Gary DeWaal and Associates LL

Gary DeWaal's Bridging the Week: December 23, 2013 to January 3 and 6, 2014 (Recordkeeping and Soft Dollar Violations; The Wolf of Wall Street)

Bridging the Week Compliance Weeds Totally Irrelevant (But Is It?)

Published Date: January 06, 2014

Santa Claus may have left presents for many during the holiday season, but a few financial services' industry registrants received only coal in their stockings during the past two weeks. These matters, a flurry of year-end no action letters issued by the US Commodity Futures Trading Commission, and helpful advisories issued by a number of regulatory entities highlight the first Bridging the Week for 2014.

Specifically the following matters are covered for what should be more correctly titled "Bridging the Weeks: December 23, 2013 to January 3, 2014:"

Barclays Capital fined US $3.75 Million for record retention failures (includes Compliance Weeds);
Instinet sanctioned more than US $800,000 for soft dollar violations;
US CFTC and US FERC enter into jurisdictional and information sharing memoranda of understanding;
CFTC seeks public comment on previously issued advisory regarding non-US swaps arranged by US persons;
FINRA announces regulatory and examination priorities for 2014;
CFTC says don't tell a lie during an interview – or else;
CFTC extends deadline for annual compliance report for some FCMs and Swap Dealers; relief for certain Swap Dealers from filing an annual compliance report in 2014 also is granted;
CFTC issues advisory regarding Commodity Trading Advisors' new obligations related to swaps; also extends relief for certain Introducing Brokers from certain financial requirements and certain Floor Traders from certain aggregation requirements;
US NFA summarizes new CFTC enhanced customer protection requirements for FCMs; some are effective January 13;
ICE and NYMEX fine members for miscellaneous violations including pre-arranged trading; last trading day delivery mishandling; and allowing multiple users to share a single user ID for electronic market access; and
CFTC approves SGX-DC as a DCO; EUREX to take 5% interest in TAIFEX.

Also included is a new feature, Totally Irrelevant (But Is It?) that has my review of the new Martin Scorsese film, The Wolf of Wall Street.

Video version:

Article version:

Barclays Capital Sanctioned US $3.75 Million for Record Retention Failures

On the day after Christmas, December 26, Barclays Capital was fined US $3.75 Million by the US Financial Industry Regulatory Authority (FINRA) for various electronic record keeping breakdowns; the Firm had agreed to the fine in an Offer of Settlement.

Among other things, according to FINRA, the Firm failed to retain:

electronic business records in non-rewritable, non-erasable format (i.e., WORM format – Write Once, Read Many) from at least 2002 to April 2012;
attachments to Bloomberg-system generated e-mails that were duplicates of attachments previously included in another prior generated email from May 7, 2007, through May 19, 2010; and
instant messages generated through the Bloomberg system from October 28, 2008 through May 19, 2010.

Although FINRA acknowledged that Barclays conducted conformance and validation testing since 2004 to help ensure its compliance with applicable record retention rules, the testing was aimed at ensuring that the Firm retained records for, and was able to retrieve such records within, required time periods, as opposed to whether they were stored in the required WORM format.

FINRA said that Barclays' failures regarding email attachments and instant messages arose because of inadequacies related to the setup of the Firm's method to capture Bloomberg-system provided data into its own electronic communication storage vault. FINRA alleged that because the Firm's capture system "…was functioning according to its default settings (albeit improperly configured settings), no alerts were generated indicating that the program had malfunctioned."

In May 2013, FINRA also fined five ING firms US $1.2 Million for deficiencies related to their email retention (see: http://www.garydewaalandassociates.com/?p=182).

Compliance Weeds: All principal international regulators have rules related to the generation and retention of records. These rules typically describe the type of records that must be prepared in the first instance; how long and in what format such records must be retained; and to whom and in what time period such records must be produced when requested by an authorized requestor. Unfortunately, given the large number of records that even a small size registrant generates in a given day, it is easy for a firm to run afoul of applicable requirements. This is why each registrant should (1) ensure it is fully familiar with applicable requirements, (2) design a comprehensive system that ensures compliance with these requirements in the first instance, but most importantly, (3) routinely test the applicable procedures afterwards. This testing should be two-fold: (1) from front to back, to ensure that the system is set up and functions according to requirements; and (2) back to front, to ensure that a wide variety sampling of documents (and with electronic communications, include attachments and so-called "bcc's") generated from different sources can be produced fully (and within time periods) as expected by regulators. Firms should periodically ensure also (1) that electronic documents are stored in a non-rewritable and non-erasable format and (2) that internal systems designed to capture electronic communications from different sources, capture all aspects of those communications including attachments and bcc's. Where oral communications are required to be retained, firms periodically should also test that applicable requirements are adhered to, especially that polices are robust related to order-related conversations occurring solely on recorded phones (to the extent required by the applicable regulation) and that there is adequate monitoring to ensure compliance.

Instinet Sanctioned More Than US $800,000 for Soft Dollar Violations

The US Securities and Exchange Commissions sanctioned Instinet LLC more than US $800,000 for approving soft dollar payments to an investment advisory firm when there allegedly were numerous "red flags" that such payments were for expenses never properly disclosed by the advisory firm to its clients. The investment advisory firm was San Diego, California-based J.S. Oliver Capital Management, LP.

According to the SEC, Instinet remitted US $430,000 in client commission credits to JS Oliver from January 2009 through July 2010 for expenses that were never properly disclosed by JS Oliver to its clients. These expenses included:

US $329,365 to the ex-wife of JS Oliver's president, Ian O. Mausner, related to their divorce;
US $65,000 for 13 months of rental payments for offices of JS Oliver and Mr. Mausner's personal residence; and
US $40,095 for upkeep on Mr. Mausner's New York City timeshare.

The SEC claimed that Instinet made these payments, despite one or more of its employees being aware of various red flags. These included, among other things:

in connection with the payments to Mr. Mausner's ex-wife, the fact that (1) the recipient was the ex-wife; (2) Mr. Mausner's gave inconsistent justifications for the purpose of the payment; and (3) despite Instinet's request, JS Oliver never provided Instinet with an employment agreement for the ex-wife or a legal opinion justifying the payments;
in connection with the rental payments, the fact that the JS Oliver's offices were at Mr. Mausner's home address; and
in connection with the time shares, the addressee was "Fifth & Fifty-Fifth Residence Club Association, Inc., and the expenses described as a "Maintenance Fee."

For its sanctions, Instinet agreed to pay disgorgement and interest totaling in excess of US $438,000 and a fine of US $375,000, as well as retain an independent consultant to review its policies, procedures and practices related to soft dollars and issue recommendations.

On August 30. 2013, the SEC filed charges in an administrative action against JS Oliver, Mr. Mausner and Douglas Drennan, who has served as a portfolio manager and Chief Compliance Officer for JS Oliver at various times since June 2011. These charges related to the soft dollar payments discussed in the Instinet action, as well as the SEC's allegation that, from June 2008 to November 2009, JS Oliver purportedly gave favorable trades to some clients (including four affiliated hedge funds) while disfavoring others, through a cherry-pick trade allocation scheme, hurting such unfavored clients by US $10.7 Million. This action remains pending.

And briefly:

US CFTC and US FERC Enter into Jurisdictional and Information Sharing Memoranda of Understanding: the United States Commodity Futures Trading Commission and the US Federal Energy Regulatory Commission entered into a Memorandum of Understanding on January 2, 2014, to help resolve jurisdictional overlaps between the two agencies as well as to avoid duplicative regulation. In general the MOU provides for pro-active communication between the agencies when one agency determines that an entity is seeking authorization or exemption for an activity that may arguably fall within the overlapping authority of the other agency. At such point, the MOU provides for dialogue between the agencies to resolve the jurisdictional overlap, including escalation processes potentially up to the commissioners of each agency until a dispute is resolved. The MOU appears to address solely instances of an entity seeking to engage in activities, rather than situations where both agencies claim enforcement authority over the same entity for allegedly wrongful conduct. In a judicial decision during March 2013 (Brian Hunter v. FERC), the United States Court of Appeals for the District of Columbia Circuit, concluded that the CFTC has exclusive jurisdiction over all transactions involving commodity futures contracts, and rejected FERC's efforts to fine petitioner for allegedly manipulating natural gas futures contracts. Separately, the CFTC and FERC also entered into an information sharing agreement on January 2 to assist the other agency "…in connection with market surveillance or an investigation into potential manipulation, fraud, or market power abuse in markets subject to such Participating Agency's regulation or oversight."

CFTC Seeks Public Comment on Previously Issued Advisory Regarding non-US Swaps Arranged by US Persons: In an unexpected development, the CFTC is now seeking public comment on an advisory issued last November 2013 by its Division of Swap Dealer and Intermediary Oversight (DSDIO) regarding swaps involving a non-US swap dealer arranged by US employees or agents. Generally the advisory said that in connection with such swaps, the non-US swap dealer would be subject to CFTC transaction requirements (see relevant article, http://www.garydewaalandassociates.com/?p=1406). The CFTC said it was now seeking comments "[i]n view of the complex legal and policy issues with respect to the Staff Advisory." The vote among CFTC Commissioners to seek comment was 3-1, with Commissioner Scott O'Malia dissenting. According to Commissioner O'Malia: "If you thought the Commission's approach last year regarding cross-border issues resulted in unsound rulemaking process, the start of 2014 is no better. Today's announcement of the request for comment…abrogates the Commission's fundamental legal obligations under the Administrative Procedure Act and provides another example of the Commission's unsound rule process." Comments will be due by 60 days after publication of the CFTC's request in the Federal Register. Separately, three CFTC divisions extended until September 15, 2014, the day non-US swap dealers must be in compliance with DSDIO's November 2013 advisory.
FINRA Announces Regulatory and Examination Priorities for 2014: On the day after New Year's Day, January 2, FINRA announced its regulatory and examination priorities for 2014. This provides a helpful roadmap for regulated firms to review internal policies and practices to ensure they are complying with applicable requirements in areas that are a priority to at least one regulator. Among other matters FINRA will be looking at more closely include (1) the suitability of recommendations to retail clients related to complex products (e.g., products sensitive to interest rate or volatility changes, products with fee structures that may be difficult to grasp); (2) conflicts of interest; (3) cyber security; (4) general solicitation and advertising of private placements; (5) anti-money laundering (with a special warning about the responsibility of prime and executing brokers related to customer identification programs); (6) insider trading; (7) funding and liquidity risk; (8) accuracy of a firm's financial statements and net capital; (9) algorithmic trading and trading systems; (10) high frequency trading; and (11) audit trail integrity. In connection with its review of funding and liquidity, FINRA particularly noted its concern "…about the heightened potential for collateral squeezes and the adverse impact these may have on firms' ability to fund their operations. The increased use of CCPs and cleared swaps is boosting demand for high-quality collateral. Meeting this demand may prove challenging and may raise the cost of some traditional channels for obtaining such collateral, e.g., through collateral upgrade trades."

CFTC Says Don't Tell a Lie During an Interview – or Else: The CFTC entered into a voluntary settlement with Artem Obolensky for allegedly lying to its staff during an investigation related to non-competitive trading that occurred on one day in 2011 between a foreign bank where he currently serves as president, and another foreign entity involving Japanese Yen call options traded on the Chicago Mercantile Exchange. The CFTC claims that, during an interview with its staff, Mr. Obolensky said that it was simply "pure coincidence" that the two entities traded opposite each other; "[t]here was no bad intent." However the CFTC alleges that subsequent to Mr. Obolensky's interview, it discovered that the two entities traded opposite each other more than 182 times between May 2010 and June 2011, and changed their orders repeatedly to ensure their orders would match. As part of his settlement, Mr. Obolensky agreed to cease and desist from making false or misleading statements to the Commission and to pay a fine of US $250,000. According to the website of SMP Bank of Latvia, Mr. Obolensky is its Deputy Chairman of the SMP Bank Council. In August 2012; SMP Bank and Epaster Investments, Ltd. agreed to pay US $700,000 and US $280,000 respectively for engaging in wash sales related to the CME's Japanese Yen options contract between April 15 and May 5, 2011.

CFTC Extends Deadline for Annual Compliance Report for Some FCMs and Swap Dealers; Relief for Certain Swap Dealers from Filing an Annual Compliance Report in 2014 Also Granted: For 2014 only, the CFTC's Division of Swap Dealer and Intermediary Oversight (DSDIO) says that all registered futures commission merchants and swap dealers may file their annual compliance reports by no later than 90 days following the firm's fiscal year. The Futures Industry Association had requested this relief on behalf of CFTC registrants that also are registered with the US Securities and Exchange Commission as Broker Dealers that otherwise would have had to file their annual compliance report within 60 days following the firm's fiscal year. Separately the CFTC's DSDIO said that firms not required to register with it as Swap Dealers prior to December 31, 2013, and which have a fiscal year ending December 31, 2013, are not required to file annual compliance reports for 2013 during 2014. This is relevant for firms that exceeded the threshold that required registration as a swap dealer during 2013, but have two months after the month in which they exceed the threshold (which would occur during 2014) to register.

CFTC Issues Advisory Regarding Commodity Trading Advisors' New Obligations Related to Swaps; Relief for Certain Introducing Brokers from Certain Financial Requirements and Certain Floor Traders from Certain Aggregation Requirements Also Granted: Because of Dodd Frank and related new rules imposed by the CFTC, the Agency's Division of Swap Dealer and Intermediary Oversight (DSDIO) issued an advisory summarizing new obligations applicable to commodity trading advisors generally, as well as which types of advisors, previously exempt, are now required to register formally as CTAs. The CFTC's DSDIO reminded CTAs that are exempt from registration that they may still be subject to certain requirements applicable to all CTAs. These include that all CTAs may not reference any testimonials or simulated or hypothetical performance without certain disclosures, and may not handle customer funds unless also registered as a futures commission merchant. The CFTC's DSDIO pointed out that there are now additional disclosures required of registered CTAs related to the material risks of certain swaps transactions. Also, unless exempt, persons advising so-called "special entities" (e.g., a Federal agency, a state, a state agency, city, municipality or other political subdivision of a state) regarding swaps transactions must be registered as a CTA. Separately, the CFTC's DSDIO granted relief (1) to certain introducing brokers from including as a liability in their calculation of adjusted net capital, certain employee owed compensation associated with swaps transactions; and (2) to certain foreign-based introducing brokers from (a) preparing their unaudited and audited financial statements in accordance with GAAP (provided they are prepared in accordance with International Financial Reporting Standards, and, (b) if they were registered initially from October 1 through December 31, 2013, from filing an audited financial report for the year ending December 31, 2013. Certain conditions must be met to qualify for these reliefs. The CFTC's DSDIO also granted relief to certain floor traders and their affiliates in connection with swaps trades, permitting them to exclude certain swaps from their aggregate gross notional amount calculation to assess whether they are required additionally to register as swap dealers.

US NFA Summarizes New CFTC Enhanced Customer Protection Requirements, Some of Which Are Effective January 13: In time for New Year's Eve, on December 31, the US National Futures Association, in a very concise and helpful publication, summarized new notification and report filing requirements that become effective this year, beginning January 13, as a result of the enhanced customer protection rules enacted by the CFTC last year. Beginning that day, a US registered future commission merchant must give immediate notice to the CFTC and its designated self regulatory organization (DSRO) if (1) the amount it holds in each of its segregated, secured or cleared swaps customer funds' categories is insufficient to satisfy its targeted residual interest amount; (2) funds in any customer protected category are invested in investments not permitted by the CFTC; or (3) it or any material affiliate experiences a material adverse impact to its creditworthiness or ability to fund its obligation, including any change that could imperil its liquidity resources. An FCM must give notice within 24 hours if (1) it experiences any material change to its operations or risk profile, including the cessation of a business line or a change in any senior manager; (2) it receives notice that it is subject to a formal investigation from the SEC, or any futures or securities SRO; (3) it receives notice from the SEC or any securities SRO that it has concerns regarding the FCM's capital adequacy, liquidity or internal controls; or (4) the SEC or any securities SRO issues an examination report to the FCM (and the FCM must provide a copy of the report). All notices must include a discussion of how the relevant issue originated and what measures have been take, are being taken or will be taken to resolve the issues. In addition, beginning January 13, an FCM must obtain acknowledgement letters from its new depositories of customer funds (as required by CFTC rule) in the new CFTC-prescribed form within three business days of establishing a new account, and file such copies with the CFTC and its futures DSRO. It must update existing acknowledgment letters for customer funds accounts by July 12, 2014, and also file such letters with the CFTC and its futures DSRO. FCMs must also file with the CFTC and their futures DSRO their initial Risk Management Program that complies with the CFTC's new enhanced customer protection rules by July 12.

ICE and NYMEX Fine Members for Miscellaneous Violations Including Pre-arranged Trading; Last Trading Day Delivery Mishandling; and Allowing Multiple Users to Share a Single User ID for Electronic Market Access: Just prior to Christmas, the Business Conduct Committee of ICE Futures US found that a member firm, Rex Trading, LLC at the direction of its principals, Jonathan Kleisner and Dave Schelhorn, and the principals of a non-member firm (PB Investments), Cary Potkin and Warren Alper, may have engaged in pre-arranged accommodation trades involving rolls of the Continuous Commodity Index futures contract during April, June and October 2009. These pre-arranged transactions may have involved impermissible pre-execution communications. Rex and Messrs. Joseph Carman and Kleisner were additionally found liable for violations stemming from Mr. Carman's execution of electronic trades purposely using Mr. Kleisner's unique trader identification. For all these violations Mr. Kleisner was fined US $200,000 and suspended from membership and exchange trading privileges for six months; Mr. Potkin was fined US $150,000; Rex Trading was fined US $75,000; Mr. Alper was fined US $75,000 and suspended from membership and exchange trading privileges for one year; and Messrs. Schelhorn and Carman received lesser sanctions. Separately the the New York Mercantile Exchange (CME Group) fined Newedge USA, LLC US $20,000 for failing to liquidate in an orderly fashion open positions involving the physically settled August 2013 Crude Oil futures contract on the last trading day of the contract (July 22, 2013) as required pursuant to the Exchange's rules. In another matter, FC Stone also was fined by NYMEX US $22,500 for allowing multiple users to use a single user ID ("Tag 50 User ID") for access to an automated trading system, as well as for other Tag 50 violations between August and December 2010. Both Newedge and FC Stone settled their matters.

CFTC Approves SGX-DC as a DCO; EUREX to Take 5% Interest in TAIFEX: The Singapore Exchange Derivatives Clearing Limited was approved as a designated clearing organization by the CFTC on December 27. Earlier, the CFTC's Division of Clearing and Risk had indicated it would take no action through March 31, 2014, regarding members of SGX-DC who maintained OTC commodity contracts trades for US persons without being registered with the CFTC as future commission merchants; such non-FCM members could also accept liquidating contacts through such date. Separately, Eurex Zurich AG announced it would acquire a 5% interest in the Taiwanese Futures Exchange subject to approval by the Taiwanese regulatory authorities. Previously, both EUREX and TAIFEX had announced plans to list on EUREX beginning May 15, 2014, daily expiring futures based on TAIEX index futures and options.

And finally:

Totally Irrelevant (But Is It?): I saw The Wolf of Wall Street during the recent holiday period. This is Martin Scorsese's depiction of the rise and fall of Jordan Belfort, the founder of Stratton Oakmont one of the infamous pump and dump brokerage operations of the 1980's and 90's. Although the leading cast members in the movie perform admirably, especially Jonah Hill as Belfort's --2, the depiction of both Belfort and Stratton Oakmont are quite disturbing. Plain and simple, Belfort was a criminal who, to me, got off way too easily in light of the extensive nature of Stratton Oakmont's fraudulent operations and its horrible rip off of many retail clients (he served less than two years in prison for his crimes). However, Belfort's character, as depicted by Leonardo DiCaprio, appears glorified in the movie, and he is portrayed, in a cameo role at the end of the film as a reformed, successful motivational speaker. Indeed, the message of the film seems to be "so what?" However, Belfort's actions deserve condemnation not glorification. Even through today, Belfort may be failing to live up to his sentencing requirement to pay 50% of his income up to US $110 Million as restitution, despite his now successful career as a motivational speaker, as an author (he has written two life stories), and now as an actor in this film. If you have not done so already, go see this film but not necessarily to enjoy it; rather to be reminded of the danger of greed and a life of excess. Let's just hope that Martin Scorsese isn't planning as a sequel an equally enthusiastic portrayal of Russell Wassendorf and the collapse of Peregrine Financial Group. And, despite the title of the film, Stratton Oakmont was headquartered on Long Island, NY, not on Wall Street -- and not remotely like any firm on Wall Street that I have ever come across!

For additional information:

CFTC-FERC Jurisdiction and Information Sharing MOUs:
Jurisdiction:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcfercjmou2014.pdf
Information Sharing:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcfercismou2014.pdf

See also: Brian Hunter v. FERC (USCA, DC Cir. March 15, 2013):
http://www.ferc.gov/legal/court-cases/opinions/2013/11-1477-opinion.pdf

See also, CFTC's Extension of Compliance Date of November 2013 Advisory for non-US Swap Dealers:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-01.pdf

EUREX to Take 5% Interest in TAIFEX:
http://www.eurexgroup.com/group-en/newsroom/press-releases/765462/
FINRA 2014 Examination Priorities:
http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p419710.pdf
FINRA v. Barclays:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p413666.pdf
In the Matter of Instinet, LLC (SEC action):
http://www.sec.gov/litigation/admin/2013/34-71191.pdf

See also: In the Matter of J.S. Oliver Capital Management LP et al (SEC action):
http://www.sec.gov/litigation/admin/2013/33-9446.pdf

Miscellaneous Exchange Disciplinary Actions:
FC Stone (NYMEX):
Available on Request
Newedge USA (NYMEX):
http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0221520&case=13-9534-BC+NEWEDGE+USA+LLC&contrib=NYME
Rex Trading (ICE):
http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0227420&case=2012-074&contrib=ICE
NFA Summary Regarding CFTC Enhanced Customer Protection FCM Obligations:
http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4371
In the Matter of Artem Obolensky (CFTC action):
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfobolenskyorder010214.pdf

See also: In the Matter of SMP Bank and Epaster Investments Ltd:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfsmporder082712.pdf

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 January 4, 2014, 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.