A carrot and a stick. Two weeks ago the US Commodity Futures Trading Commission granted relief from certain obligations under its large trader reporting regime by extending the deadline for the filing of certain reports to various dates in 2015 and 2016. Last week the CFTC filed an enforcement action against a futures commission merchant for not complying with other large trader reporting obligations, although the fault seemed to originate with defective third-party vendor software. Also last week, the Financial Crimes Enforcement Network of the US Department of the Treasury proposed new anti-money laundering know-your-customer obligations on certain financial institutions.
As a result, the following matters are covered in this week’s Bridging the Week:
JP Morgan Securities Settles with CFTC for US $650,000 for Alleged Large Trader Reporting Violations
The Commodity Futures Trading Commission filed and simultaneously settled an administrative enforcement action against JP Morgan Securities for the firm’s alleged failure to comply with large trader reporting requirements.
In settling this matter, JPMS agreed to pay a penalty of US $650,000 and file with the Commission within 120 days a sworn statement affirming that the company has enhanced its systems and controls to enable it to comply with applicable large trader reporting obligations.
Under the CFTC’s large trader reporting requirements, future commission merchants, clearing members and foreign brokers are required to file a report with the Commission for each account—termed a “special account”—for each business day that exceeds a designated reportable amount. For all contract months and option expirations for which a special account is reportable, this report includes: (1) all open positions in all contract months and option expirations; (2) the total of all delivery notices issued or stopped; and (3) the total of all exchange of futures for related positions.
According to the Commission, beginning in 2012, CFTC staff identified a number of errors in JPMS’s large trader reports. These errors included overstating certain EFRPs. JPMS attributed these errors to software provided by a third-party vendor.
JPMS advised Commission staff on December 18, 2012, that it was working with its vendor to fix this problem by the end of January 2013. However, according to the Commission, the problem with EFRPs and other large trader reporting issues persisted through February 2014.
In November 2013, the CFTC finalized rules that increased certain obligations related to its large trader reporting regime. Some of these obligations were postponed two weeks ago to various dates in 2015 and 2016. (For details, click here to see the article “CFTC Delays OCR Compliance Date” in the Bridging the Week edition of July 21 to 25 and 28, 2014.)
Compliance Weeds: The CFTC has repeatedly stated that it relies on data received through its large trader reporting regime as a critical tool of its market surveillance program to, among other things, ensure compliance with speculative position limits and help avoid the undue exercise of “market power without detection.” Unfortunately, much can go wrong with brokers assembling large trader data to be provided to the Commission, particularly where the data originates with customers trading through far-away affiliates whose positions may pass through one or more omnibus accounts. Problems can arise with initial account set-ups, delays or mistakes in close-outs, the use of incorrect commodity contract codes, or internal or third-party software defects (such as those that seem to have given rise to the JPMS CFTC enforcement action), among other issues. It is important that FCMs, clearing members and foreign brokers trading US futures and options maintain robust policies and procedures related to all matters that could impact their large trader reporting obligations, periodically and formally review their compliance with these obligations, and formally track problems identified by the CFTC and other self-regulatory organizations to help detect and resolve large trader reporting issues promptly. Unfortunately, practical options may be limited for many brokers when a problem is caused by a third-party vendor's software where the vendor delays fixing a programming bug despite diligent follow-up by a firm. At a minimum, firms must pro-actively interact with their vendors to ensure required fixes and document such dealings, and implement other third-party or internally developed work-arounds, if possible.
FinCEN Proposes New Beneficial Ownership Knowledge Requirement for Banks and Brokers
The Financial Crimes Enforcement Network of the US Department of the Treasury proposed new rules to require certain financial institutions to know and verify the identity of beneficial owners of entities who are their customers.
Potentially impacted financial institutions are those currently required to maintain a customer identification program by FinCEN. These financial institutions include banks, broker-dealers in securities, and mutual funds, as well as FCMs and introducing brokers in the futures industry.
Legal entities potentially impacted by the new rules include corporations, limited liability companies, partnerships or similar entities whether formed under US or non-US law.
These new requirements would apply solely in connection with new customers established after the implementation date of any final new rules, and would apply only to customers who currently are subject to a customer identification program. Thus, an executing broker would not have to know and identify the beneficial owners of an entity named as a customer in a futures industry give-up agreement; the clearing broker solely would have such obligation. Likewise, a broker-dealer maintaining an omnibus account would be permitted to consider the intermediary as the legal customer and not the underlying customers.
Certain other enumerated entities would also be exempt from the beneficial ownership requirement, including Securities and Exchange Commission registrants such as investment advisers, investment companies, exchanges and clearing agencies, and CFTC registered commodity pool operators, commodity trading advisors, retail foreign exchange dealers, swap dealers and major swap participants. FinCEN is seeking comments on whether certain pooled vehicles (e.g., a commodity pool operated by a CPO) should be exempt from the beneficial ownership requirement too.
FinCEN proposes defining a beneficial owner as an individual who directly or indirectly owns 25 percent or more of a legal entity or who has “significant responsibility to control, manage or direct” such entity. Each test would have to be applied independently and the same individual could be identified in connection with both parts of the test.
Relevant financial entities would be required to have legal entities complete and certify a standard certification form at the time of account opening in order to identify beneficial owners. They would not be required to update this form afterwards, however.
As part of its proposed rulemaking, FinCEN also proposes formally requiring affected financial institutions to “understand the nature and purpose of customer relationships” and to undertake “ongoing monitoring… in each covered financial institution’s core anti-money laundering program requirements.”
Comments on the proposed rules should be submitted to FinCEN within 60 days following publication of the rule proposal in the Federal Register.
Culture and Ethics: This matter apparently involved a unique set of circumstances that prompted the SEC to award the claimant a whistleblower award when he did not meet the technical requirements to receive such an award under current SEC rules. However, this matter should nonetheless remind firms of the importance of establishing and frequently publicizing a formal process that encourages employees and agents to report suspected illegal conduct internally without fear of retaliation. This process should be documented, and should provide alternative ways to report wrongdoing (e.g., to supervisors, to managers in different departments or to an independent ombudsman in charge of whistleblowing complaints). Allegations of illegal conduct should be formally reviewed and complainants should be given periodic updates and a final update. Part of establishing a strong compliance culture is encouraging employees and agents to speak out when they see illegal conduct.
And even more briefly:
For more information, see:
CFTC and FCA Charge Lloyds Companies With LIBOR Manipulation:
US Department of Justice:
Company CEO and CFO Subject to SEC Enforcement Action For Hiding Internal Control Breakdowns:
FCA Finds Many Firms Are Not Applying Best Execution Rules for Retail and Professional Clients:
FinCEN Proposes New Beneficial Ownership Knowledge Requirement for Banks and Brokers
See FIA Comment Letter dated October 18, 2012, to FinCEN Initial Notice of Proposed Rulemaking dated March 5, 2012:
Joint Committee of ESA Cautions EU Banks and Insurance Companies About Placing Their Own Financial Products with Retail Investors:
JP Morgan Securities Settles With CFTC for US $650,000 for Alleged Large Trader Reporting Violations:
ICE Futures Proposes to Clarify Rule Related to Non-Enumerated Hedging Exemption From Speculative Position Limits:
MFA Submits Wish List to New CFTC Chairman Massad and Other Commissioners:
Monetary Authority of Singapore Seeks Comments on the Regulation of Financial Benchmarks:
SEC Awards Whistleblower More Than US $400,000 After Claims Review Staff Recommends Against Award:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 2, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article.
Quotations attributable to speeches are from published remarks and may not reflect statements actually made.
Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office.
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Bridging the Week by Gary DeWaal: July 28 to August 1 and 4, 2014 (CFTC Carrot and Stick; Proposed New AML Obligations; MFA Wish List; ICE Hedges)Jump to: Bridging the Week Compliance Weeds Culture and Ethics