaint, Newedge USA LLC is identified as a voice broker for DRW for the Three Month Contract during the relevant time. Gary DeWaal was Group General Counsel of Newedge during this period.)
CFTC: Proposed Aggregation and Position Limit Rules:
Aggregation:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister110513.pdf
Position Limits:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister110513c.pdf

CFTC v. Yadgir:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfyadgircomplaint110513.pdf
ESMA Trade Repository Approval:
http://www.esma.europa.eu/content/ESMA-registers-trade-repositories
FCA Statement regarding LME Approved Warehouses:
http://www.fca.org.uk/news/firms/statement-london-metal-exchange
FINRA Reporting and Supervisory Enforcement Actions:
TD Ameritrade:
http://disciplinaryactions.finra.org/viewDocument.aspx?DocNb=34594
SG Americas Securities:
http://disciplinaryactions.finra.org/viewdocument.aspx?DocNB=34593
ICE Clear US: Notice Regarding Guaranty Funds and Money Market Funds:
https://www.theice.com/publicdocs/clear_us/notices/13-106_SubPartC_Changes.pdf
MF Global Payment:
http://dm.epiq11.com/MFG/Project--Section2_46
SAC Management Companies Criminal Stipulation, Order of Settlement and Related Documents:
http://www.justice.gov/usao/nys/pressreleases/November13/SACCapitalPleaPR/U.S.%20v.%20SAC%20Capital%20Advisors%20LLP,%20et%20al.%20Cover%20Ltr,%20Plea%20Agt,%20and%20Stip.pdf
SEC v. RBS:
http://www.sec.gov/litigation/complaints/2013/comp-pr2013-239.pdf
SGX: Default Fund Structure and OTC Financials Default Management Proposed Changes:
http://www.sgx.com/wps/wcm/connect/fe202f8041ba59348733f7935b097956/Consultation%2BPaper_Refinements%2Bto%2BClearing%2BFund%2BStructure.pdf?MOD=AJPERES

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of November 9, 2013, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.

Gary DeWaal's Bridging the Week: November 4 to 8 and 11, 2013

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