Fitting for the dog days of August in the United States, the US Commodity Futures Trading Commission demonstrated it has both a meaningful bark and bite by settling two high profile enforcement actions: one against alleged manipulators of crude oil futures and another against an alleged falsifier of internal trading records of his employer. In an unrelated development, industry participants roundly criticized CFTC proposed position limits rules in the final days of a re-opened comment period.
As a result, the following matters are covered in this week’s Bridging the Week:
CFTC Settles Crude Oil Manipulation Action Against Parnon Energy and Other Defendants for US $13 Million Fine
Five defendants agreed to settle a Commodity Futures Trading Commission enforcement action involving their alleged manipulation and attempted manipulation of crude oil futures from late 2007 through April 2008 by consenting to payment of a US $13 million civil penalty.
The defendants are Parnon Energy Inc., Arcadia Petroleum Ltd., Arcadia Energy (Suisse) SA, James Dyer, and Nicholas Wildgoose.
The CFTC had alleged that the defendants engaged in a manipulative strategy by accumulating a large quantity of physical crude oil that satisfied relevant delivery requirements of crude oil futures contracts traded on the New York Mercantile Exchange and ICE Futures Europe in order to “dominate and control” the relevant supply although they had no business need. At the same time, the defendants purchased long futures positions on the relevant NYMEX and ICE crude oil contracts to help drive up the value of their physical positions. The CFTC claimed the defendants later sold short the same futures contracts at “artificially high prices,” and subsequently sold off their physical positions unexpectedly. This drove down crude oil futures prices dramatically, thus increasing the value of defendants’ short futures positions.
In settling this matter, none of the defendants admitted or denied any of the CFTC’s substantive allegations in the complaint. In addition to agreeing to pay a civil penalty, the defendants consented to various undertakings in order to resolve this matter.
(For a related reading click here, to see the article “Federal Judge Blocks Defendants’ Subpoena for Identity of Confidential Informant in CFTC Manipulation Action,” in the May 26 – 30 and June 2, 2014 edition of Bridging the Week.)
Flurry of Opposing Views Greets CFTC’s Position Limits’ Proposal in Final Days of Comment Period
The CFTC received a flurry of letters during the last few days of a re-opened comment period in response to its Fall 2013 proposals to establish position limits on 28 agricultural, energy and metals futures contracts, as well as on options and swaps that are economically equivalent to such contracts, and to amend its aggregation policy. In all, the Commission received more than 265 letters, most of which were critical of its proposals.
In general, commentators requested that the Commission expand the definition of bona fide hedging, provide a more efficient process to request non-enumerated hedging exemptions, and relax its aggregation proposal.
For example, the National Grain and Feed Association – which says it represents 1,000 companies that operate 7,000 US facilities in the grain, feed and processing industry – argued against a too restrictive definition of bona fide hedging. According to the Association,
[we believe] strongly that strategies historically utilized by commercial hedgers to reduce and manage business risk – and long recognized by the CFTC as bona fide hedges – cannot now be thrown into question or written out of a new definition. To do so would be to expose these businesses, the farmer-customers with whom they are working to price and market their crops and US consumers to increased risk, lower price bids and fewer risk-management alternatives for farmers and ranchers, and higher costs to consumers.
Similarly, the National Council of Farmer Cooperatives – which claims to represent two million farmers and ranchers that belong to one or more farmer cooperatives – criticized the CFTC’s proposed process to handle requests for non-enumerated hedge exemptions. According to the Council,
the process for exemption appears to lead to a lengthy open-ended review by the Commission, whether or not it is commonly used as a risk management practice that previously has been recognized as a bona fide hedging exemption.
The Chicago Mercantile Exchange strongly criticized the Commission’s aggregation proposal which it claims is based on the “unprecedented notion that hedging on an ‘enterprise-wide’ basis across affiliated but independently organized and managed entities is conventional.” However, says the CME,
equating an ownership interest in a separately organized entity… with an ownership interest in the owned entity’s futures and swaps “accounts” is unauthorized by [applicable law] and has not been a “longstanding” Commission precedent that has been consistently administered by the agency across all markets.
Not all views were critical of the CFTC, however. For example, at least one commentator, Occupy the SEC, asked for the Commission to err on the side of being restrictive in its interpretations. According to this organization, “[w]e share with leading advocates and academics the view that strict position limits are necessary to ensure against manipulative and speculative practices that have caused abrupt changes in the price and supply of vital natural resources.”
Valuable Lessons Learned: Nick Leeson, Joseph Jett, Toshihide Iguchi, John Rusnak, Jerome Kerviel, Kweku Adaboli, and many others. The list of infamous rogue traders in financial services is far too long and, my guess is that other names will be added to this dishonor roll regrettably too. Why? Despite all the publicity surrounding rogue trading events, firms over time let down their guard, and common sense operational risk controls fall by the wayside, whether for budgetary considerations, temporary business expedience that becomes too long term or otherwise. There are common denominators among rogue trading events – the so-called four elements of the “fraud diamond” – opportunity, motivation, rationalization and capability. Within the opportunity category, there are often common operational breakdowns: lapses or holes in firm reconciliation practices; overlap in responsibilities between front and back office personnel; and technological deficiencies. Firm culture plays a major role in rogue trading too. Companies should minimize fragmentation among control units to ensure that anomalies are capable to be identified early and staff should be repeatedly trained in fraud prevention. Moreover, a firm’s culture should encourage the reporting of potentially problematic matters.
Compliance Weeds: Future commission merchants and foreign brokers can help their clients by maintaining procedures to ensure that instruct or leave-open accounts are consulted in advance of the relevant day where offsets are no longer permitted, to ensure that desired offsets are implemented. Otherwise a client can end up taking market exposure and paying unexpected commissions when liquidating positions in the marketplace.
And even more briefly:
For more information, see:
CFTC Settles Crude Oil Manipulation Action Against Parnon Energy and Other Defendants for US $13 Million Fine:
See also Initial Complaint: CFTC v. Parnon Energy Inc., et al:
CME Clarifies When Netting Cannot Occur in Spot Month Positions in Physically Delivered Contracts:
CoCo Securities Prohibited for Retail Investors by FCA:
ESMA Issues Guidelines and Recommendations to Implement CPSS-IOSCO Financial Market Infrastructure Principles for Clearinghouses; But There’s Just One:
Fed and FDIC Strongly Criticize Resolution Plans of 11 Banking Organizations:
FERC Issues Notice of Alleged Violations Against Private Fund That Posts Defenses on Internet:
See also Powhatan Website Setting Forth Its Defenses:
FERC Settles Enforcement Proceeding Against the Imperial Irrigation District Over 2011 Pacific Southwest Blackout:
FIA and FIA PTG Provide Suggestions to CFTC Regarding Data Collection and Market Surveillance:
Flurry of Opposing Views Greets CFTC’s Position Limits Proposal on Final Days of Comment Period:
Former Citigroup Director Settles CFTC Lawsuit for Mismarking and Inflating the Value of Ethanol Futures to Hide Trading Losses:
See also Initial Complaint: CFTC v. John Brooks:
ICE Futures Europe Postpones Rollout of EMIR-Compliant Customer Segregation Rules:
See also, Proposed Amendments to ICE Futures Rules to Accommodate EMIR Customer Segregation Requirements:
IOSCO Publishes Central Clearing Requirements Product by Product, Jurisdiction by Jurisdiction:
IOSCO Solicits Views on the Effects of Warehouses on Commodity Derivatives Prices:
LME Inaugurates Commitments of Traders Publication:
SEC Charges So-Called “Nickel” Broker Dealer and President With Net Capital and Recordkeeping Violations; President Also Charged Criminally For Obstructing SEC’s Investigation:
See also Criminal Complaint Against Charles Moore:
SEC Publishes Lists of Registered Alternative Trading Systems:
The Sour Grapes of Wrath: Judge Approves SEC Citigroup CDO Settlement:
See also Initial SEC Complaint v. Citigroup Global Markets:
UK FCA Seeks Input on Proposed Social Media Guidance:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 9, 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: August 4 to 8 and 11, 2014 (Manipulation, Falsification, Position Limits Criticism, Sour Grapes of Wrath)Jump to: Valuable Lessons Learned Bridging the Week Compliance Weeds