Gary DeWaal and Associates LLC

After more than one year under the umbrella of Gary DeWaal and Associates, “Bridging the Week” begins a new life today as a weekly publication of Katten Muchin Rosenman LLP. This is prompted by my joining Katten as a Special Counsel in the firm's New York office as of today, April 28, 2014, where I look forward to servicing my existing clients as well as new clients. My periodic breaking news updates will also be continued, now to be called “Between Bridges.” For details of my joining Katten, click Here; but feel free to contact me directly at my new phone number, (212) 940-6558 or by email at: gary.dewaal@kattenlaw.com. Thanks to all my existing clients, readers of my blogs, and friends for their support of Gary DeWaal and Associates these past 16 months!

More relevant to this publication, there were no earth-shattering regulatory developments this past week – just more Flash Boys fallout. However, a few items are worthy of attention.

As a result the following matters are covered in this week’s Bridging the Week:

• City of Providence, Rhode Island Files a Class Action Lawsuit Against More Than 40 Securities Exchanges, Brokerage Firms and Proprietary Trading Organizations (includes Compliance Weeds);
• IIROC (Canada) Begins Third Phase of Low Latency Trading Study;
• FINRA Board Concludes Charles Schwab & Co. Wrongfully Sought to Prohibit Customers from Participating in Class Actions; Firm and FINRA Agree on Settlement;
• ICE Futures US Amends Pre-Execution Communications FAQs to Make Clear Certain Activities Are Prohibited While Orders Are Pending;
• Royal Bank of Scotland Fined by HK SFC Over 2011 Rogue Trader Incident;
• FINRA Seeks to Require Enhanced Background Checks on Potential Registrants; and
• CFTC Extends Recording Deadline for CTA Members of DCMs and SEFs.

Video version:

Article version:

• City of Providence, Rhode Island Files a Class Action Lawsuit Against More Than 40 Securities Exchanges, Brokerage Firms and Proprietary Trading Organizations: In another legal action that appears principally motivated by the publication of Michael Lewis Flash Boys: A Wall Street Revolt a few weeks ago, the City of Providence, Rhode Island named more than 40 securities exchanges, brokerage firms and proprietary trading organizations in a class action lawsuit. The City alleges that the defendants manipulated “US securities markets and the trading of equities on those markets, diverting billions of dollars annually from buyers and sellers of securities to themselves” from April 18, 2009, through the present. Quite transparently, the lawsuit credits Flash Boys as authority for a number of its principal allegations. This lawsuit was filed in a US Federal court in NYC. Just two weeks ago, the Chicago Mercantile Exchange and the Chicago Board of Trade were sued by three traders who claimed the exchanges improperly revealed price data to high frequency traders before anyone else; the CME vehemently disputed these allegations (see article in “Bridging the Week” April 7 to 11, 2014, entitled “Flash Boys Redux: CBOT and CME Sued for Allegedly Revealing Price Data to High Frequency Traders Before Anyone Else; CME Vehemently Refutes Charges” by clicking Here).

Compliance Weeds:  As I indicated last week in response to the release by the Securities and Exchange Commission of Frequently Asked Questions regarding risk controls for market access, low latency trading remains in the glare of the public spotlight even though a few weeks have now passed since the publication of Michael Lewis’ book. Unfortunately, it is unlikely that this attention will abate anytime soon. Again, an appropriate response to all this adverse publicity is for low latency trading firms with direct market access – whether to securities or futures markets – to double check that (1) they have robust policies and procedures that, at a minimum, cover all applicable regulatory requirements; (2) their employees routinely are reminded about these internal rules; (3) the firms and their employees follow internal rules; and (4) they routinely conduct adequate surveillance to ensure their ongoing compliance. In addition, to the extent industry organizations have published best practices, firms should endeavor to ensure their policies and procedures promote these standards (see, e.g., the Futures Industry Association’s “Market Access Risk Management Recommendations” (April, 2010; access by clicking Here), and FIA’s  “Software Development and Change Management Recommendations” (March 2012; access by clicking Here). Katten Muchin Rosenman will be hosting two seminars, one in Chicago and one in NYC, on April 28 and May 6, respectively, specifically addressing “Recent Publicity Concerning Proprietary Trading: Potential Regulatory Responses” (for details, click Here for the Chicago event, and Here for the NYC event).

• IIROC (Canada) Begins Third Phase of Low Latency Trading Study: The Investment Industry Regulatory Organization of Canada announced last week that it had enlisted two teams of academics to help assess the impact of low latency trading on the Canadian equity marketplace. One team will expressly review the role of low latency traders in “integrating markets and whether or not their activities are beneficial.” The other team will concentrate on the impact of short selling by low latency traders. This review is the third phase of a multi-year study that began in 2011 for IIROC better to understand low latency and algorithmic trading.
   
• FINRA Board Concludes Charles Schwab & Co. Wrongfully Sought to Prohibit Customers from Participating in Class Actions; Firm and FINRA Agree on Settlement: The Board of Governors of the Financial Industry Regulatory Authority ruled last week that Charles Schwab & Co. wrongfully tried to prevent its customers from participating in judicial class action litigations against it when the firm unilaterally amended its existing customers’ agreement in October 2011. This amendment required Schwab’s customers to litigate disputes against the firm solely in arbitration on an individual basis. Previously, in February 2013, a FINRA hearing panel had reached the same conclusion based on certain FINRA rules, but determined that FINRA could not enforce these provisions because they conflicted with Federal law dealing with arbitrations. The Board overturned this portion of the hearing panel’s decision, claiming that FINRA, could, in fact, enforce its rules. As part of its decision, the Board also remanded this matter back to a hearing panel to determine sanctions. Schwab, however, pre-empted this by agreeing to pay US $500,000 to resolve this matter, and to notify all its customers that the objectionable amended language to its customer agreement was withdrawn and no longer in effect.
   
• ICE Futures US Amends Pre-Execution Communications FAQ to Make Clear Certain Activities Are Prohibited While Orders Are Pending: Last week ICE Futures US announced amendments to its pre-execution communication Frequently Asked Questions to make clear that it is prohibited for either a potential buyer or seller, after submission of a pre-discussed order for execution, to enter requests for quotes (RFQs) during the mandatory waiting time of the pending trade. Currently, after the parties agree to a proposed transaction following a pre-execution dialogue, the proposed trade is entered into the exchange’s electronic trading system. There is then a mandatory five second delay for all futures, energy options and equity options, and a 15 second pause for agricultural and other financial options before the proposed transaction is executed, provided other traders don’t first interpose themselves into the transaction. During this waiting time, the original parties are prohibited from entering better bids or offers. Effective June 7, 2014, both parties will also be prohibited from entering RFQs while the trade is being executed. This is to minimize the likelihood that other market participants will be distracted from the pending trade, says the exchange; currently only the submitter of the trade is prohibited from entering an RFQ. There are other slight amendments in the revised FAQs too. Separately, ICE Futures expanded the list of offenses for which the Vice President of Market Regulation could issue a summary fine of up to US $10,000. These new offenses include (1) failure to report large trader positions; (2) misreporting of energy contracts' open interest; and (3) improper submission of a RFQ by a party to a pending pre-execution communication order, among other matters.
   
• Royal Bank of Scotland Fined by HK SFC Over 2011 Rogue Trader Incident: The Royal Bank of Scotland was fined HK $6 million (approximately US $ 774,000) by the Securities and Futures Commission of Hong Kong for internal control deficiencies that the regulator claims prevented the firm from avoiding a 2011 rogue trading incident involving a trader on its emerging markets rates desk. SFC commenced an investigation into RBS following unauthorized trading and mismarking by Shirlina Tsang Pui Yu that resulted in losses to RBS in excess of GB £24.4 million (at today’s value, approximately US $41 million). In August 2013, Ms. Tsang was convicted of fraud and sentenced to 50 months imprisonment related to this matter. Among other things, SFC found that RBS had “inadequate and ineffective front office supervision” and “an absence of controls over the process for independent price verification to mitigate the risk of inaccurate marking by traders of their positions.” However, SFC claimed it did not sanction RBS more severely in light of the firm’s proactive and timely action in alerting SFC regarding the rogue trading incident that prevented Ms. Tsang from fleeing Hong Kong after her actions were detected.

And more briefly:

• FINRA Seeks to Require Enhanced Background Checks on Potential Registrants: FINRA’s Board of Governors approved an amendment to its supervision rules to require member firms to confirm information submitted on an applicant’s registration application. This will apply to first time as well as transfer applicants. Firms will also be required to implement written procedures in connection with this new requirement. FINRA will now submit this proposed rule amendment to the Securities and Exchange Commission for its approval. In addition, FINRA will enhance its own review of public records of registered representatives, particularly public criminal records of persons not fingerprinted within the past five years.
   
• CFTC Extends Recording Deadline for CTA Members of DCMs and SEFs: On Friday last week, the Commodity Futures Trading Commission’s extended until December 31, 2014, by when commodity trading advisors who are members of swap execution facilities or designated contract markets must mandatorily record all oral communications related to the execution of swaps. This extension was granted through a no action letter issued jointly by the Division of Swap Dealer and Intermediary Oversight and the Division of Market Oversight.

For more information, see:

CFTC Extends Recording Deadline for CTA Members of DCMs and SEFs:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-60.pdf

City of Providence Litigation:
http://sdnyblog.com/wp-content/uploads/2014/04/14-Civ.-02811-Complaint.pdf

FINRA Board of Governors Decision Involving Charles Schwab:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p493598.pdf

FINRA’s Proposed Enhanced Background Check Requirement:
http://www.finra.org/Newsroom/NewsReleases/2014/P493588

ICE Futures Pre-Execution Communications Notice and FAQ:
https://www.theice.com/publicdocs/futures_us/exchange_notices/Exchange_Notice_Amendments_to_Pre_Ex_FAQ.pdf
https://www.theice.com/publicdocs/futures_us/Pre_execution_Communication_FAQ.pdf

ICE Summary Fines Amendment:
https://www.theice.com/publicdocs/futures_us/exchange_notices/Exchange_Notice_Amendments_to_Disciplinary_Rule21_02.pdf

IIROC Begins Third Phase of Low Latency Trading Study:
http://www.iiroc.ca/Documents/2014/f31112c4-9b20-4ea6-a1f8-5439e5c19d78_en.pdf

SFC Fines Royal Bank of Scotland Over 2011 Rogue Trading Incident:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=14PR46

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 26, 2014.  No representation or warranty is made regarding the accuracy of any statement or information in this article.  Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel.  Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article. 

Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained in this article is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

---

© 2024 Gary DeWaal and Associates LLC | 1 (212) 382-4615 | 1180 Avenue of the Americas, Suite 809, New York, NY 10036