This past week the Chicago Mercantile Exchange issued its long awaited final rules addressing so-called transitory EFRPs, while the European Parliament passed important measures dealing with trading venues, algorithmic trading and commodity position limits, among other topics. In addition, once again, the judge in NYC hearing many of the private lawsuits involving MF Global issued a ruling that helped narrow the focus of one of the many very protracted and contentious litigations.
As a result, the following stories are covered this week on Gary DeWaal’s Bridging the Week:
- Many Defendants Are Dismissed from MF Global Individual Customer Action; Five, including Corzine, Remain;
- CME Amends EFRP Rules; Prohibits All Transitory EFRPs by Name, but Permits Equivalent Transactions for Certain Inventory Financing and FX;
- MIFID II and MIFIR Passed by European Parliament; Greater Controls on Trading Venues and Algorithmic Trading, as well as Position Limits in the EU for the First Time Are Likely;
- SEC Answers Frequently Asked Questions regarding Risk Controls for Market Access (includes Compliance Weeds and High Frequency Trading);
- SEC Proposes Recordkeeping and Reporting Requirements for Security-Based Swap Dealers;
- SEC Begins Assessment of Broker Dealers’ Cyber Security Preparedness (includes Compliance Weeds);
- SEC Charges Investment Adviser Total Wealth Management and its CEO for Conflicts of Interest; Current and Former CCOs Also Named;
- BIS Issues Basel III Q&A regarding Liquidity Coverage Ratio; Final Standards for Measuring and Controlling Large Exposures Are Also Released;
- CME Revises Certain Deadlines regarding Large Trader Reporting (includes Compliance Weeds);
- ESMA Seeks Comments on Margin Proposals for Non-cleared OTC Derivatives; and more.
This week only, information regarding some particularly helpful charities to consider for donations is also included in the Totally Aside section near the end of this blog. Please take a look and consider helping out!
Many Defendants Are Dismissed from MF Global Individual Customer Action; Five, including Corzine, Remain
Last week multiple defendants, including private investment firm JC Flowers, were dismissed entirely from an individual customer action arising from the collapse of MF Global in October 2011. Five defendants, including senior officers Jon Corzine, Bradley Abelow and Henri Steenkamp had some allegations dismissed but remain in the litigation. Generally, the plaintiff, Sapere CTA Fund L.P., claimed that all the defendants had violated various provisions of the Commodity Exchange Act and New York State statutory and common law.
Just a few weeks ago, the same judge in this matter, the Hon. Victor Marrero of the Federal District Court in New York City, issued a non-holds barred decision dismissing some defendants entirely, but authorizing proceeding against at least some other defendants in part, in connection with a customer class action lawsuit (“Commodities Customer Action") involving the firm (for details of this other matter, see “Some Defendants and Former Accounting Firm Dismissed in Private Class Action Lawsuit Involving Customers of MF Global; Not John Corzine and Certain Other Former Officers,” within Bridging the Week February 10 to 14, 2014, by clicking Here). Around the same time, the MF Global Inc. Trustee announced he would make a full distribution to all of the firm's prior customers (see the article on this website, "MF Global Inc. Trustee Announces Final 100% Distribution to Customers" by clicking Here).
The plaintiff in this action previously had an account at MF Global for trading domestic and foreign futures and related options. Sapere’s complaint incorporated many of the same allegations addressed in the Commodities Customer Action, but raised new claims regarding fraud and for violation of New York law, as well as included additional defendants.
JC Flowers was named in the Sapere’s complaint, among other reasons, under the theory that it was “…negligent in selecting, supervising, or otherwise controlling” Corzine and therefore responsible for Corzine’s alleged wrongful conduct. However the Court dismissed these charges entirely on the grounds that the plaintiff failed adequately to plead that Corzine “had any propensity to commit any of his alleged misconduct, much less that JCF know of any such propensity.” The Court also rejected the plaintiff’s claim that Corzine acted as JCF’s agent “...within the scope of [Corzine’s] authority in committing the wrong acts that harmed Sapere.”
The Court completely discharged from this matter: David Bolger, Eileen Fusco, David Gelber, Martin Glynn, Edward Goldberg, David Schamis, and Robert Sloan, all previously independent directors; Michael Stockman, former Chief Risk Officer; and Dennis Klejna, former Deputy General Counsel. The court maintained as parties in the litigation: Corzine, Abelow, and Steenkamp, the three top former senior officers; Edith O’Brien, former Assistant Treasurer and David Dunne, former Treasurer.
- CME Amends EFRP Rules; Prohibits All Transitory EFRPs by Name, but Permits Equivalent Transactions for Certain Inventory Financing and FX: The CME Group on April 14, 2014, announced a rule amendment that will ban all transitory Exchange of Futures for Related Positions ("EFRPs"). However, without calling such transactions “transitory,” CME will permit what effectively are equivalent to transitory EFRPs in connection with certain inventory financing, as well as foreign currency futures. In addition, as part of its Market Regulation Advisory announcing its rule change, CME issued helpful Frequently Asked Questions (and Answers) related to EFRPs. The new rule is effective June 2, 2014. For more details, see the article on this website, “Lord Voldemort Hovers over the Futures Industry: CME Prohibits All Transitory Exchange of Futures for Related Positions By Name,” by clicking Here.
- MIFID II and MIFIR Passed by European Parliament; Greater Controls on Trading Venues and Algorithmic Trading, as well as Position Limits in the EU for the First Time Are Likely: The European Parliament ("EP") approved new measures on April 15, 2014, that, once finally implemented, will increase regulation of European financial markets, including imposing new requirements on certain algorithmic trading. The new measures, known as the Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR), will impact investment firms; certain large traders on stock, financial and commodity derivative markets; and trading venues, among others. The measures potentially will have a cross-border impact. MiFID II and MIFIR are still subject to additional legislative steps prior to formal adoption, and implementation is not expected until 2016 because of these steps and other requirements too. For more details, see the article on this website, “European Parliament Takes Further Step to Increase Requirements for Trading Venues and Algorithmic Trading, and to Introduce Commodity Position Limits in Europe,” by clicking Here.
- SEC Answers Frequently Asked Questions regarding Risk Controls for Market Access: The Security and Exchange Commission’s Division of Trading and Markets issued helpful answers to frequently asked questions related to its Market Access Regulation (“MAR”). This regulation, adopted in 2010, generally requires a broker or dealer with access to trading securities directly on an exchange or alternative trading system to have procedures and controls that limits their financial exposure as a result of such access, and ensures compliance with all applicable regulatory requirements. MAR especially applies to a broker that provides direct market access to certain customers (for more, see SEC Regulation 15c3-5: http://www.sec.gov/rules/final/2010/34-63241.pdf). In its Q&A published on April 15, 2014, the SEC provides a concise summary of the relevant regulation as well as answer to 19 questions regarding it. These questions include: does MAR apply to quotes (yes, MAR applies to all orders, including market maker quotes); and security futures products (yes, for broker dealers that trade security futures on an exchange or alternative trading system but not for Notice-registered futures broker dealers); and may a broker dealer that provides access to an affiliate broker dealer grant the affiliate control over its risk management controls and supervisory procedures (no).
Compliance Weeds, High Frequency Trading: Active debate regarding low latency trading shows no signs of abating although a few weeks have now passed since the release of Michael Lewis’ “Flash Boys.” Moreover, last week the media reported that at least six high frequency trading firms were served with subpoenas by the NY Attorney General to determine whether any of the firms have an illicit advantage over other traders (see, e.g., http://online.wsj.com/news/articles/SB10001424052702304626304579505931086501344?mg=reno64-wsj). The current environment should prompt firms with access to trading securities directly on an exchange or ATS to double check that (1) they have robust policies and procedures that cover all applicable regulatory requirements; (2) their employees routinely are reminded about these internal rules; (3) they follow their internal rules; and (4) they routinely conduct adequate surveillance to ensure their ongoing compliance. Unfortunately, given the high political temperature, even de minimis violations may give rise to enforcement actions to generate public approbation.
- SEC Proposes Recordkeeping and Reporting Requirements for Security-Based Swap Dealers: The SEC last week proposed (1) recordkeeping, reporting and notification requirements for security-based swap dealers (“SBSDs) and major security-based swap participants (“MSBSPs); (2) additional recordkeeping obligations for broker dealers that are not dually registered as SBSDs or MSBSPs to account for their security-based swap business; and (3) so-called “securities count requirements” for certain SBSDs. (Typically most broker dealers must examine and count all securities they hold or which are in transfer, transit, or similarly subject to its control on a quarterly basis; for background, see: http://www.finra.org/web/groups/industry/@ip/@reg/@rules/documents/interpretationsfor/p037778.pdf.) According to the Commission, “[t]he broker-dealer recordkeeping, reporting, notification and security count requirements served as the model for the proposals because SBSDs and MSBSPs are expected to operate in financial markets and effect financial transactions that are similar to the financial markets in which broker-dealers operate and the financial transactions that broker-dealers effect.” Previously, the SEC recommended the adoption of net capital requirements for stand-alone SBSDs; now the SEC is also proposing certain capital charge provisions that it says it inadvertently failed to include in its prior recommendations. These are equivalent to capital charges Broker Dealers currently must take in connection with certain securities’ reconciliation issues. The SEC says its staff consulted with staff of the Commodity Futures Trading Commission in drafting these proposals. Comments on the SEC’s proposals are due within 60 days after the Agency’s proposal is officially published in the Federal Register.
- SEC Begins Assessment of Broker Dealers’ Cyber Security Preparedness: Last week, the SEC’s Office of Compliance Inspections and Examinations provided additional information in a Risk Alert regarding its previously announced initiative to assess cyber security preparedness. OCIE also disclosed it will conduct examinations of more than 50 broker-dealers and investment advisers and concentrate on the following broad topics, among others: (1) identification of risks/cyber security governance; (2) protection of firm networks and information; (3) risks associated with remote customer access and funds transfer requests; (4) risks associated with vendors and other third parties; and (5) detection of unauthorized activity. OCIE provided a detailed list of items it will be reviewing at the selected firms in an Appendix to its Risk Alert.
Compliance Weeds: Every firm in the financial services industry should be augmenting its controls around cyber security, its ability to detect actual and potential breaches, and its periodic reviews of these controls and detection abilities. OCIE’s schedule of items for review in its Risk Alert provides a useful checklist even for firms not under the SEC’s jurisdiction and SEC-overseen firms not selected for review, let alone firms that are targeted.
- SEC Charges Investment Adviser Total Wealth Management and its CEO for Conflicts of Interest: The SEC filed charges against an investment advisory firm, Total Wealth Management Inc., as well as Jacob Keith Cooper, its CEO, and its current and former Chief Compliance Officers claiming they misled investors and breached their fiduciary duty to customers. The current CCO, Nathan McNamee, is also the firm’s president, while the former CCO, Douglas Shoemaker, is also the firm’s co-founder. In its complaint in an administrative proceeding before the Agency, The SEC's Division of Enforcement claims that all the respondents engaged in “malfeasance” in connection with an unregistered fund, the Altus Capital Opportunity Fund and a series of fund of funds known as the “Altus Portfolio Series.” The Agency specifically alleged that, since at least 2009, (1) Total Wealth and Cooper engaged in a fraudulent scheme to collect and conceal their receipt of revenue sharing fees from other investment funds that they recommended to their clients; (2) all the respondents received these undisclosed fees that were routed through entities created to mask their receipt; and (3) Total Wealth failed to obtain annual audits from a qualified independent public accountant, as required by rule. In all of Total Wealth’s offering memoranda and certain filings with the Commission from May 2010, the company disclosed it “may” receive revenue sharing fees, when in fact it already was receiving such fees, says the SEC. According to the Agency, for 2010, for example, 92% of Altus Capital Fund’s investments were with funds with revenue sharing agreements. The SEC seeks a cease and desist order, disgorgement and fines.
- BIS Issues Basel III Q&A regarding Liquidity Coverage Ratio; Final Standards for Measuring and Controlling Large Exposures Also Released: Last week the Basel Committee on Banking Supervision issued Questions and Answers related to its January 2013 publication entitled the “Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools” (see: https://www.bis.org/publ/bcbs238.pdf). Certain Q&A’s relate to banks' obligations under Basel III in connection with their relationships with central clearing houses. Separately, the Committee issued standards for measuring and controlling banks’ large exposures. The objective, according to the Committee, is to limit the maximum loss a bank would sustain in the event of sudden failure of a material counterparty or related counterparties.
- CME Revises Certain Deadlines regarding Large Trader Reporting: The CME issued a Market Regulation Advisory Notice last week reminding clearing members, omnibus accounts and foreign brokers of their obligation to report specified information regarding the account’s owner(s) and controller(s) to its Market Regulation Department within three days of the first day that a trading account first has a reportable level of positions. In addition, for so-called “reportable accounts,” clearing firms and omnibus accounts are obligated to accurately report open interest, large trader positions and if relevant, long positions for delivery by strict deadlines. (Information regarding CME Reportable levels can be found at: http://www.cmegroup.com/market-regulation/position-limits/.)
Compliance Weeds: Operations staff dealing with Open Interest and Large Trader submissions must comply not only with deadlines for initial submissions, but for subsequent adjustments too. Accurate mapping of customer accounts through omnibus accounts within large group organization with numerous futures subsidiaries is critical to ensure that open interest for specific customers and omnibus accounts are aligned in order to avoid inconsistent and inaccurate reporting.
- ESMA Seeks Comments on Margin Proposals for Non-cleared OTC Derivatives: The European Securities and Market Authority formally sought comment on its proposed Regulatory Technical Standards related to the minimum amount of initial and variation margin to be required in connection with non-cleared over the counter derivatives, as well as the methodologies to compute such amounts. ESMA’s proposal also addresses acceptable collateral that can be used to satisfy margin obligations as well as capital haircuts to reflect market and foreign exchange volatility, among other matters. ESMA also proposes that margin requirements (1) be different for at least some products (e.g., not requiring initial margin for physically-settled FX swaps), and be implemented in a “proportionate manner” (e.g., requiring initial margin only for the largest counterparties at the beginning). Comments are due by July 14, 2014.
Totally Aside (good causes):
- Doctors without Borders (Medecins sans Frontieres): I try to support Doctors without Borders as much as I can because I think they do valuable work helping the very sick and injured throughout the globe, including in many infamous dangerous spots (if you are not familiar with this charity, check out: http://www.doctorswithoutborders.org). On May 4, I will be bike riding on their behalf for 40+ miles through the streets of New York City to help raise funds for them. If you support their outstanding efforts, please consider making a contribution at: https://events.doctorswithoutborders.org/index.cfm?fuseaction=donate.start&destination=P&participantID=1886.
- Breakthrough NY: Another commendable charity is Breakthrough NY which is NYC-based, and helps motivated low-income students prepare for college so they can transform their lives (if you are not familiar with this charity, check out: http://www.btny.org). On April 29, 2014, this group will honor Bonnie Litt, who is the organization’s Vice Chair, a Managing Director at Goldman Sachs and a legend in the exchange-traded derivatives industry. You can help out this organization and honor Bonnie by making a contribution at: https://breakthroughnewyork.thankyou4caring.org/smarter.
For additional information, see:
FAQ re: Liquidity Coverage Ratio:
Measuring and Controlling Large Exposures:
CME Position Adjustments:
ESMA Consults on Non-Cleared Swaps Margin:
MF Global Individual Customer Action Motion:
SEC Cyber Security Preparedness Initiative:
SEC Market Access Q&A:
SEC Proposed Recordkeeping and Reporting Rules for Security Based Swap Dealers:
SEC v. Total Wealth Management, Jacob Cooper:
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 April 19, 2014, 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 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.
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