Gary DeWaal and Associates LLC

No single theme dominated financial industry regulatory news this past week; news came from many corners of the industry.

That being said, this upcoming week promises to have an important development, as the US Commodity Futures Trading Commission will have an open meeting on October 30 to discuss, among other things, its proposed rules related to the protection of customer funds at future commission merchants and designated clearing organizations.

Could we finally have definitive insight whether the CFTC – as proposed -- will pull the trigger on its proposal to reverse decades of its interpretation of applicable law now to require FCMs to post their own funds 24/7 to cover margin calls required to be paid by customers but not yet paid, although every expectation is that such margin calls will be paid completely and timely? We'll soon find out!

In the interim, the specific stories covered on Bridging the Week this week are:

• the US NFA issues a Member Responsibility Action against AlphaMetrix LLC related to its financial problems: AlphaMetrix is told don't place new trades until your old problems are fixed;
• the US SEC sanctions three investment advisory firms after prior warnings regarding their compliance programs go unheeded: this is a reminder, don't ignore warnings from regulators to fix problems;
• the US SEC commences two enforcement actions under the Foreign Corrupt Practices Act: the SEC reminds companies not to bribe foreign government officials even a little bit to help get or maintain business;
• the US Federal Reserve Board proposes stringent liquidity rules: BASEL III is not looking so tough by comparison;
• Not being registered dethrones the HK "Futures King" who sells an on-line automated advisory service and lands him in jail too;
• IOSCO issues its second hedge fund survey: equity funds are the most dominant type of fund;
• the CFTC publishes a trip down memory lane in reviewing the highlights of its 2013 enforcement actions (includes Valuable Lessons Learned);
• the CFTC issues  temporary "No Action" relief to permit clearing firms to resubmit a trade executed on a SEF for clearing that initially failed to clear solely for operational or clerical reasons;
• the Singapore Exchange proposes a remote clearing membership to benefit US persons and explores areas of cooperation with the Shanghai Futures Exchange; and much more.

Video Overview:


 
Article Overview:

US NFA Issues a Member Responsibility Action against Alphametrix LLC

On October 21, the US National Futures Association issued a Member Responsibility Action against AlphaMetrix LLC (AlphaMetrix) requiring it to repay US $600,000 of advisory fees that it had deducted from commodity pools it operates and that were required to be reinvested in such pools but were not. If AlphaMetrix does not repay this amount by close of business November 1, it will be prohibited from (1) placing any trades for pools it operates, except for liquidating trades or (2) disbursing or transferring any funds from any customer or pool account without NFA prior approval.

Previously, on October 10, AlphaMetrix Group LLC (AMG), the group's parent company, had advised its customers that it had sustained "significant cash flow issues," and had fired its Chief Financial Officer as a result. AMG volunteered that it had withdrawn management and incentive fees from various pools but not paid those fees to the relevant third party money managers.

The failure to reinvest the $600,000 has had an impact on the relevant pools' net asset values. According to NFA, this failure constituted an unlawful loan of pool assets to AlphaMetrix and AMG.

AlphaMetrix is registered with the CFTC as both a commodity pool operator and a commodity trading advisor, acts as the CPO of approximately 90 active pools, and had US $700 Million under management as of August 31, 2013. On November 26, 2012, a subsidiary of AMG, AlphaMetrix360, LLC announced that it was chosen by NFA and the Chicago Mercantile Exchange to provide certain data aggregation services to help the regulators keep track of customer funds at depositories by future commission merchants.

US Securities and Exchange Commission Commences Two Enforcement Actions under the Foreign Corrupt Practices Act

In a vivid reminder that it's not permitted to give any type of monetary incentives, directly or indirectly, to foreign officials for the purpose of influencing their decisions to obtain or retain business, two companies were charged by the US Securities and Exchange Commission with violating the anti-bribery and certain other provisions of the Foreign Corrupt Practices Act in connection with their alleged efforts to secure and retain certain lucrative overseas business.

In connection with one matter the SEC charged Diebold, Inc., a global provider of automated teller machines and bank security systems, with violations of the FCPA for "lavishing international leisure trips, entertainment, and other improper gifts" on certain foreign officials to help obtain and retain business with government owned banks in China and Indonesia, and for paying bribes in connection with the sale of ATMs to private banks in Russia. The value of illicit payments in these countries from 2005 through 2010 was approximately US $3 Million.

In a second action, the SEC also charged Stryker Corporation, a US-based medical-technology company, with various FCPA violations because of illicit payments from 2003 through 2008 of approximately US $2.2 million made by its subsidiaries in Greece, Mexico, Poland and Romania. These payments were described as legitimate expenses in the company's books and records for consulting and service contracts, charitable contributions, travel expenses and commissions.

Diebold simultaneously settled its SEC action (which is subject to Court approval) by agreeing to a permanent injunction, appointment of an independent compliance monitor, and payment of disgorgement and prejudgment interest of US $22,972,942. Stryker settled its matter by agreeing to a permanent injunction, and payment of disgorgement and prejudgment interest of approximately US $9.8 Million, and a penalty of US $3.5 Million. In discussing Stryker's remedial actions in its Settlement Order, the SEC noted that Stryker had retained outside counsel to conduct an internal investigation into the company's compliance with the FCPA; had implemented a company-wide anti-corruption compliance program; and since 2007, engaged a third party consultant to perform annual FCPA compliance assessments. As a result,

"[b]ased on the improvements described above, Stryker has demonstrated a commitment to designing and funding a meaningful compliance program in order to prevent and detect violations of the FCPA and other applicable anti-bribery laws."

CFTC: Play It Again Sam (or David -- as in Meister); The Commission Issues Its Enforcement Division's Annual Results

The CFTC issued its annual summary of enforcement actions brought during the fiscal year 2013. Last year the Commission filed 82 actions and obtained approximately US $1.7 billion in monetary sanctions.

In addition to highly publicized cases involving LIBOR and other interest rate benchmarks, and enforcement actions against MF Global and Peregrine Financial Group, the CFTC filed and settled 14 actions against future commission merchants related to violations of customer funds' protection requirements. In conjunction with the UK Financial Conduct Authority, the CFTC also filed its first enforcement action for spoofing against Panther Energy Trading, LLC and Michael J. Coscia, algorithmic traders, under the new disruptive trading practices prohibitions under the Commodity Exchange Act.

Valuable Lessons Learned: In assessing which areas of their firms registrants should pay particular attention to when evaluating their internal controls, a review of prior CFTC enforcement actions provides a useful roadmap. A quick way of reviewing these is by looking at CFTC Annual Reports published on the CFTC website, as well as the Commission's annual enforcement action surveys.

US SEC Sanctions Three Investment Advisory Firms after Prior Warnings Regarding Their Compliance Programs

The SEC brought enforcement actions against three investment advisors that it previously had warned about compliance deficiencies but that failed to take satisfactory rehabilitative actions in response: Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC. Each firm agreed to pay financial penalties and retain compliance consultants in order to settle their matter.

Under rules adopted by the SEC during December 2003 and which were required to be complied with by October 2004, investment companies and investment advisers are now required to maintain written policies and procedures (Compliance Policies) reasonably designed to prevent violations of applicable federal securities laws; review their Compliance Policies at least annually to assess their adequacy and the effectiveness of their implementation; and appoint a chief compliance officer (CCO) who is responsible to administer the Compliance Policies.

In the case of Modern Portfolio Management, the SEC alleged that the firm and its owners (one of whom has served as the firm's CCO since November 2012) failed to complete annual compliance reviews in 2006 and 2009, and made misleading statements on its website and in its investor brochure, despite prior warnings from SEC examiners to correct ongoing compliance violations. The firm and its owners agreed to pay a fine of US $175,000 and retain a compliance consultant for three years, in addition to other sanctions.

In the Equitas Capital Advisors and Equitas Partners matters, which included charges against their current owner, their current CCO, and their past owner and CCO too, the SEC alleged that the firms failed to adopt and implement Compliance Policies and conduct annual compliance reviews, among other violations. These violations occurred, claimed the SEC, despite warnings by SEC examiners during reviews of the firms during 2005, 2008 and 2011. To settle these matters, among other matters, most of the respondents agreed to pay a total of $225,000 in penalties; the firms will reimburse customers for certain overcharges; and the firms have hired independent compliance consultants who must conduct three annual reviews of the firms' Compliance Policies.

And briefly:

• The CFTC Announces Two Upcoming Open Meetings: The CFTC announced two upcoming public meetings on important matters. This week, on October 30, the CFTC will hold an open meeting to discuss its proposed rules to enhance customer protection related to funds held by future commission merchants and designated clearing organizations, as well as collateral of counterparties to uncleared swaps. During that meeting the CFTC will also address its proposed Ownership and Control reports. The following week, on November 5, the Commission will hold an open meeting to discuss proposed position limit rules for derivatives including aggregation of accounts. A US Federal Court had struck down prior final rules during September 2012.
   
• The CFTC Temporarily Authorizes Mechanism for Resubmitting for Clearing SEF Trades Initially Rejected for Clearing for Clerical or Operational Errors: On October 25 the CFTC indicated that it would not take enforcement action against a Swap Execution Facility for permitting opposite clearing members to resubmit for clearing a trade initially rejected for clearing solely for clerical or operational errors or omissions. A SEF would have to comply with a number of conditions to take advantage of this relief, which is available through June 30, 2014.
   
• ESMA Publishes Table of AIFMD Memoranda of Understandings: The European Securities and Markets Authority published a table showing the status of Memoranda of Understandings signed by EU national supervisors with non-EU regulators worldwide. The signing of these MOUs between EU and non-EU supervisors enable non-EU fund managers from the relevant non-EU jurisdictions to market alternative funds (i.e., hedge funds, private equity funds and real estate funds) within the relevant EU jurisdiction under the Alternative Investment Fund Directive provided certain other conditions are also satisfied.
   
• The Federal Reserve Board Proposes Tough Liquidity Rules: On October 24 The Federal Reserve Board proposed a standardized minimum liquidity requirement for large and internationally active banking organizations, as well as systemically important, non-bank financial companies as identified by the Financial Stability Oversight Council. These entities would be required to hold minimum amounts of high quality liquid assets (HQLA) that could be converted easily and quickly into cash, such as central bank reserves and government and corporate debt. The amount of liquidity would have to be equal or greater than an entity's projected cash outflows minus its projected cash inflows during a short term stress period. Comments on the proposed rule will be accepted through January 31, 2014. According to the Board, "[t]he requirement is designed to promote the short-term resilience if the liquidity profile of internationally active banking organizations, thereby improving the banking sector's ability to absorb shocks arising from financial and economic stress." The Board claims its proposed liquidity coverage ratio is consistent generally with requirements under Basel III with some modifications, such as having a shorter transition period and more stringent requirements, including the type of assets that will qualify as HQLA. US firms would be required fully to comply with the new rules by January 1, 2017.
   
• Not Being Registered Dethrones HK "Futures King" and Lands Him in Jail: On October 24, a Hong Kong court convicted Mr. Gordon Mui Kwong Yin, known as the "Futures King" for advising other related to futures contracts without being registered with the Securities and Futures Commission of HK. Mr. Yin maintained a website from November 2009 through July 2010 where he provided futures trade signals for a subscription fee on the Hang Seng index and Hang Seng China Enterprises Index futures contracts. Mr. Yin has been remanded to jail pending sentencing on November 14.
   
• The US Financial Industry Regulatory Authority fines Firms for Best Execution, Sale of Unregistered Penny Stocks and AML Violations: FINRA last month fined Oppenheimer and Co. US $1.425 Million because of its sale of unregistered penny stock and for not having an adequate anti-money laundering program to detect and report suspicious penny stock transactions. FINRA claimed that Oppenheimer did not systemically review trading in penny stock for suspicious activity and failed to follow-up on certain red flags suggesting AML violations. Oppenheimer is also required to retain an independent consultant to review its handling of penny stocks and AML procedures, among other things. FINRA also fined Morgan Stanley US $1 Million and ordered restitution to customers for its failure to provide best execution in certain customer transactions involving corporate and agency bonds, among other violations. Because of new written supervisory procedures implemented by Morgan Stanley in response to an October 2011 US $1 Million fine by FINRA also related to markups and markdowns charged in corporate and municipal transactions, FINRA did not charge Morgan Stanley with failure to supervise in this action.
   
• IOSCO Issues Its Second Hedge Fund Survey: A week after issuing its first Securities Market Risk Outlook, IOSCO issued its Second Hedge Fund Survey. Four basic findings were:
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  1. the hedge fund industry is principally dominated by management/advisory firms located in the US and UK;
  2. the hedge fund industry remains mostly off-shore when considering the domicile of the investment vehicle, with the Cayman Islands being the dominant country of location;
  3. equity-oriented funds are the most represented strategy among active funds. Also significant are macro-oriented and multi-strategy funds; and
  4. although information is incomplete (because there is no US data), it appears that leverage is important for hedge funds, as their market footprint is greater than what their net asse t values would suggest. The gross leverage ratio for funds is greatest in the UK.

IOSCO's survey captured 1,044 directly managed funds internationally only (i.e., not funds of funds); each had assets under management or a net asset value in excess of US $500 Million.

• The Singapore Exchange Proposes A Remote Clearing Membership to Benefit US Persons and Explores Areas of Cooperation with the SHFE: The Singapore Exchange has proposed establishing a remote membership to permit US-based Futures Commission Merchants to clear swaps for US customers through SGX Derivatives Clearing. SGX Derivatives Clearing has applied to the CFTC to be a Designated Clearing Organization, and currently has no action relief for its clearing activities in the US. Comments may be submitted to SGX regarding its proposal by November 8. Separately SGX announced plans to cooperate with the Shanghai Futures Exchange to develop derivatives for energy, metals, chemicals and commodity indices.

For more details, see:

CFTC 2013 Enforcement Review:
http://www.cftc.gov/PressRoom/PressReleases/pr6749-13
CFTC SEF Relief regarding Trades Resubmitted for Clearing after an Initial Rejection for Clerical or Operational Errors:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-66.pdf
ESMA: Memoranda of Understanding signed by EU National Supervisors:
http://www.esma.europa.eu/news/ESMA-publishes-signed-AIFMD-cooperation-agreements
Federal Reserve Board Proposed Liquidity Rule:
http://www.federalreserve.gov/FR_notice_lcr_20131024.pdf
FINRA Enforcement Actions:
Oppenheimer & Co:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p315930.pdf
Morgan Stanley:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p317818.pdf
Hong Kong Unlicensed Futures Contract Adviser Jailed:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=13PR102
IOSCO: Report on Second Hedge Fund Survey:
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD427.pdf
NFA MRA against AlphaMetrix LLC:
http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seqnum=3768
SEC Sanctions under Compliance Program Initiative:
Overview:
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540008287--.UmsfOpF5vra
SEC v. Modern Portfolio Management:
http://www.sec.gov/litigation/admin/2013/ia-3702.pdf
SEC v. Equitas Firms:
http://www.sec.gov/litigation/admin/2013/34-70743.pdf
SEC Foreign Corrupt Practices Act Enforcement Actions:
In the Matter of Stryker Corporation:
http://www.sec.gov/litigation/admin/2013/34-70751.pdf
SEC v. Diebold, Inc:
http://www.sec.gov/litigation/complaints/2013/comp-pr2013-225.pdf
Singapore Exchange:
Cooperation with the SHFE:
http://www.sgx.com/wps/wcm/connect/sgx_en/home/higlights/news_releases/SGX+and+Shanghai+Futures+Exchange+to+collaborate+on+commodity+derivatives
Proposal for Remote Membership:
http://www.sgx.com/wps/wcm/connect/sgx_en/home/higlights/news_releases/SGX+proposes+remote+membership+for+clearing+of+US+customers+swaps

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 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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