Gary DeWaal and Associates LLC

Gary DeWaal's Bridging the Week: September 30 to October 4, and October 7, 2013 (Compliance Officers, SEFs and AIF Reporting)

Valuable Lessons Learned    Bridging the Week   
Published Date: October 07, 2013

In a week punctuated by the beginning of trading on Swap Execution Facilities and the simultaneous shut down of the US Commodity Futures Trading Commission, other important developments occurred internationally and in the US relevant to all financial service participants. These matters included:

Video Overview:

Article Overview:

Compliance Officers in the Cross Hairs by the UK FCA and the US SEC (with Valuable Lessons Learned)

Last week, the UK Financial Conduct Authority again took disciplinary action against a UK-based compliance officer, while the US Securities and Exchange Commission issued guidance regarding what activities compliance and legal officers at broker dealers can take in furtherance of their roles without being regarded as supervisors of business line personnel and potentially being liable for such persons' law or rule violations under a failure to supervise theory.

FCA Action

The FCA enforcement action involved Alison Moran, the former compliance officer of Catalyst Investment Group Limited, a UK-based company authorized by the FCA to engage in a wide-range of investment activities.

From October 2007 through May 2010 Catalyst had promoted and arranged transactions involving bonds for ARM, a Luxembourg incorporated securitization vehicle. However, beginning in November 2007, ARM believed it required a license from the Commission de Surveillance du Secteur Financier (CSSF), the Luxembourg financial regulator, to issue such bonds ("ARM Bonds"). However, it never obtained a license.

According to the FCA, Catalyst (1) became aware of ARM's views on licensing during November 2007; (2) knew ARM applied for a license from CSSF in July 2009; yet (3) continued to promote and arrange transactions in ARM Bonds through May 2010 knowing that ARM never obtained a license. This was even after November 20, 2009, when CSSF issued a notice expressly requiring ARM to cease promoting and arranging transactions in ARM bonds until ARM was licensed, and Catalyst became aware of this notice too.

Previously, on July 27, 2009, Ms. Moran became aware that ARM had earlier that month applied for a license from CSSF. On December 10, 2009, Ms. Moran became aware of CSSF's notice to ARM to cease issuing bonds on November 20, 2009. Finally on December 24, 2009, Ms. Moran became aware it was mandatory for ARM to have a license to issue bonds. ARM's request for a license from CSSF was formally rejected by CSSF on August 29, 2011.

FCA charged Ms. Moran with a breach of its Principle 6, which required her to exercise due skill, care and diligence in managing Catalyst's compliance function. The basis for this charge was that Ms. Moran did not seek to understand why ARM might be applying for a license from CSSF during July 2009 and the consequence of ARM not obtaining a license. As a result she did not seek to amend Catalyst's financial promotions related to ARM bonds.

Moreover, even after Ms. Moran became aware during December 2009 that CSSF had requested ARM not to issue bonds any further because it required a license, she still did not seek to amend Catalyst's financial promotions. Among other things, Ms. Moran permitted Catalyst to send a letter to financial intermediaries during December 2009, and investors during March 2010, that FCA adjudged misleading regarding the status of ARM. According to FCA, Ms. Moran accepted that, in hindsight, these letters ‘did not give the full picture."

As a result of these matters, Ms. Moran was fined by FCA GB £20,000 (US $32,000) while Catalyst was censured. Were Catalyst able to pay a fine, FCA says it would have fined the company GB £450,000 (US $720,000).

In addition, the former CEO of Catalyst, Timothy Roberts, has been fined GB £450,000 (US $720,000) and permanently banned from the industry, while Andrew Wilkins, a former director, has been fined GB £100,000 (US $160,000) and barred from holding senior roles in the industry, as a result of their involvement with Catalyst's promotion and arrangements to sell ARM bonds.

In July 2012, the UK Financial Services Authority (predecessor to the FCA) issued total penalties of GB £70,258 against David Davis, the former chief compliance officer of the broker Paul E Schweder Miller & Co. related to his violation of FCA Principle 6 too. (For more information on this matter see:

SEC Frequently Asked Questions regarding Legal and Compliance Officers' Potential Liability under a Failure to Supervise Theory

Separately, on September 30, the US SEC issued a "Frequently Asked Questions," about the potential liability of compliance and legal personnel of US registered broker dealers for failure to supervise. While acknowledging "the critical role" compliance and legal personnel perform in efforts by BDs to comply with legal and regulatory requirements, applicable law "does not presume that a BD's compliance legal personnel are supervisors solely by virtue of their compliance or legal functions."
However, claims the SEC, compliance and legal personnel could be responsible as supervisors of business persons  -- even where they have no express supervisory authority for such persons -- because liability for supervision requires a "fact and circumstances determination." According to the SEC:

"…the question is whether compliance or legal personnel have supervisory authority over business units or other personnel outside the compliance and legal departments as could be the case, for example, if a chief executive or operating officer also is the firm's chief compliance officer. Supervisory authority also can be implicitly delegated to, or assumed by compliance or legal personnel."

Although the SEC's FAQs did not break new ground, they are a reminder to compliance and legal personnel at BDs that the SEC might seek to hold them liable for violations of law by business line personnel under certain circumstances. The SEC might consider supervision of such persons implicitly delegated to compliance or legal personnel (even where the organization chart of a firm clearly shows no supervisory link) if such personnel had,

"…the power to affect another's conduct. Did the person for example, have the ability to hire, reward or punish that person… Did the person otherwise have the authority and responsibility such that he or she could have prevented the violation from continuing even if he or she did not have the power to fire, demote or reduce the pay of the person in question?"

Valuable Lessons Learned:
The expectations of regulators regarding Chief Compliance Officers and other compliance and legal staff are increasing. Under applicable US Commodity Futures Trading Commission regulations, for example, CCOs must have the authority to perform a number of express responsibilities, including taking reasonable steps to ensure their firm's compliance with applicable provisions of the Commodity Exchange Act and CFTC rules. As a result, firms' Board of Directors and Chief Executive Officers, as well as the CCOs themselves, must ensure that CCOs have that authority not just in theory but in practice too. Red flags of potential law violations (particularly material ones) that come to CCOs' attention should be systemically followed-up and appropriate actions taken. CCOs should consider maintaining a log or other documentation of all such red flags and follow-up.

For more details regarding the obligations of CCOs under CFTC regulations and the Annual Compliance Report, see an article on this website:

ADM Investor Services, Inc. Fined by CFTC for Segregation Violations (with Valuable Lessons Learned)

The CFTC again last week charged and settled with a Futures Commission Merchant related to its violations of requirements related to the handling of customer funds. In this matter involving ADM Investor Services, Inc., the firm included in its positions and funds separately set aside for customers (as required by applicable law and regulations), positions and funds associated with accounts of various of its affiliates. These accounts should have been considered "non-customer" says the CFTC and not included among customer-segregated funds.

ADMIS transferred its non-customer positions and associated funds out of customer segregated accounts during July 2011. For this matter, ADMIS was fined US $425,000.

Valuable Lessons Learned:
As a result of various actions against FCMs by the CFTC over the past few months, FCMs have a useful checklist of technical offenses they should seek to avoid in connection with their handling of customer funds. Again, given the "zero tolerance" stand of the CFTC in connection with customer funds' offenses, FCMs should review their policies and procedures, as well as staffing, to ensure that that they comply with all requirements regarding the handling of customer funds, including that,

Periodic testing of firms' compliance with these requirements by firm's' internal audit or other control functions, or by a third party, may also be advisable.

And briefly:

For my reflections on the inauguration of SEFs, check out an article on this website:

For more information see:

CFTC v. ADM Investor Services Inc:
CFTC v. Dominick Cognata:
CFTC FAQs related to Commodity Options:
CFTC SEF-related Relief:
Pre-execution Screening:
Compliance Officer Potential Liability:
FCA v. Catalyst:
FCA v. Alison Moran:
FCA v. Timothy Roberts:
FCA v. Andrew Wilkins:
SEC FAQs about the Potential Liability of Compliance and Legal Personnel at Broker Dealers:
ESMA Reporting Requirements for Alternative Fund Managers:
Excessive System Usage Fee:
Order to Trade Ratio:

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 October 5, 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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