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Gary DeWaal's Bridging the Week: November 25 to 29 and December 2, 2013 (Attempted Manipulation, Client Money Breaches, and Money Laundering)

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Published Date : December 02, 2013

Turkey and stuffing might have been the main items on the menus of residents of the United States this past week, but a few litigation and regulatory developments provided supplemental food for thought for those in the financial services industry worldwide. The articles covered in this week's Gary DeWaal's Bridging the Week are:

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CFTC Fines and Permanently Bans Trader and His Trading Firm from Trading CFTC Regulated Crude Oil Contracts

The US Commodity Futures Trading Commission accused Daniel Shak and SHK Risk Management LLC on two days in 2008 of (1) attempting to manipulate the New York Mercantile Exchange's Light Sweet Crude Oil contract, and (2) violating intra day spot moth speculative position limits for these same futures contracts. In response, the respondents settled with the CFTC by agreeing to pay a US $400,000 fine, never to trade in any financial instrument involving crude oil regulated by the CFTC, and not to trade during the closing period on any market regulated by the CFTC for two years.

SHK was a registered commodity pool operator, and Shak was the sole principal and registered associated person of SHK. The CFTC alleged that Shak controlled SHK.

According to the CFTC, respondents attempted their manipulation by acquiring a substantial short position prior to the closing period using a NYMEX trading mechanism by which they agreed to take the day's settlement price (as opposed to the contemporaneous price, as normally is the case) as the price of their trades (i.e., Trading at Settlement or "TAS"). Afterwards, just prior to and during the closing period of trading, respondents purposely bought a large number of futures contracts to attempt to drive up the settlement price, which was based in part on trading during this period. According to the CFTC, the goal was to have the settlement price (and thus the price of respondents' short positions) exceed the price of respondents' long positions. The CFTC viewed this activity as prohibited "banging the close" or "marking the close."

Shak engaged in this strategy personally, while SHK engaged in this strategy through Shak and another SHK trader in the trading account of a commodity pool controlled by the respondents. As part of the settlement, SHK's registration as a CPO and Shak's registration as an AP of a CPO are suspended for two years.

FCA Fines UK Asset Manager for Client Money Breaches

The UK Financial Conduct Authority fined SEI Investments (Europe) Limited UK £900,200 (US $1.47 Million) for violating its client money rules numerous times and ways from November 1, 2007 through October 4, 2012. Specifically, among other things, FCA alleged that SEI failed:

  1. on several occasions to perform an internal client money calculation (termed a "reconciliation") and to ensure that any shortfall or excess identified by the calculation was paid into or withdrawn from the client bank account by the end of the day of the calculation;
  2. to make mandatory notifications of the above-breaches to the FCA:
  3. to use a standard method of internal calculation and as a result did not obtain an auditor approval of this method and provide to FCA a written confirmation of this; and
  4. adequately to train employees with operational responsibility or oversight over client money.

Although no clients' were harmed by SEI's failures, FCA considered the firm's violation serious because, among other matters, the problems continued for such a long period, and were not identified by SEI, but rather by the regulator itself. The problems also occurred during a period when "…there was a high level of awareness in the financial services industry of the importance of adequately protecting client money" as evidenced by the FCA's predecessor's  (i.e., Financial Services Authority) communication to firms regarding its concerns about client money failings.

During the relevant period, SEI maintained an average daily balance of client money of UK £84.3 Million (US $140 Million). According to FCA, SEI provides asset management services principally to professional and retail clients, and holds client money through its sale of fund units. The firm has been authorized and regulated by FCA and its predecessor since May 2000.

My View: At some point all national securities and futures (including swaps) regulators, perhaps under the leadership of IOSCO, will adopt requirements as currently exist for futures brokers in China and the US, that registrants must daily file with an independent third party regulator or self-regulatory organization records of funds owed their customers and simultaneously grant the third party entity direct read only access to depositories' that hold such funds, so that the third party may perform daily automated independent reconciliations. This practice should happen not only for futures brokers, but for all brokers and collective funds' vehicles too. This technique is the most effective way in the first instance to help identify and minimize fraud involving the mishandling of customer funds. (See an interview I gave on the China Futures Margin Monitoring Center, published during December 2012 on JohnLothian News™:  http://www.johnlothiannews.com/2012/12/confirmations-china-gary-dewaal-newedge/--.UptFiJF5u1k.)

And briefly:

Valuable Lessons Learned: This enforcement action should serve as a reminder of why it is ill advised to accept third party payments for an account's payment obligations. Although there may be times when acceptance of such third party payment is warranted, at a minimum, such occasions should be rare, well documented, and authorized in writing by a senior manager. Too often third party payments and receipts are missed red flags of an account being different than what it had been represented to be -- for an example an omnibus account when the account was supposed to be an account on behalf of a single individual.

For further information, see:

ASIC's New Surveillance System:
http://www.asic.gov.au/asic/asic.nsf/byheadline/13-316MR+ASIC%27s+next+generation+market+surveillance+system+commences?openDocument
CFTC v. Daniel Shak and SHK Risk Management:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfshakorder112513.pdf
CFTC No-Action Letter re: Non-US Swap Dealers:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-71.pdf
ESMA Guidance re: EFTs and UCITS:
http://www.esma.europa.eu/system/files/2013-1547_qa_on_guidelines_on_etfs_and_other_ucits_issues.pdf
FCA v. SEI:
http://www.fca.org.uk/static/documents/final-notices/sei-investments-europe-limited.pdf
Germany High Frequency Trading Act:
EUREX High Frequency Trading Report:
https://www.eurexchange.com/blob/exchange-en/4060-721152/721142/2/data/er13255e.pdf
BAFIN Q&A re: the HFT Act:
http://www.bafin.de/EN/DataDocuments/FAQ/HFT-Gesetz/hft-gesetz_node.html
IOSCO Letter to EC re: QCCPs:
http://www.iosco.org/committees/aprc/pdf/20131122_APRC_letter_to_EU.pdf
SFC v. Cho and Ju:
http://www.sfc.hk/web/files/ER/PDF/13PR113_statement.pdf

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 30, 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.

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