Gary DeWaal's Bridging the Week: September 23 to 27 and 30, 2013

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Published Date : September 30, 2013

Last week, brokers once again learned through enforcement actions against ICAP Europe that failure to maintain a robust supervisory system over their employees can be costly and embarrassing. However, brokers also learned in a NY court decision involving Amaranth Advisors, that the threshold to hold futures commission merchants liable for their clients' possible manipulative practices is very very high.

This week swap dealers and other users of swaps will learn whether the decision of the US Commodity Futures Trading Commission to force trading of certain swaps by US persons onto registered Swap Execution Facilities on October 2 promotes transparency and liquidity, engenders anger and confusion, results in a bit of both, or ends up being postponed at least in part. And, who can keep up with all the last minute flurry of guidance and no action letters?

These and other matters covered this week on Bridging the Week are:

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CFTC and UK FCA Sue and Settle with ICAP Europe; Three Non-US Individuals Indicted by the US Department of Justice

As widely reported elsewhere, ICAP Europe Limited was sued by and settled with the US Commodity Futures Trading Commission and the UK Financial Conduct Authority related to the actions of three of its non-US based employees who endeavored to manipulate the Yen London Interbank Offered Rate (Yen LIBOR) from at least October 2006 through January 2011. The three employees also were charged by the US Department of Justice with conspiracy to commit wire fraud and wire fraud in connection with their conduct.

In settling these matters, ICAP agreed to pay a fine of US$ 65 Million to the CFTC and a fine of GB £14 Million (US$ 22.4 Million). ICAP also agreed with the CFTC to augment its internal controls by (1) strengthening certain compliance procedures, (2) routinely reviewing certain electronic and audio communications, (3) placing compliance personnel among certain brokers, (4) enhancing certain monitoring and electronic exception reporting systems, (5) requiring recording and retaining of recordings of certain communications for at least one year, (6) enhancing internal training, and (7) using third party auditors to conduct annual audits for at least four years of certain broker desks, among other matters.

Each of the non-US employees of ICAP faces a maximum penalty of 30 years in prison for each count charged if convicted.

Essentially, two of the ICAP employees charged by the DOJ are alleged to have encouraged a third ICAP employee to provide false information to third party banks regarding Yen borrowing rates. This false information was then used by the banks in a process that led to the worldwide dissemination each business day of Yen Libor fixing rates that benefited a third party client of ICAP (in large part UBS AG – which previously settled FCA and CFTC enforcement actions too regarding this matter), and did not reflect the banks' true assessment of borrowing rates. The evidence against the employees (and included by the CFTC, FCA, and DOJ in their enforcement actions) included much colorful electronic communication that contained explicit references to the alleged manipulative scheme.

The FCA and CFTC cited a breakdown in supervision at ICAP as the cause of the Firm's problems. According to the CFTC,

"ICAP's ineffectual supervision of the Yen derivatives and cash desks, its misplaced reliance on the expectation that Yen desk heads would enforce a compliance regime on their desk colleagues, and its failure to audit the Yen derivatives desk or adequately review the Yen brokers' communications with clients, among other internal controls and supervisory deficiencies, allowed this misconduct to continue for years."

Although all the actors and nefarious conduct involved in this matter were situated outside the USA, the CFTC asserted jurisdiction saying that the three employee's conduct to influence the Yen LIBOR rate "…affect[ed] or tend[ed] to affect the prices of commodities in interstate commerce, including the daily rates at which Yen LIBOR is fixed." ICAP was held liable for the acts of its employees and managers who engaged in wrongful conduct.

In connection with the FCA matter, ICAP was charged with failing (1) to observe proper standards of market conduct, and (2) to take reasonable care to "organize and control its affairs responsibly" and to maintain adequate risk management systems.

In commenting upon his Firm's settlements, ICAP Group CEO Michael Spencer said, "We have learned from this, we will further improve our risk and compliance systems and we will continue to provide our clients with the highly professional service that they expect across many markets and geographies."

My View:
A costly lesson hopefully learned once again is that inadequate internal controls, especially involving poor supervision of employees, coupled with arrogant employees who value compensation above all else, can hurt a firm economically – both in substantial fines by regulators and litigation expense, as well as loss of business due to impaired reputation and distraction of internal staff who must deal potentially with both government investigations and litigation. However, does the authority of the US regulators know no bounds? In these days of severely limited government resources is it an efficient use of resources for US regulators to pursue an overseas incident involving solely overseas-based persons already prosecuted by the local regulator?

Valuable Lessons Learned:
Requiring Desk Heads and Front Office supervisors to participate in the oversight of their Front Office subordinates is a good practice. However, this should not be in lieu of Compliance's and other control functions' routine monitoring and periodic formal review of such subordinates, as well as of the managers, too; compliance should never be entrusted solely to Front Office personnel. Determining the appropriate amount of Compliance and other control function resources to dedicate to routine monitoring and periodic review should be done using a risk-based analysis, especially reviewing desks that have a high proportion of their business involving just a few customers (let alone just one) or seem to have customers subject to a high incidence of regulatory requests. Review the specific commitments of ICAP Europe to the CFTC and assess whether any  measures might be appropriate to be adopted by your firm too.

Amaranth Litigation: Standards for Aiding and Abetting Violations by Brokers for Clients Are Very Rigorous

In an important decision in the Amaranth Natural Gas Commodities Litigation, the Federal Circuit Court of Appeals Court in NY ruled that the requirements to demonstrate successfully that a futures commission merchant is responsible for a client's manipulative activities are quite rigorous.

Specifically, in this matter Amaranth Advisors LLC was sued by a class of traders who claimed that the company had manipulated the price of natural gas futures during 2006, and that its clearing broker, JP Morgan Futures, Inc., a CFTC registered FCM, had aided and abetted Amaranth's manipulation. A lower court previously rejected the traders' initial and subsequently amended claim against JPM.

The traders had argued that JPM was liable for Amaranth's manipulation, because as its clearing broker, JPM was aware of Amaranth's positions and trading activity including the fact that Amaranth violated New York Mercantile Exchange natural gas position limits and exceeded the Exchange's accountability levels at various times. The traders also alleged that JPM knew that Amaranth engaged in "slamming the close" activities (an indicia of manipulative activity), as well as of a NYMEX and CFTC investigation into Amaranth's trading.

In upholding the lower court's rejection of the traders' claim, the Circuit Court held that to establish aiding and abetting there must be proof of an unlawful intent to further the underlying violations. In the words of a former judge, aiding and abetting requires the defendants "…in some sort [to] associate himself with the venture, that he participate in it as in something that he wishes to bring about, that he seek by his action to make it succeed."

Here claims the Court, JPM solely provided routine clearing services. Although JPM may have known about Amaranth's large positions, large positions in and of themselves do not imply manipulation. This is even when such large positions violated applicable position or accountability levels as the goals of such limits are not just to preclude manipulation, but also to ameliorate excessive speculation, to ensure effective price discovery of markets, and to ensure sufficient liquidity for hedgers.

Likewise even where JPM was aware of Amaranth's slamming the close activities and could not provide any "legitimate economic reason" why Amaranth would engage in such conduct, such knowledge by itself was not sufficient to satisfy an aiding and abetting charge. Although slamming the close may suggest manipulative conduct, it is not dispositive, says the Court.

According to the Court,

"It suffices to conclude that in the circumstances presented here, the provision of routine clearing services, when combined only with allegations that the clearing firm knew of trading activity that was highly suggestive but not dispositive of manipulation, is not enough to state a claim for aiding and abetting under [the Commodity Exchange Act]."

Valuable Lessons Learned:
This decision is an important and favorable decision for FCMs. However, FCMs should still be investing in monitoring systems to help detect potential trade practice and speculative limit violations by their customers, and have appropriate personnel to review the output of such systems and act on at least some criteria of exceptions.

SEFs Go Live October 2: Chilton and O'Malia Recommend Delay; A Flurry of Guidance and No Action Letters Is Released September 25-27
Despite wide-spread public expressions of concern, including from at least two CFTC Commissioners, Bart Chilton and Scott O'Malia, the CFTC seems determined to go forward with the October 2 go live date for Swap Execution Facilities. As of September 27, 17 SEFs were approved for trading and two SEFs applications were pending.

As of October 2 all multiple to multiple swap trading venues must register as SEFs if they facilitate transactions on behalf of US persons, even if they only offer products that, as of that date, are not subject to a trade execution mandate – the so-called "Footnote 88" issue. Single dealer platforms not offering products subject to the trade execution mandate are not required to register as SEFs by October 2.

Among the concerns regarding the go live date for SEFs is that such requirement may cause serious issues for European-based multilateral trading facilities that accommodate US persons. According to Commissioner O'Malia:

"…the Commission is facing serious problems regarding its treatment of EU-regulated multilateral trading facilities ("MTFs"). In the Barnier-Gensler "Path Forward" document, the Commission assured European regulators that it will extend appropriate time-limited transitional relief to certain EU-regulated MTFs, in the event that the Commission's trade execution requirement is triggered before March 15, 2014. However, the flexibility embodied in this agreement appears to be in direct contradiction to the SEF final rules that expressly require all platforms meeting a SEF definition to register by October 2, or cease operation. I don't think the current registration requirement on October 2is consistent with either the spirit or the letter of the "Path Forward" document. It is unclear to me what the impact on liquidity will be if as a result of this problem, all U.S. persons are required to trade exclusively on U.S. SEF platforms or else to be forced to revert to bilateral trading."

In suggesting a two month delay for the reporting rules related to the October 2 go live date, Commissioner Chilton cited technological and other impracticalities. According to Commissioner Chilton:

"We have heard from many quarters that, absent providing some relief, we are at risk of causing serious market disruptions and possible serious liquidity crises. At this particular time, given the possibility of a federal government shut-down, it is simply not reasonable to turn a deaf ear to these requests. Let's be reasonable."

In anticipation of this go-live date, CFTC staff issued guidance on September 26 regarding swaps straight-through processing. Among other things, staff provided its view that (1) a clearing FCM cannot reject a trade executed on a SEF that previously passed its pre-execution risk-based limits while an order; (2) Designated Clearing Organizations must accept or reject trades executed on a SEF or Designated Contract Market (for which the SEF or DCM has established processes for clearing) as soon as technologically practical which is now regarded as within 10 seconds (previously this was 60 seconds); and (3) any trade executed on a SEF or designated contract market that is not accepted for clearing should be regarded as void. As a result, FCMs, Swap Dealers, SEFs and DCMs should not require breakage agreements as a condition for access to trading on a SEF or DCM.

In addition, during the evening on September 27, the CFTC's Division of Market Oversight (DMO) issued a flurry of limited no action relief to facilitate the October 2 go live date.

In one letter, DMO extended the date on which SEFs must make real time reports of swaps transactions and pricing data to Swap Data Repositories (SDR). This relief expires at 12:01 AM eastern time on October 30, 2013, for swaps in the FX asset class, and 12:01 AM eastern time on December 2, 2013, for swaps executed in equity and commodity asset classes. In another letter, DMO provided temporary relief to reporting counterparties to uncleared swaps transactions executed initially on a SEF for errors or omissions in swap continuation data reported to an SDR to the extent such errors or omissions were caused by incomplete information provided by a SEF. This relief expires no later than October 29, 2013, for swaps executed in the FX asset class, and December 1, 2013 for swaps executed in the equity and commodity asset classes. And finally, DMO provided temporary relief to SEFs temporarily registered by October 2 from fulfilling certain of their enforcement responsibilities with regard to activities of market participants who trade on or through such SEFs; this relief expires November 1, 2013. A myriad of conditions apply to all participants desiring to take advantage of the offered relief.

My View:
Is this really the most effective way to roll out a significant new regulatory requirement? 

And briefly:

CFTC Sues Yet Another Trader For Hiding His Trading Losses: Late on Friday afternoon, the CFTC filed an enforcement action against John Aaron Brooks related to his alleged efforts to hide trading losses from his employer, an affiliate of an unnamed "large NY-based commercial bank," from November 2010 through October 2011. As a result of his activities, the CFTC alleges that the affiliate sustained US$ 40 Million in losses.

According to the CFTC, Mr. Brook's committed his fraud by manually entering false values for CBOT-traded ethanol futures into the bank's computer system. The CFTC charged Mr. Brooks with violations of the anti-fraud and new fraud-based manipulation sections of the Commodity Exchange Act and related regulations.

Compliance Weeds:
Hopefully by now, firms are prohibiting their traders from manually entering their own trades into internal bookkeeping systems.

CME to Allow Excess LSOC Collateral Value to Cover Variation Margin Losses: Effective October 21, 2013, CME will permit clearing firms that offer their cleared swaps customers LSOC "with-excess" to use a client's excess LSOC value to cover its variation loss to the extent the customer's required cash on deposit is in the currency for which the variation loss occurs. LSOC refers to Legal Segregation with Operational Commingling and is a mandatory segregation practice by FCMs for cleared-swaps customers that is aimed to reduce fellow customer risk and to expedite the porting of swaps positions and collateral in the event of an FCM default. The use of this CME LSOC enhancement will be optional.

Industry Organizations and Participants Continue to Fight Against Proposed CFTC Segregation and BIS Leverage Ratio Frameworks that Could Materially Hurt FCMs. The week before last a large group of organizations representing a wide cross section of the agricultural futures market (Ag Group Consortium) filed a letter with the CFTC arguing against the CFTC's November 2012 proposals to require FCMs to maintain an amount of their own funds in their customer segregated accounts 24/7 at least equal to the amount of their customers' aggregate deficit balances. According the Ag Group Consortium, this proposal, if adopted, most likely will require customers to pre-margin hedge accounts, discourage farmers from using futures markets to manage their risks, and expose farmers more to FCMs -- "the last thing customers want to do now, in the wake of MF Global and Peregrine Financial Group." This past week, a bipartisan group of senior legislators from both Senate and House CFTC oversight committees wrote a letter to the CFTC echoing these sentiments and reminding the Commission that "[t]he goal of increasing futures customer protections should be to strengthen the markets without harming the ability of American farmers, ranchers, and end-users to hedge their legitimate business risks."

Separately, the week before last, a consortium of industry organizations, including GFMA, SIFMA, ISDA, and the Financial Services Roundtable filed one letter, and the Futures Industry Association another, that cautioned the Basel Committee on Banking Supervision from adopting rules that might penalize banks that have FCM subsidiaries that engage in cleared swaps, futures or options business for their customers. The proposed rules might do this by requiring banks to take leverage capital charges for the exposure BIS posits FCMs have to clearing houses on the one side, and customers, on the other, in connection with each cleared customer swap, futures or options transaction. In other words, BIS proposes to deconstruct what FCMs consider to be agency transactions on behalf of their customers into two separate principal-like transactions for capital computation purposes. However, the proposal seems to ignore that FCMs should have no liability to their customers if a clearinghouse fails, and that customers post margin to offset their exposure to FCMs. According to FIA, the proposed leverage capital charges,

"…will make client clearing economically unviable for clearing member banks and prohibitively expensive for end users. These high capital charges will be passed down to customers in the form of fees. Where derivatives must be cleared through CCPs (such as swaps in the United States), end-users may elect not to hedge with these derivatives at all rather than pay the high fees associated with client clearing. Where derivatives are not mandated to be cleared through CCPs, end-users may elect to engage in bilateral, uncleared trades. All of these consequences would make the market less, rather than more, safe."

My View
When will regulators step back and think about regulation holistically? If the goal is to lessen customers' exposure to their brokers, why propose regulations potentially to increase their exposure (reversing decades of law interpretation to do so)? If the goal is to promote central clearing why propose regulations to discourage central clearing?

Help to Broker Dealers (Regarding Suitability Assessments) and CPOs and CTAs (Regarding Disclosures): The US Financial Industry Regulatory Authority (FINRA) issued a Regulatory Notice setting forth observations and recommendations regarding firms' compliance with its new suitability rule (2111; keep in mind, that for broker dealers suitability assessments are required for institutional customers in addition to retail customers unless certain criteria are satisfied). Separately, the National Futures Association issued a revised guide for Commodity Pool Operators and Commodity Trading Advisors in connection with their preparation of disclosure documents, to reflect changes in CFTC rules that became effective during August 2013.

More Madoff Fallout: SEC Charges Madoff Accountant for Role in Creating False Books and Records: The SEC charged Paul Konigsberg with creating false books and records in connection with Bernard Madoff's Ponzi scheme. These books and records, including inaccurate trade confirmations, were alleged to have been used to help defraud many of Madoff's oldest and wealthiest clients.  The US Attorney's Office for the Southern District of NY filed criminal charges against Mr. Konigsberg too related to this matter. The SEC seeks return of ill-gotten gains, penalties and an injunction. In connection with his criminal matter, Mr. Konigsberg faces up to 40 years in prison in addition to fines and disgorgement requirements.

Just Like the CFTC, ESMA is Considering the Application of its Rules to Transactions between non-EU entities: The European Securities and Markets Authority (ESMA) had been scheduled to submit to the European Commission by  September 25, 2013, its proposed technical standards related to the application of EMIR – the European equivalent of Title VII of Dodd Frank – to transactions between non-EU entities with a direct, substantial and foreseeable effect within the EU. The new deadline is November 15, 2013.

When a Regulator Announces it Will Not Bring an Enforcement Action, That's News; CFTC Ceases 2008 Silver Markets' Investigation: The CFTC announced this week that it will not bring an enforcement action related to alleged manipulation of the silver markets in 2008 that its Division of Enforcement began investigating that year. The CFTC commenced its investigation (and publicly confirmed it) after receiving complaints regarding silver prices. The CFTC made its decision not to bring any charges, after spending more than 7,000 enforcement staff hours and reviewing market fundamentals and trading between cash, futures and over the counter markets.
In an interview on RT America on November 13, 2012, Commissioner Bart Chilton said that he believed there had been "nefarious actions" and "violations of the law" in connection with silver trading during the relevant time.

You Think You Had a Bad Week?: Vision Financial Markets Fined in Two Separate CFTC Actions, One for Segregation Violations, One for Failure to Supervise: Vision Financial Markets LLC -- a US-based FCM (and also a broker dealer registered with the US SEC) -- was the subject of not one, but two enforcement actions by the CFTC last week, both of which it settled for an aggregate of US$ 665,000. In the first matter, Vision was charged by the CFTC with failure to supervise because of its failure to aggregate multiple accounts of a customer in order to assess whether the customer was violating Chicago Mercantile Exchange speculative position limits. Apparently Vision relied on faulty software in making its error. After Vision discovered the error in July 2012, the error was not corrected until January 2013.

In the second matter, Vision was charged by the CFTC with failing to segregate properly its customer funds from August 2008 through May 2009. In this matter, Vision purchased securities with customer funds, but commingled these securities with its own funds in a single account at the Depository Trust Company. After Vision was alerted to this issue following a routine examination by the CME, it recalculated its customers' segregated funds and learned that it had been under-segregated from December 2008 through May 2009. Prior to the CME audit, Vision did not report it was under segregated either to the CFTC or CME. Vision was charged both for being under segregated and failing to notify the CFTC and CME that it was under segregated.

Vision's segregation issues did not result in any loss to any customer.

My View:
How do you report something you are not aware of?

RJO O'Brien Also Fined for a Segregation Violation: R.J. O'Brien & Associates -- a US-based FCM -- also was sued and settled with the CFTC for payment of a US$ 125,000 fine related to a violation of the CFTC's segregation rules related to customer funds in support of the trading of non-US futures and options. In this matter, RJO carried an account for another FCM (non-clearing FCM), and on one day in February 2012  transferred funds from the non-clearing FCM's secured foreign futures and options customer omnibus account to reduce a margin deficiency in the non-clearing FCM's segregated domestic futures and options omnibus account. This transfer was made without calling the non-clearing FCM for margin or advising the non-clearing FCM it was making the transfer. The transfer caused the non-clearing FCM to have insufficient funds to meet its obligation to its own foreign futures and options customers.
RJO's segregation issue did not result in any loss to any customer.

Valuable Lessons Learned:
Post MF Global, the CFTC appears to have a zero tolerance for any violation of law or rule related to the handling of customers funds -- even if the violation is for a very short duration and never harmed any customer. As a result, FCMs must consider whether there are any double checks or "four eyes" approaches that will help reduce the possibility of any error in the handling of customer funds going undetected. At a minimum, the handling of customer funds should be at least annually reviewed by Internal Audit, absent good cause.

What do each of these matters mean practically for your business? For questions or assistance, do not hesitate to contact Gary DeWaal and Associates at (212) 382-4615 or at:

For more information, see:

In re Amaranth Natural Gas Commodities Litigation:
Basel III Proposed Leverage Ratio Framework
Consultative Document:
Industry Responses:
GFMA et al:
CFTC v. John Aaron Brooks:
CFTC Proposed Enhancements to Customer Protection
CFTC Proposal:
Agricultural Consortium Letter:
Congressional Letter:
CFTC v.  R.J. O'Brien and Associates:
CFTC: SEFs Go Live October 2
Staff Guidance on Swaps Straight-Through Processing:
DMO No Action Letter on SEF Reporting:
DMO No Action Letter regarding Continuation Data Reporting:
DMO No Action Letter regarding SEF Enforcement Responsibilities:
Statement of Commissioner Chilton regarding the October 2 Go Live Date:
Statement of Commissioner O'Malia regarding the October 2 Go Live Date:
CFTC Silver Markets Investigation:
Announcement of Closure of Investigation:
Bart Chilton 2012 RT America Interview:
ESMA Revised Delivery Date on Cross Border Application of EMIR:
FINRA: Suitability Guidance:
ICAP Enforcement Actions:
Department of Justice:
ICAP Statement:
CME Excess LSOC Proposal (search for Advisory 13-440):
Madoff – Actions involving Paul Konigsberg
SEC civil action:
US Attorney's Office criminal action:,%20Paul%20S11%20Indictment.pdf
National Futures Association: Disclosure Document Guide to CPOs and CTAs:
Vision Financial Markets Actions:
CFTC action re: segregation:
CFTC action re: failure to supervise (position limits):

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 September 26, 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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