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Gary DeWaal's Bridging the Week: March 17 to 21 and 24, 2014 (Manipulation and Fraud: More than "I know it when I see it?")

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Published Date : March 24, 2014

The Commodity Futures Trading Commission again warned the financial services industry how broadly it construes and is willing to apply its new anti-manipulation and anti-fraud authority in an enforcement action against an employee of an introducing broker who engaged in unauthorized trading of two customers’ accounts and endeavored to hide his activities from the customers and his employer. As a result, the following matters are covered on this week’s Gary DeWaal’s Bridging the Week:

CFTC Sues IB Employee for Unauthorized Trading and Concealment; Charges Violation of New Anti-Manipulation Law and Rule (includes My View);
The UK FCA Bans and Fines a Trader for Attempting to Manipulate a UK Government Bond in a Proposed Transaction with the Bank of England;
CFTC Extends No-Action Relief to Swaps Executed on EU Regulated Multilateral Trading Facilities;
SEC Charges Managing Clerk at a Major Law Firm and a Stockbroker with Insider Trading;
ICE Clear Credit Proposes Rules to Implement LSOC with Excess Model: ICE Clear Europe Asks SEC for Approval of Rules Related to Non-Default Losses;
Through Disciplinary Actions, CME Reminds Members (Again) of the Importance of Complying with Rules Regarding Position Limits (Even Intraday) and EFRPs;
Singapore MAS Will Regulate Virtual Currency Intermediaries for Money Laundering Risks;
FINRA and BATS Fine Citigroup Global Markets for Short Selling Prior to Participating in Five Public Offerings; and more.

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CFTC Sues IB Employee for Unauthorized Trading and Concealment; Charges Violation of New Anti-Manipulation Law and Rule

In a preview of how broadly the Commodity Futures Trading Commission’s Division of Enforcement may employ its newly gotten anti-manipulation and anti-fraud authority under Dodd Frank, the Commission filed a lawsuit last week against an employee of an introducing broker who engaged in unauthorized trading in two clients’ accounts, as well as endeavored to conceal the illicit trading from the customers as well as the IB’s principals. The CFTC relied on traditional fraud charges in bringing in this action, but also threw in its new anti-manipulation and anti-fraud authority for good measure too. According to the CFTC’s Complaint filed in a Federal District Court in Ohio, Bradley Miklovich, an associated person of Rice Investment Company, a guaranteed introducing broker, traded without authorization through three customer accounts of one customer, and the single account of another customer from July 23 through 30, 2013.

Because during this time Mr. Miklovich temporarily assumed certain reconciliation functions on behalf of an employee on vacation who ordinarily performed these tasks, he allegedly was able to falsify both the reconciliations viewed by Rice’s principals, as well as daily account summaries viewed by one of Rice’s customers. Rice did not become aware of Mr. Miklovich’s unauthorized trades, according to the Complaint, until the morning of July 31, 2013, when it was advised by the FCM carrying the relevant accounts that one of Rice’s customers required additional margin or would be liquidated.

In response, the CFTC charged Mr. Miklovich with fraud, unauthorized trading and making false statements, under traditional provisions of the Commodity Exchange Act and CFTC Regulations (i.e., CEA §§4b(a) and 4c(b) and Commission Regulations 33.10 and 166.2). However, the CFTC also charged Mr. Miklovich under its newly gotten anti-manipulation authority under Dodd Frank, as well as its recently adopted anti-manipulation and anti-fraud rule (i.e., CEA §6(c)(1) and Commission Regulation 180.1(a)). The Commission claimed that Mr. Miklovich employed,

“…manipulative or deceptive devices or contrivances in connection with commodities for future delivery on or subject to the rules of a registered entity, including: i) knowingly effecting commodity futures transactions in Rice's customers' non-discretionary accounts without obtaining their authorization to effect those transactions; ii) willfully misrepresenting and omitting material facts, including but not limited to, the commodity futures transactions he effected, the profits and losses incurred by those transactions, and the magnitude of the risks to which he subjected the customers' accounts; iii) knowingly and willfully making false daily accounts statements for [one] Customer[‘s] commodity trading accounts at Rice and causing those false account statements to be sent to [the] Customer…; and iv) knowingly and willfully preparing false Rice reconciliations.”

CFTC Rule 180.1 prohibits any person from intentionally or recklessly engaging in deceptive or manipulative practices in connection with swaps, cash commodity contracts or regulated futures (or related options contracts) without regard to price or market effect. (For a detailed discussion of the CFTC’s new anti-manipulative authority, see “My View: Reflections on the JP Morgan's Settlements -- Human Nature, Internal Controls, and the CFTC's Broad New Anti-Manipulation Authority,” at http://www.garydewaalandassociates.com/?p=934.)

The CFTC did not charge either the Introducing Broker, who paid its guaranteeing FCM the majority of its customers’ losses, or its guaranteeing FCM in connection with this matter. According to NFA Basic™, Rice is guaranteed by ADM Investor Services Inc. The Commission seeks an injunction and damages against Mr. Miklovich as well as an order requiring Mr. Miklovich to make Rice whole, among other remedies.

My View: Coming just a few months after the CFTC’s lawsuit and settlement involving the so-called London Whale (see article “US CFTC Files and Settles Charges against JP Morgan Chase Bank Employing Its New Anti-Manipulation Authority Related to Certain of the Bank’s London Whale Trading” at http://www.garydewaalandassociates.com/?p=1179), this new enforcement action demonstrates how broadly and readily the CFTC’s Division of Enforcement is prepared to use its newly gotten anti-manipulation and anti-fraud authority under Dodd Frank, as well as its new Rule 180.1. In the JP Morgan London Whale case, the Commission solely charged violation of these provisions; here, at least, it coupled a charge regarding violations of these provisions with other more traditional sections of applicable law and regulations. The industry can only hope that the CFTC’s Division of Enforcement uses these powerful provisions judiciously and considers to provide sufficient guidance so that the industry can understand what might now be considered manipulation other than applying a standard, to quote Justice Potter Stewart in a famous US Supreme Court case dealing with obscenity (Jacobellis v. Ohio (1964)), “I know it when I see it.”

And briefly:

The UK FCA Bans and Fines a Trader for Attempting to Manipulate a UK Government Bond in a Proposed Transaction with the Bank of England: The UK Financial Conduct Authority banned and fined Mark Stevenson, a former bond trader with Credit Suisse Securities (Europe) for attempting to manipulate a UK Government Bond (i.e., “gilt”) on October 10, 2011, to take advantage of anticipated Quantitative Easing purchases by the Bank of England. Between 9 am and 2:30 pm on that day, Mr. Stevenson allegedly purchased 92% of the value of all of a certain illiquid government bond issue (UKT 8.75% 2017) that traded during that time; this amount represented 2,700% of the average daily volume traded in the relevant issue during the prior four months. He then offered to sell GB £850 Million of the Bond (including the amount he bought earlier on October 10) to the Bank of England later that afternoon at an inflated price influenced by his earlier purchases. The Bank ended up not buying the Bond that day “following significant changes in its yield in the run up to the auction.” The FCA charged Mr. Stevenson with violations of its market abuse prohibition; he consented to the sanctions.

CFTC Extends No-Action Relief to Swaps Executed on EU Regulated Multilateral Trading Facilities: On Friday last week, the CFTC extended until May 14, 2014, Swap Execution Facilities’ registration requirements for certain EU-regulated multilateral trading facilities that effectuate swaps for US persons. Such MTFs previously had been granted a temporary exemption from registration through 11:59 pm March 24, 2014 in order to comply with certain conditions to obtain a longer-term exemption from registration. The CFTC claims that such an extension is warranted because it soon will issue long term relief that will track the previously granted conditional relief “but will contain several notable clarifications and amended conditions for qualifying for such conditional relief.”

SEC Charges Managing Clerk at a Major Law Firm and a Stockbroker with Insider Trading: Just a few weeks after it and the District Attorney of Manhattan initiated proceedings against lawyers and financial personnel formerly associated with a highly regarded law firm that is now defunct related to alleged accounting fraud (see article: “Lawyers and Financial Personnel Criminally Indicted and Sued Civilly in Connection with Collapse of Formerly Highly Regarded Law Firm,” at http://www.garydewaalandassociates.com/?p=2162), the Securities and Exchange Commission filed a lawsuit in a Federal Court in New Jersey against the managing clerk at another well-regarded law firm and a stock broker related to insider trading. In this new, unrelated matter, the SEC claims that Steven Metro, a managing clerk at Simpson Thacher, on at least 13 occasions since 2009 passed along material non-public information related to pending mergers, acquisitions or tender offers he learned through his employment to a middleman. The middleman allegedly passed along the information to Vladimir Eydelman, who was a registered representative with Oppenheimer & Co. through September 2012, and currently is registered with Morgan Stanley. Both the middleman and Mr. Eydelman, claims the SEC, traded for their own benefit using the inside information. Mr. Metro graduated from law school but is not a practicing attorney, according to the SEC’s Complaint. On the same day as the SEC’s action, the US Attorney’s Office for the District of New Jersey announced the arrest of and that criminal charges were filed against Mr. Metro and Mr. Eydelman related to this matter. According to the SEC, the information exchanges between the middleman and Mr. Eydelman typically occurred in the main concourse of Grand Central Station in NYC by the central information booth and clock. In a rendition that appears fit for film,

“[t]he Middleman [typically] passed the information to Eydelman by showing him a post-it note or napkin on which the Middleman wrote the stock ticker symbol of the company to be acquired. The Middleman then chewed up, and sometimes ate (with Eydelman watching), the post-it note or napkin to destroy evidence of the tip. The Middleman also conveyed to Eydelman at this time the approximate transaction price and timing of the deal.”

ICE Clear Credit Proposes Rules to Implement LSOC with Excess Model: ICE Clear Europe Asks SEC for Approval of Rules Related to Non-Default Losses: Ice Clear Credit submitted to both the CFTC and the SEC proposed rule amendments to permit its clearing members to use a so-called “LSOC with Excess” model (LSOC stands for Legal Segregation with Operational Commingling). Under this model, clearing members may transfer to ICC customers’ excess collateral not required to meet their initial margin requirements related to their cleared swaps’ positions. As part of these rules, clearing members are required to provide enhanced reporting to ICC in conjunction with customers’ margin. LSOC was mandated by the CFTC to minimize the likelihood that the default of one swaps customer at a Futures Commission Merchant would detrimentally impact another customer and to help facilitate the portability of customers’ swaps positions from one FCM to another in case of the initial carrying FCM’s insolvency. LSOC only applies to swaps positions, not futures or related options positions. Separately, ICE Clear Europe filed with the SEC proposed rule changes to address possible losses to ICE Clear Europe arising other than from clearing member default, including general business risk, investment and custody risk, and operational risk. Under the proposed rules, non-default losses would first be covered by non-default loss assets provided by ICE Clear Europe (expected up to US $90 Million), and then from the proceeds of a non-default loss contributions call to all clearing members based on a formula related to a clearing member’s aggregate guaranty fund contribution.

Through Disciplinary Actions, CME Reminds Members (Again) of the Importance of Complying with Rules Regarding Position Limits (Even Intraday) and EFRPs: Last week, David Kotz, a NYMEX member agreed to a modest fine and to disgorge trading profits related to his intraday violation of position limits involving the October 2011 Henry Hub Natural Gas Futures contract on September 27, 2011. During that day, at different times, Mr. Kotz exceeded the relevant standard expiration month position limit by 81 contracts and 96 contracts. In an unrelated action, HSBC Bank USA agreed to a fine of US $40,000 related to its entry in three Exchange of Futures for Related Position transactions on January 28 and May 30, 2012 where it was on both sides of each transaction. The Bank was also charged with not maintaining required documentation related to corresponding cash positions in violation of COMEX rules. CME Group recently has brought and settled a number of disciplinary actions related to position limits and EFRPs (see articles “CME Settles Cases Involving Position Limits’, Wash Trades’, and a Potpourri of Other Violations; Asserts Jurisdiction over an Employee of an Affiliate of a Member, at: http://www.garydewaalandassociates.com/?p=1969, and “CME Publicizes a Plethora of EFRP Fines Involving Incomplete Documentation, Late Submissions and Improper Parties,” at: http://www.garydewaalandassociates.com/?p=2110).

Singapore MAS Will Regulate Virtual Currency Intermediaries for Money Laundering Risks: The Monetary Authority of Singapore announced that it will regulate Singapore-based virtual currency intermediaries for potential money laundering and terrorist financing links. While acknowledging that it, like most worldwide regulators, does not regulate virtual currencies per se, MAS instructed intermediaries that handle virtual currencies to verify the identities of their customers and report suspicious transactions in accordance with requirements of the Singapore Suspicious Transaction Reporting Office. As did the Financial Industry Regulatory Authority in the US last week (see article, “FINRA Issues Warning Regarding Bitcoins,” at: http://www.garydewaalandassociates.com/?p=2185), MAS cautioned consumers and businesses regarding the “significant risks” associated with virtual currency transactions.

FINRA and BATS Fine Citigroup Global Markets for Short Selling Prior to Participating in Five Public Offerings: The Financial Industry Regulatory Authority and BATS Global Markets required Citigroup Global Markets to pay more than US $1.1 Million in sanctions (including $559,000 in disgorgement) related to its short selling of certain securities on five occasions during 2009 and 2010 just prior to purchasing the same securities in public offerings. Citigroup consented to this sanction. In general, in the US, persons are prohibited from purchasing a security during a public offering that they sold short within the prior five days. Just a few weeks ago, the SEC brought a similar action against Worldwide Capital Inc. and its sole owner and president for short selling securities in advance of 60 public stock offerings (see article: “SEC Fines Proprietary Trading Firm US $7.2 Million for Short Selling Violations; Issues Alert on Short Sales in Connection with Public Offerings,” at http://www.garydewaalandassociates.com/?p=2162).

And even more briefly:

The CFTC is seeking comments regarding its swap data recordkeeping and reporting requirements. Comments are due by 60 days after publication of its request for comments in the Federal Register.

CME Group filed a proposed rule change with the CFTC permitting it to allocate to other financial safeguard waterfalls on a pro-rata basis any excess house assets in one waterfall following a clearing member’s default. Currently, the CME maintains three distinct financial safeguard waterfalls – one each involving interest rate swap products, credit default swap products, and all products other than IRS or CDS.

The SEC and FINRA will be holding compliance outreach programs for broker dealers in many metropolitan areas in the US, including Chicago, NYC and Miami, beginning this spring in order to highlight “observed deficiencies and control weaknesses.” Registration is free and available to BD risk, audit, legal and compliance professionals at: http://www.sec.gov/info/complianceoutreach-bd.htm or http://www.finra.org/Industry/Education/ConferencesEvents/P037195.

For further information, see:

CFTC v. Bradley A. Miklovich:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfmiklovichcomplaint031914.pdf.

CFTC: Extension of Time for MTFs Not To Have To Register as SEFs:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-31.pdf.

CFTC Seeks Comments regarding its Swap Data Recordkeeping and Reporting Requirements:
http://www.cftc.gov/PressRoom/PressReleases/federalregister031914.

Citigroup BATS and FINRA Fine Related to Certain Short Sales:

BATS: http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p464891.pdf.
FINRA: http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p464890.pdf.

CME Group Disciplinary Actions:

EFRPs: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0434534&case=13-9300-BC+HSBC+BANK+USA+N.A.&contrib=CEI.
Position Limits: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0329209&case=11-08557-BC+DAVID+KOTZ&contrib=NYME.

CME Proposed Waterfall Amendments:
http://www.cmegroup.com/market-regulation/files/14-097R.pdf.

FCA Final Notice Regarding Mark Stevenson:
http://www.fca.org.uk/static/documents/final-notices/mark-stevenson.pdf

ICE Clear Credit: Proposed LSOC with Excess Models:

CFTC: https://www.theice.com/publicdocs/regulatory_filings/ICC_CFTC_031814.pdf.
SEC: https://www.theice.com/publicdocs/regulatory_filings/ICC_SEC_032814.pdf.

ICE Clear Europe Proposed Non-Default Loss Coverage:
https://www.theice.com/publicdocs/regulatory_filings/ICEU_SEC_032114.pdf.

MAS Regulation of Virtual Currency Intermediaries for AML Risks:
http://www.mas.gov.sg/news-and-publications/press-releases/2014/mas-to-regulate-virtual-currency-intermediaries-for-money-laundering-and-terrorist-financing-risks.aspx.

SEC v. Vladimir Eydelman and Steven Metro:
http://www.sec.gov/litigation/complaints/2014/comp-pr2014-55.pdf.

See also US Attorney, District of NJ Announcement regarding Criminal Action: http://www.justice.gov/usao/nj/Press/files/Metro,%20Steven%20and%20Eydelman,%20Vladimir%20Charged%20News%20Release.html

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 March 22, 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 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: March 17 to 21 and 24, 2014 (Manipulation and Fraud: More than "I know it when I see it?")

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