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Gary DeWaal’s Bridging the Week: February 3 to 7 and February 10, 2014 (Position Limit Violations, CME Expanded Jurisdiction, AML Violations (Again))

Bridging the Week Compliance Weeds My View

Published Date: February 10, 2014

Friday February 14 may be Valentine’s Day, but whether there will be any love this week in the financial services industry may depend on how certain important deadlines and hearings worldwide play out. Among other things, this week will see (1) European financial and non-financial institutions begin reporting their OTC and exchange traded derivatives transactions under EMIR commencing February 12; (2) the first interest rate swaps certified as “Made Available to Trade” (MAT) mandatorily being executed in most instances on or subject to the rules of a SEF or DCM starting on February 15; (3) certain non-US swaps trading platforms being required to qualify by February 15 as SEFs in order to handle for US persons swaps subject to MAT certifications – absent relief from the Commodity Futures Trading Commission; and (4) three distinct public hearings at the CFTC addressing (a) how to handle the execution of multiple legged “package transactions” where one leg involves a swap subject to a MAT certification; (b) certain aspects of the CFTC’s Cross Border Guidance; and (c) issues related to automated trading systems, among other topics.

However, last week there also were many important developments involving the financial services industry, and these are all covered on

Gary DeWaal’s Bridging the Week, including:

Acting CFTC Chairman Mark Wetjen signals a possibly more conciliatory approach to international regulation;
CME settles cases involving position limits', wash trades', and a potpourri of other violations; asserts jurisdiction over an employee of an affiliate of a member (includes Compliance Weeds);
FINRA says Brown Brothers Harriman had an unsatisfactory anti-money laundering program; sanctions firm and former global AML compliance officer (includes Compliance Weeds);
CFTC issues Notice related to FCM and depository reporting under its new enhanced customer protection rules;
ESMA reminds firms regarding expected practices for selling complex financial products to retail investors;
SEC announces draft strategic five-year plan;
Singapore MAS and SGX consider securities market structure and practices;
CFTC’s Division of Clearing and Risk approves ASX Clear (Futures) Pty Limited to clear proprietary trades of US clearing participants (includes My View);
SEC commences enforcement action against two friends related to “parking” securities; and more.

Video Version:

Article Version: Acting CFTC Chairman Mark Wetjen Signals a Possibly More Conciliatory Approach to International Regulation

In a speech last week before the US Senate Committee on Banking, Housing & Urban Affairs, Mark Wetjen, Acting Chairman of the US Commodity Futures Trading Commission appeared to signal a more conciliatory approach in addressing the international coordination of swaps regulation. Among other things, with an important deadline related to non-US swaps trading facilities handing certain interest rate swaps subject to the February 15 MAT determination upcoming, Acting Chairman Wetjen suggested that greater reliance on home country supervision of trading venues and clearing houses, as opposed to each country insisting on its own regulation, may promote “efficient and liquid markets.” According to the Acting Chairman in his prepared remarks:

“Harmonizing regulations governing clearinghouses and trading venues, in particular, is critical to sound and efficient market structure. Even if firms are able to navigate the conflicts and complexities of differing regulatory regimes, regulators here and abroad must do what they can to avoid incentivizing corporate structures and inter-affiliate relationships that will only make global financial firms more difficult to understand, manage, and unwind during a period of market distress… A global regime is the best means to avoid balkanization of risk and risk management that may expose the U.S. financial system over time to risks that are unnecessary, needlessly complex, and difficult to predict and contain.”

Acting Chairman Wetjen also implied that there may be additional determinations that foreign jurisdictions' regulation of swaps is “comparable to and as comprehensive” as US regulation. This could open the door to non-US Swap Dealers and Major Swap Participants relying on more of their local, domestic rules to comply with many of their requirements under CFTC rules.

CME Settles Cases Involving Position Limits’, Wash Trades’, and a Potpourri of Other Violations; Asserts Jurisdiction over an Employee of an Affiliate of a Member

The Chicago Mercantile Exchange announced a number of exchange disciplinary actions, two of which are particularly worth noting because of issues related to position limits in related contracts, and the claimed reach of CME jurisdiction.

Position Limits (Related Contracts): NYMEX settled two matters with Vermillion Asset Management related to violations of its position limits requirements. In the first matter, the Firm agreed to pay a fine of US $45,000 related to its violation on March 22, 2013, of a conditional position limit it had been granted in connection with the April 2013 Henry Hub Natural Gas Look-Alike Last Day Financial Futures contract. According to the Exchange, Vermillion had been granted a 1,000 lot position limit on the financially settled Henry Hub financial contract subject to the firm holding no positions in the related physically settled April 2013 Henry Hub Natural Gas futures contract on its last three trading dates. However, on one of those dates, Vermillion held a nominal intraday position in the physically settled contract of 35 lots, thus violating the conditional limit. The Firm also agreed to pay a fine of US $35,000 related to a second, but earlier violation of a position limit on November 26, 2012, involving the December 2012 Henry Hub Natural Gas futures contract. Here too, Vermillion had been granted a 5,000 lot position limit on the financially settled contract provided the firm held no positions in the related physically settled contract on its last three trading dates; however, on one of those dates, it also held an intraday position in the physically settled contract -- in excess of 2,000 lots -- thus violating the conditional limit.
Wash Trades (Jurisdiction): Separately, both COMEX and NYMEX settled two actions with Merrill Lynch Commodities (Europe) Limited, headquartered in the UK, for failing to supervise an employee who allegedly engaged in wash trades on various dates during April 2012. Apparently, an MLCE employee, Guillaume Marchand, engaged in a series of buy and sell trades in various gold options and copper futures, as well as crude options and futures contracts between accounts with the same beneficial owner. MLCE agreed to pay a fine of US $15,000 for each matter (total US $30,000). Mr. Marchand was charged separately by both the COMEX and NYMEX related to these matters and agreed to pay fines totaling US $10,000. In connection with the COMEX matter, Mr. Marchand also was banned from all CME trading for five business days.
Wash Trades: An individual COMEX member also settled with the Exchange for alleged violations of wash trades’ and prearranged trades’ prohibitions. In this matter, John Forlenza, a registered floor broker, agreed to pay a fine of US $50,000 for allowing other brokers on multiple occasions from March 2011 to May 2011 to take the opposite side of certain of his customers’ trades. In addition, Mr. Forlenza agreed to disgorge profits earned on this activity (US $2,175) and to a five-week suspension for trading on CME platforms.
Trading Ahead: Finally, two individuals were charged by COMEX with trading ahead of customer orders in non-competitive transactions. In one matter related to trading on various dates from March through May 2011, Christopher Moore, a registered floor broker, agreed to pay a fine of US $60,000, to disgorge profits (US $3,212), to pay customer restitution (US $3,037) and to be barred from trading on CME platforms for three weeks. In the other action related to conduct on March 7 and April 8, 2011, Louis Quaglia, a registered floor broker, agreed to pay a fine of US $30,000, to disgorge profits (US $1,125), to pay customer restitution (US $250), and to be barred from trading on CME platforms for two weeks.

Compliance Weeds: The Merrill Lynch Commodities matter should remind members that the CME considers that it has jurisdiction over (1) not only its members, but (2) employees of its members, (3) certain of their affiliates, as well as (4) employees of these affiliates too -- no matter where physically located. Indeed, CME Rule 418 expressly provides that any person who trades a CME product expressly consents to the jurisdiction of the CME in connection with its investigatory and disciplinary process -- whether associated with a member or not:

"Any Person initiating or executing a transaction on or subject to the Rules of the Exchange directly or through an intermediary, and any Person for whose benefit such a transaction has been initiated or executed, expressly consents to the jurisdiction of the Exchange and agrees to be bound by and comply with the Rules of the Exchange in relation to such transactions, including, but not limited to, rules requiring cooperation and participation in investigatory and disciplinary processes."

Separately, the Vermillion Asset Management matters, should remind trading firms how important it is today to have the capacity to monitor in real time trading positions on a futures equivalent basis against position limits, particularly in situations where position limits in one contract may be conditioned on adherence to position restrictions in another contract. Even a temporary intra-day position limit violation corrected by the end of day may be prosecuted as a rule violation. Imagine how complicated this will be when swaps, futures and options must be aggregated across affiliated entities and monitored real time on a futures equivalent basis in order to comply with CFTC position limit requirements.

And briefly:

FINRA Says Brown Brothers Harriman Had an Unsatisfactory Anti-Money Laundering Program; Sanctions Firm and Former Global AML Compliance Officer: Brown Brothers Harriman & Co. agreed to pay a fine of US $8 Million related to an allegation by the Financial Industry Regulatory Authority that it had “substantial” anti-money laundering compliance failures from January 1, 2009, through June 30, 2013. FINRA claimed these failures related to BBH’s monitoring and detection of suspicious activity related to transactions in low-priced securities (i.e., penny stocks). In addition, Harold Crawford, the Firm’s Global AML Compliance Officer during the relevant time, agreed to pay a fine of US $25,000 and a one month suspension from association with any FINRA member in any capacity. This matter arose in connection with the Firm’s business of executing sales in or, as a custodian, delivering to other firms shares of penny stocks. According to FINRA. “[t]rading in penny stocks typically poses a higher than average risk, because of the possibility of low trading volumes and relative lack of information regarding issuers.” During the relevant time, BBH conducted penny stock transactions on behalf of certain bank customers through omnibus accounts from known bank secrecy “havens” such as Switzerland, Guernsey and Jersey, without being able to obtain (1) “critical” information regarding the stocks’ beneficial owner, (2) how the stocks were obtained or (3) the beneficial owners’ relationship with the issuers. BBH and Mr. Crawford, says FINRA, were aware through AML investigations, regulatory inquiries and other sources that certain of its clients were depositing and then quickly selling large blocks of penny stocks. However, they failed adequately to monitor and detect suspicious penny stock activity in general, and failed to ensure that suspicious activity was reported, or that previously filed reports of suspicious activity were updated within 90 days, as required by law. Prior to this matter, in 2007, BBH entered into a written agreement with the NYS Banking Department to improve its system of internal controls related to the verification of account identities and to devote sufficient resources to implement and maintain an effective AML program.

Compliance Weeds: Clearly, as numerous recent AML matters indicate, regulators worldwide, especially FINRA, have made prosecuting AML violations a high priority with costly consequences. If you haven't reviewed my prior Compliance Weeds regarding how better to keep track of "Red Flags," now is the time. Check out http://www.garydewaalandassociates.com/?p=1769 ("JP Morgan Criminally Charged and Settles Related to Its Handling of Bernard Madoff Accounts; OCC and FINCEN Civil Charges Also Settled; " see Compliance Weeds at the end of the article).

US Commodity Futures Trading Commission Issues Notice related to FCM and Depository Reporting under its Enhanced Customer Protection Rules: Under new CFTC enhanced customer protection rules, future commission merchants are required to obtain from each depository that holds their customer funds certain acknowledgment letters in a standard form recently approved by the Commission. In these template letters, depositories agree to comply with applicable law in holding such funds. FCMs have been required to use these new form letters since January 13 for new accounts, and to implement these form letters by July 12 for all accounts existing as of January 13. (see article, "US NFA Summarizes New CFTC Enhanced Customer Protection Requirements, Some of Which Are Effective January 13" at: http://www.garydewaalandassociates.com/?p=1719.) A copy of each executed acknowledgment letter must also be filed with the CFTC by each FCM and each depository holding customer funds within three business days after the opening of a new account, or the signing of an acknowledgement letter for an old account. In a Notice issued last week the CFTC’s Division of Swap Dealer and Intermediary Oversight advised FCMs to file executed Acknowledgement letters with it through the WinJammer ™ Online Filing System, and for depositories holding customer funds (including FCMs clearing for other FCMs) through a newly-developed on line submission site, accessible at: https://forms.cftc.gov/_layouts/Forms/AcknowledgementLetter.aspx. In the Notice, the DSIO also (1) proposed a means of assistance (i.e. call Kevin Piccoli, DSIO Deputy Director) for depositories whose operations and security protocols require the name(s) of CFTC staff in account opening documents where such depositories agree to provide the CFTC read-only access to customer segregated or secured accounts; and (2) instructed FCMs also to file through the WinJammer ™ system certain other mandatory filings under the new enhanced customer rules: certain regulatory notices; risk assessment reports; risk management policies and procedures; risk exposure reports, and their certified annual financial report.
ESMA Reminds Firms Regarding Expected Practices for Selling Complex Financial Products to Retail Investors: The European Securities and Markets Authority has issued an Opinion setting forth its minimum expectations regarding the conduct of investment firms when they sell complex products to retail investors. ESMA has issued this Opinion because it is “concerned” that firms selling practices under the Markets in Financial Instruments Directive “may have fallen short in a number of cases.” The Opinion is directed both to investment firms as well as national regulators, and follows its review of structured products sold to retail investors as well as UCITS (a type of collective investment under the European Undertakings for Collective Investments in Transferrable Securities Directives) pursuing alternative investment strategies in recent years. To ESMA, products are “complex” when (1) they are derivatives or include a derivative; (2) are made up of financial instruments that are difficult to value; (3) rely on opaque indices; (4) have barriers to exit that are not clearly explained; (5) have returns or pay-off structures that are subject to complex mathematical formulas, and/or (6) include capital protection that may be conditional or withdrawn. Among other things, investment firms should have (and national regulators should review investment firms to ensure they have) (1) internal controls related to their provision of complex products to both retail and professional clients; (2) adequate staff training; (3) suitability and appropriateness assessments as part of their practices related to advising clients on complex products; and (4) adequate disclosure.
US SEC Announces Draft Five-year Strategic Plan: The US Securities and Exchange Commission announced a Draft Strategic Plan for its fiscal years 2014 to 2018. This plans includes the SEC’s proposed mission, values, strategic goals, major initiatives and performance metrics for this period. Although the strategic goals are mostly very high level (e.g., “[e]stablish and maintain an effective regulatory environment”), there are some proposed specific areas for initiatives. These include (1) modernizing beneficial ownership reporting; (2) modernizing the regulatory treatment and valuation of certain portfolio holdings of registered investment companies (e.g., derivatives); (3) reviewing the impact of algorithmic and other automated trading on markets to assess the impact on volatility and to consider, if warranted, an “appropriate policy response;” and (4) evaluating equity market structure. Comments are due by March 10, 2014.
Singapore MAS and SGX Considers Securities Market Structure and Practices: The Monetary Authority of Singapore and the Singapore Exchange Limited also are considering issues related to securities market structure and practices. In connection with an ongoing review, the MAS and SGX have concluded that Singapore’s securities market is “…sound and continues to facilitate fair, orderly and transparent trading” of the securities listed on SGX. However, MAS and SGX are considering possible enhancements related to measures to (1) promote orderly trading (e.g., , minimum securities’ prices, collateral requirements for securities trading, and enhanced safeguards for customers’ assets); (2) augment the transparency of market intervention measures; and (3) enhance the process to admit new listings and to enforce against listing rule breaches. Comments are due by May 2, 2014.
US SEC Commences Enforcement Action Related to “Parking:” The US SEC commenced administrative enforcement actions against two friends related to the efforts by one individual to avoid a prohibition by his broker dealer employer from holding securities for too long. He endeavored to avoid the restriction by having his friend’s different broker dealer employer temporarily purchase the relevant securities subject to a buy back arrangement that would ensure his friend’s employer a profit. According to the SEC, Thomas Gonnella sought out the assistance of his friend, Ryan King, to avoid a charge to his trading account, and ultimately a reduction to his bonus, he would incur if he held certain securities for more than three months. Mr. Gonnella’s pre-arranged transactions with Mr. King violated his employer’s policies, says the SEC. Both respondents allegedly took affirmative steps to try to evade detection by interposing an interdealer broker and communicating by cell phones after Mr. Gonnella’s supervisor began asking about the trades. Simultaneously with the filing of these actions, Mr. Ryan settled with the SEC by agreeing to pay disgorgement and prejudgment interest in excess of US $24,000 and not to work in the securities industry for at least three years. Additional financial penalties may be determined at a later date. The action against Mr. Gonnella is pending. Both friends previously were terminated by their employers for this matter.

And even more briefly:

The CFTC’s Division of Clearing and Risk approved ASX Clear (Futures) Pty Limited to clear proprietary trades of US clearing participants in Australian and New Zealand dollar-denominated interest rate swaps until the earlier of December 31, 2014, or its registration as a Designated Clearing Organization. ASXCF currently is not registered with the CFTC as a DCO.

My View: Could this be an early example of Acting Commissioner’s Mark Wetjen’s more conciliatory approach in addressing the international coordination of swaps regulation?

The CFTC also issued NZX Limited an Order of Registration that grants it the authority to provide direct market access through its electronic order entry and trade matching system to certain US persons.
The Dubai Financial Services Authority has prevailed in its enforcement action against Deutsche Bank AG to compel the Bank to produce certain information and documents (see http://www.garydewaalandassociates.com/?p=1406, "DFSA Commences an Enforcement Action for Information against Deutsche Bank").

For more information, see:

CFTC NZX Order:
http://www.cftc.gov/stellent/groups/public/@otherif/documents/ifdocs/nzxfobtregistorder.pdf.
CFTC DCR Approval OF ASXCF Handling of Certain Proprietary Swaps Trades of US Clearing Members: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-07.pdf.
CFTC DSIO Notice Related to Reporting of Certain Matters:
http://www.cftc.gov/ucm/groups/public/@forms/documents/file/dsionotice_20140205.pdf

CME Disciplinary Actions:

John Forlenza: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0037870&case=11-8253-BC+JOHN+FORLENZA&contrib=CEI.

Merrill Lynch Commodities (Europe) Limited:

COMEX Violation: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0444689&case=12-9058-BC+MERRILL+LYNCH+COMM+EUROPE&contrib=CEI. NYMEX Violation: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0444689&case=13-9457-BC+MERRILL+LYNCH+COMM+EUROPE&contrib=NYME.

Christopher Moore: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0036687&case=11-8253-BC+CHRISTOPHER+MOORE&contrib=CEI.

Louis Quaglia: http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0247220&case=11-8253-BC+LOUIS+QUAGLIA&contrib=CEI.

Vermillion Asset Management:
March 22, 2013 Violation:
http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0354314&case=13-9375-BC+VERMILLION+ASSET+MNGMNT&contrib=NYM.
November 26, 2012 Violation:
http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0354314&case=12-9155-BC+VERMILLION+ASSET+MNGMNT&contrib=NYME.

DFSA Prevails in Enforcement Action against Deutsche Bank:
http://www.dfsa.ae/WhatsNew/DispForm.aspx?Id=279.
ESMA Opinion on Complex Products:
http://www.esma.europa.eu/system/files/ipisc_complex_products_-_opinion_20140105.pdf.
FINRA AWC re: Brown Brothers Harriman:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p443448.pdf.
Singapore MAS Consultation Paper on Securities Market Structure and Practices: http://www.mas.gov.sg/~/media/MAS/News%20and%20Publications/Consultation%20Papers/Review%20of%20Securities%20Market%20Structure%20and%20Practices.pdf. US SEC Enforcement Action related to “Parking”

Thomas Gonnella http://www.sec.gov/litigation/admin/2014/33-9544.pdf.
Ryan King http://www.sec.gov/litigation/admin/2014/33-9543.pdf.

US SEC Proposed Five-Year Strategic Plan:
http://www.sec.gov/about/sec-strategic-plan-2014-2018-draft.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 February 8, 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.