Gary DeWaal and Associates LLC

The necessity to comply precisely with US exchange requirements regarding Exchange of Futures for Related Positions and Block Trades was highlighted last week through disciplinary actions brought by the CME and ICE Futures. Also, a UK Financial Conduct Authority enforcement action suggests the need to consider carefully the impact of not telling one regulator about a material enforcement investigation or action being undertaken by another regulator regarding an affiliate even when the affiliate may be outside the same country. As a result, the following stories are covered on this week’s Gary DeWaal’s Bridging the Week:

• UK FCA Fines Forex Dealer for Not Forwarding Trading Profits to Customers and Not Informing it about a Pending CFTC and NFA Investigation and Fine (includes Compliance Weeds);
• CME Settles Nine EFRP Proceedings;
• ICE Futures Fines Bank, FCM and Employee US $490,000 for Block Trade Mishandling (includes Compliance Weeds);
• CFTC Issues Privacy Best Practices;
• ICE Futures to Reject all Limit Orders Outside its Reasonability Limit Range;
• ICE Clear Formally Proposes Rule Amendments Permitting Variation Margin Haircutting; and
• Hong Kong Regulator to Examine Alternative Trading Systems and Dark Pools.

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UK FCA Fines Forex Dealer for Not Forwarding Trading Profits to Customers and Not Informing it about a Pending CFTC and NFA Investigation and Fine

The UK Financial Conduct Authority fined FX dealers Forex Capital Markets Ltd and FXCM Securities Ltd. UK (collectively, FXCM UK) £4 Million (US $6.7 Million) for permitting a US affiliated company not to forward trading profits that should have been paid to FXCM UK’s customers. Previously, in 2011, both the US Commodity Futures Trading Commission and the National Futures Association imposed fines against Forex Capital Markets LLC of US $8 Million combined mainly because the firm had failed to credit customers for certain beneficial price moves, but had debited them for detrimental price movements. According to FCA, FXCM UK failed to provide to its customers approximately £6 Million (almost US $10 Million) of profits kept by its US affiliate. As part of its settlement with FCA, FCM UK agreed to reimburse its customers up to almost US $10 Million. Previously, FXCM Group reimbursed their US customers over US $8 Million. In addition, to this significant sanction by the FCA, the FCA also cited FXCM UK for failing “…to be sufficiently open and co-operative and disclose to the Authority information of which it would reasonably expect notice,” specifically information regarding the investigations by and settlements with the CFTC and NFA in 2010 and 2011. The losses by FXCM’s customers were sustained because of “asymmetric price slippage” that occurred between the time a customer’s order was placed and the time it was executed. The detrimental impact for customers on individual trades was very small, however, on average US $3.70. FXCM UK itself (unlike the US affiliate) did not retain any gains from favorable price movements. FXCM’s violations occurred from 2006 through 2010, after which the FXCM Group corrected its practices.

Compliance Weeds: This FCA enforcement action demonstrates how, at least one regulator may find it a violation of its rules if a registrant does not disclose to it certain material matters involving an affiliated firm outside the regulator’s jurisdiction. Even if no specific enforcement action emanates, regulators typically are not happy to learn from media reports or other third parties (including from other regulators) of material events involving companies affiliated with a company within their jurisdiction. As a result, companies should assess when an event within a group structure is material and whether it should be disclosed to regulators of affiliated companies – even if such regulators have no jurisdiction over the entity, particularly where a material adverse development has occurred or a major corporate structure change may be pending or also has happened.

Previously, the SEC complained that JP Morgan failed to file Suspicious Activity Reports in the US as it had done in the UK related to conduct in accounts related to Bernard Madoff (see article “JP Morgan Criminally Charged” at http://www.garydewaalandassociates.com/?p=1769). This is a variation of the theme, but also suggests that regulators in different jurisdictions do not like to see different behavior among related companies dealing with the same essential conduct – where behavior outside the jurisdiction is deemed appropriate, but the same behavior is not taken within the jurisdiction.

In the US, the Commodity Futures Trading Commission recently adopted a new rule that requires a futures commission merchant to file notice within 24 hours with the Commission after the firm has been notified by the Securities and Exchange Commission, or a securities or futures self-regulatory organization that it is subject to a formal investigation. It must also file such notices with the FCM’s self-regulatory organization and with the SEC too (unless the investigation was initiated by the SEC), if the FCM is a combined BD and FCM (see new CFTC Rule 1.12(m) at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister103013b.pdf).

And briefly:

• CME Settles Nine EFRP Proceedings: Last week, the Chicago Mercantile Exchange brought nine disciplinary actions against a cross section of clearing members and traders involving violations of its rules related to Exchange of Futures for Related Positions. Five of the cases alleged that the respondent failed to maintain required documents supporting the EFRP; two cases claimed that the respondent failed to submit notice of the EFRP to the CME within times required by the Exchange; and two respondents were charged with violating both a prohibition against the same market participant being on both sides of an EFRP, as well as not maintaining required documents. In each matter, the CME alleged that, as a result of its EFRP rules not being followed, the relevant EFRP was not bona fide. For more details see: http://www.garydewaalandassociates.com/?p=2110).

• ICE Futures Fines Bank, FCM and Employee US $490,000 for Block Trade Mishandling: ICE Futures fined Macquarie Bank Limited and Peter Hahn, one of its employees, for entering an order on August 2, 2011 that allegedly took advantage of information that the firm received in connection with pre-execution communications related to a block trade in Sugar No. 11 futures. Macquarie Futures USA was also fined for not reporting the block trade within the Exchange-required time frame. The three respondents paid a fine in aggregate of US $490,000 to settle this matter, without admitting or denying the relevant rule violations.

Compliance Weeds: Although it is not clear from ICE Futures’ announcement what the underlying facts were in connection with this settlement, the announcement serves as a reminder that block trades – like EFRPs -- must be executed strictly in accordance with exchange rules as they are an exception to the Commodity Futures Trading Commission’s ordinary requirements that all futures trades be executed openly and competitively on an exchange’s trading platform. Typically exchange block trade rules set forth the minimum qualifications of counterparties, the minimum size of the block trade; time reporting requirements, a ban on the entity receiving the customer’s order from trading for itself based on the order information (e.g., no pre-hedging or anticipatory hedging); and a requirement that once a person receives non-public information regarding a potential block trade, it cannot trade to take advantage of such information in advance of a public report of the block trade by the exchange (see, e.g., ICE Rule 27.22(b)(iii): https://www.theice.com/publicdocs/rulebooks/futures_us/27_Electronic_Trading_Rules.pdf; NYMEX & COMEX Block Trades Q&A: http://www.cmegroup.com/trading/energy/files/energy-blocks-FAQ.pdf).

• CFTC Issues Privacy Best Practices: The Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight issued 10 recommended best practices for futures commission merchants, commodity trading advisors, introducing brokers, retail foreign exchange dealers, swaps dealers and major swap participants to comply with their obligations to maintain confidentially their customer records and information. Among other matters, the Commission cautioned firms (1) to identify foreseeable “internal and external risks to security, confidentiality and integrity of personal information and systems processing personal information” that could potentially result in confidentiality breaches as well as to establish processes and controls to help mitigate against such risks, and (2) to develop and implement policies and procedures now for how the firm will respond if there is a confidentiality breach tomorrow.

• ICE Futures to Reject all Limit Orders Outside its Reasonability Limit Range. ICE Futures US proposes amendments to its Error Trade Policy automatically to reject limit orders to its electronic trading system outside it Reasonability Limit range. Currently limit orders outside ICE Futures’ Reasonability Limit are automatically rejected unless the orders are capable of trading opposite previously resting orders at more favorable prices within the Reasonability Limit. These amendments were submitted to the CFTC subject to self-certification and should become effective on March 10. Similar rule changes have been proposed for ICE Futures Europe and ICE Futures Canada.

• ICE Clear Formally Proposes Rule Amendments Permitting Variation Margin Haircutting: ICE Clear US, Inc. has submitted to the CFTC proposed amendments to its rules that permit it to haircut variation margin payments owed to clearing members. It proposes to take advantage of these provisions (1) following the default of one or more clearing members when there is still uncertainty regarding what may be due to or from the defaulting clearing member(s) or (2) if ICE Clear has determined that its resources are inadequate (a) to pay all variation margin payments it owes and/or (b) to cover all of the defaulting member(s) losses or shortfalls after the close-out of the defaulting member(s) positions. ICE Clearing intends to implement these rule changes by no earlier than March 11.

• Hong Kong Regulator to Examine Alternative Trading Systems and Dark Pools: The Securities and Futures Commission of HK announced it would accept comments through April 25, 2014, related to proposed enhancements to regulatory obligations imposed on HK entities that operate alternative liquidity pools (ALPs) – commonly known as dark pools. Among other things, SFC proposes to limit access to ALPs to institutional investors only; increase the disclosure required by ALPs; require that agency orders receive priority over proprietary orders of ALP operators and their affiliates; and maintain system adequacy.

And Even More Briefly:

• The Board of Governors of the Federal Reserve System has extended until April 16, 2014, the time for comments on its proposed rulemaking related to physical commodity activities by financial holding companies.
• The CFTC issued a reminder last week that certain trade option participants were required to file with it by March 1 a completed Form TO enumerating trade options for calendar year 2013 that were not required to be reported to swap data repositories. It republished a Q&A to help such participants that initially was published during September 2013.
• Three potential new CFTC commissioners, including a new Chairman, will appear before the US Senate Agricultural Committee this week on March 6: Timothy Massad (to be Chairman), Sharon Bowen and J. Christopher Giancarlo.

For more information, review:

CFTC Q&A related to Trade Options and Form TO:
https://forms.cftc.gov/_layouts/TradeOptions/Docs/TradeOptionsFAQ.pdf.
CFTC Privacy Best Practices:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-21.pdf.
FCA V. FXCM LTD:
http://www.fca.org.uk/static/documents/final-notices/forex-capital-markets-limited.pdf.

See also: In the Matter of FCM LLC (CFTC): http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enffxcmorder10032011.pdf. In the Matter of FCM LLC (NFA): http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seqnum=2963.

FRB Extends Time Period on Comments for Proposed Rulemaking regarding Physical Commodity Activities:
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140227a1.pdf.
ICE Clear Proposed Rule Change regarding Variation Margin Haircuts:
https://www.theice.com/publicdocs/regulatory_filings/14-15_ICUS_Rule_509.pdf.
ICE Futures Disciplinary Matter involving Macquarie Entities: 
http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0240934&case=2012-084&contrib=ICE.
http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0366355&case=2011-041&contrib=ICE.
ICE Futures Proposed Error Trade Policy Amendments:
https://www.theice.com/publicdocs/regulatory_filings/14-16_Amendments_to_Rule_27.02_and_Error_Trade_Policy.pdf.
HK SFC Proposed Enhancements to Dark Pool Requirements:
http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/openFile?refNo=14CP3.
US Senate Agriculture Committee Hearings:
http://www.ag.senate.gov/hearings/nominations-of-timothy-g-massad-sharon-y-bowen-and-j-christopher-giancarlo.

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 March 1, 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.

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