Gary DeWaal and Associates LLC

Last week it was speeches by key regulators; this week, reports provide the food for thought regarding certain worldwide financial industry trends, including repercussions of directing more trades to central clearing houses and the potential future scarcity of high value collateral. In addition, the US Securities and Exchange Commission commenced a subpoena enforcement action against a committee of the US House of Representatives and one of its employees, and brought its first enforcement action against an SEC registered firm and its owner for retaliatory actions taken against a whistleblower.

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

• SEC Sues House Committee and Employee to Compel Responses to Subpoenas Related to Insider Trading Probe;
• IOSCO Publishes Results of Survey of Securities Markets Risk Trends; London School of Economics and DTCC Publish Report on Collateral Demand in the Evolving Marketplace;
• UK FCA Pronounces How It Will Address Serious Failings in Firms That Don’t Meet Its Conduct Standards;
• Vision Financial Markets Barred as NFA Member; CTA Ace Investment Strategists Also Barred;
• SEC Charges Hedge Fund Manager With Retaliating Against Whistleblower and Engaging in Conflicted Transactions;
• US Senate Subcommittee Holds Hearing on High Frequency Trading;
• ICE Futures Consolidates Rules Related to Exemptions From Position Limits;
• Canadian Regulators Announce Amendments to Regulations Governing Investment Funds;
• SEC Chair Calls for Fairer Fixed Income Markets; and more.

Video Version:

Article Version:

SEC Sues House Committee and Employee to Compel Responses to Subpoenas Related to Insider Trading Probe

Two parts of the federal government duked it out in a US court in New York City last Friday.

The US Securities and Exchange Commission sought the court’s assistance to compel the Committee on Ways and Means of the US House of Representatives and Brian Sutter, the Staff Director of the Committee’s Health Subcommittee, to comply with subpoenas that previously had been served, seeking certain documents; the subpoena served on Mr. Sutter also sought his testimony. According to court papers filed by the SEC, respondents failed to answer their subpoenas, claiming that the SEC’s demands were “repugnant to public policy” and a violation of the Speech or Debate clause of the US Constitution, among other reasons.

The subpoenas had been served by the SEC as part of an ongoing investigation to determine whether information related to the April 1, 2013 announcement by the US Centers for Medicare and Medical Services (CMS) regarding reimbursement rates for the Medicare Advantage program was improperly leaked to certain members of the public prior to CMS’ formal announcement, and whether this action resulted in illegal insider trading under US securities laws. (Medicare is a US national social insurance program that provides health insurance for most Americans 65 and over and certain other persons.)

Prior to CMS’ formal announcement, it had been anticipated in the marketplace that reimbursement rates to certain health care insurers would decline from the prior year. However, CMS announced increased reimbursement rates.

Just 20 minutes prior to CMS’ announcement, claims the SEC, an analyst at one broker-dealer issued a “flash report” predicting the reversal in the marketplace expectation and CMS’ ultimate announcement. This report was sent to many of the broker-dealer’s clients, including many investment funds. Stock prices of affected health care insurers began to rise dramatically.

Prior to the analyst’s issuance of his flash report, he received an email from a lobbyist that forecasted CMS’ actions, claiming he heard the information “from very credible sources.” The SEC opened its investigation to try to determine the source of the information received by the lobbyist. The lobbyist told the SEC he spoke to Mr. Sutter approximately 10 minutes prior to sending his email to the analyst, and that they spoke about the pending reimbursement rate increase during their conversation. The SEC claims it has other information too that suggests that Mr. Sutter was the source of the lobbyist’s information.

In response, the SEC first sought a voluntary production of documents from the Committee and Mr. Sutter. After this effort was unsuccessful, the SEC issued its subpoenas on May 6, 2014.

The SEC, in its court papers, argues that the Speech or Debate clause of the US Constitution is inapplicable to respondents. This clause, which states that “for any Speech or Debate in either House, [members of Congress] shall not be questioned in any other place,” applies to legislative acts only, says the SEC, or activities that are “an integral part of the deliberative and communicative processes.” According to the SEC,

“Any enforcement proceeding that results from this investigation would address the disclosure of material nonpublic information regarding imminent action by an agency of the Executive Branch, not any act or conduct that fits within the definition of ‘legislative act’ adopted by the [US] Supreme Court.”

The SEC also argues that there is no basis to preclude Mr. Sutter’s testimony.

“[S]utter has ‘unique first-hand knowledge’ of the facts central to the [SEC’s] investigation and ‘the necessary information cannot be obtained through other, less burdensome or intrusive means.’ Under such circumstances, it is settled law that [there is] no excuse from testimony.”

According to a published report, the Hon. Paul Gardephe, the US judge hearing this matter, ordered the Committee and Mr. Sutter to respond to the SEC’s papers by June 26, and for all parties to reappear before him on July 1. (For more color on Friday's court hearing, see article “SEC Files Lawsuit to Enforce Subpoenas Issued to Congress” in The Wall Street Journal on June 21 by clicking here.) 

IOSCO Publishes Results of Survey of Securities Markets Risk Trends; LSE and DTCC Publish Report on Collateral Demand in the Evolving Marketplace

In its Survey of Securities Markets Risk Trends 2014, the Research Department of the International Organization of Securities Commissions summarized the results of an in-depth survey of both industry leaders and regulators regarding their views on risks to and within global securities markets. Not surprisingly, risk assessments by regulators and industry personnel differed. While regulators were most concerned about risks arising from illegal conduct and breakdowns in corporate governance, financial risk disclosure and benchmarking, industry participants were more concerned about the search for yield, resolution and recovery plans, central clearing houses and market fragmentation.

Separately, the London School of Economics and the Depository Trust Clearing Corporation published a study related to the use of collateral assets as a result of regulatory reform and changing market practice. The report concludes that overall there is sufficient collateral worldwide to meet projected demand. However, weaknesses in market infrastructure may likely cause collateral to be immobilized in one part of the system when it is needed in another part, at least temporarily.

In the IOSCO commissioned survey, there was a clear distinction between the concerns of market participants and regulators. According to the survey,

“Regulators are more concerned with issues of disclosure and conduct while market participants are clearly focused on changes in market behavior. Predominantly regulators see risk emanating from illegal conduct, poor corporate governance, financial risk disclosure and benchmarking issues, while only a small fraction of financial market participants recognize these topics as potential risk areas. Market participants are more concerned with risk in the areas of search for yield, resolution and resolvability plans, CCPs and market fragmentation.”

Regarding central clearing houses, respondents expressed concern about “forcing markets to concentrate large risks into [clearing houses] that are becoming too big to fail.” According to the survey,

“By creating new systemically important infrastructures that are inadequately capitalized for a crisis situation plus a lack [of] recovery and resolution plans implies CCPs may not be as safe as first thought. The primary requirement of central clearing should be to ensure transactions are always honored and the recovery of a CCP should not rely upon the haircutting of end-investor variation margin as this will be pro-cyclical, potentially escalating any financial distress, in the opinion of survey participants. Finally, CCPs may create incentives to clear products that, in the search for new business, should not be cleared.”

There appeared to be consensus among both regulators and industry participants that high frequency trading posed “challenges” to regulators although the consequences “may be hard to fully assess.” Concern was expressed regarding the potential for market abuse as well as if market confidence was diminished because of a belief that some were “gaming the market at the expense of investors.”

Finally, respondents to the survey expressed concern that uncoordinated regulation could cause market fragmentation “which will impact on liquidity levels and trading volumes.” Moreover, a fragmented market was likely to increase costs and complexity in trading, according to the survey.

Separately, the LSE and DTCC report also raised concerns regarding “the move toward centralized clearing and standardized platforms” because of the new paradigm’s increased collateral demand for initial margin. According to this report,

“A system relying principally on centralized clearing to mitigate counter-party risks creates increased demand for liquidity to service frequent margin calls. This can be met by opening up larger liquidity facilities, but indirectly this requires more collateral. To economize on the use of collateral, agents will try to limit liquidity usage, but this implies increased frequency of margin calls. This increases operational risks faced by CCPs which, given the concentration of risk in CCPs, raises the possibility that an idiosyncratic event could spill over into a system-wide event.”

The LSE and DTCC report concludes that while there are likely sufficient high quality assets outstanding worldwide to meet the anticipated demands of collateral going forward, this analysis is based on the assumption that collateral can circulate freely within the financial system. To a certain extent, this may not be true because certain collateral that may be considered high value at any one time – such as certain sovereign debt – may be downgraded at another time. Also, certain historic collateral transformation abilities of large banks are being eroded by “increased regulatory constraints.” Accordingly, says the report,

“The search for new methods of achieving economical collateral transformation is giving opportunities to market infrastructures and others to provide much needed support for credit creation. In the process, the patterns of risk bearing will be changed, and understanding this represents a challenge both to regulators but also to investors.”

And briefly:

• US Senate Subcommittee Holds Hearing on High Frequency Trading: The US Senate Subcommittee on Investigations held a hearing last week to consider high frequency trading in US stock markets. The hearing focused on payments by wholesale brokers to retail brokers for their customer orders and payment for order flow, as well as maker taker rebates or fees by execution facilities that result in payments or charges to brokers to execute on their platforms. Participants included Brad Katsuyama, president and chief executive officer of IEX, Thomas Farley, president of NYSE Group, and Stephen Quirk, a senior vice president with TD Ameritrade, among others.
   
• FCA Pronounces How It Will Address Serious Failings in Firms That Don’t Meet its Conduct Standards: The UK Financial Conduct Authority has published a paper describing how it will address regulated firms that fail to meet its minimum standards regarding culture, business models and strategies, and governance. In general FCA expects firms to place customers and market integrity “at the heart of their business;” offer products and services that meet their clients needs; and maintain a governance that ensures appropriate systems and controls are in place. Where FCA finds evidence that a firm fails to meet its minimum standards, it will place the firm on an enhanced supervision program (or possibly take other regulatory action) that will require the firm’s supervisors to review its supervisory strategy and return the firm to normal supervision by a specified date. FCA will monitor progress against this plan on a regular basis and take corrective action if the firm is not on course to deliver a successful outcome. Ordinarily the firm’s board of directors will also be required to commit to the remediation plan. In some circumstances the FCA will contract directly with a so-called “skilled person” – an independent outside consultant – to conduct a review of the firm at the firm’s expense and make appropriate recommendations. According to FCA, “enhanced supervision helps the FCA to address weaknesses in standards, governance and culture in firms. In some cases, enhanced supervision will be followed by an enforcement investigation. However, it is important that regulators use judgment, rather than a set of consequential processes, to determine what regulatory tools and powers are appropriate.”
   
• Vision Financial Markets Barred as NFA Member; CTA Ace Investment Strategists Also Barred: Vision Financial Markets agreed to withdraw its membership with the National Futures Association as a futures commission merchant within six months and pay a fine of US $1.5 million in response to an NFA complaint related to its alleged failure to prevent the misallocation of trades by one of its self-identified preferred commodity trading advisors, Ace Investment Strategists, over a three year period. This failure, charged the NFA, resulted in customer losses in excess of US $2 million. Without membership in the NFA, Vision cannot act as an FCM. Previously, Vision had paid full restitution to its customers. Steven Silver, a Vision principal and associated person (AP), and Bruce Newman, a Vision AP were charged with failure to supervise in NFA’s earlier complaint against Vision. They received no sanctions as part of Vision’s settlement though they were barred from serving on disciplinary or equivalent committees for three years. In the complaint against Vision, NFA cited four prior disciplinary matters involving supervisory issues from 1993 to 2011. In connection with a related action by NFA, Ace, Yu Dee Chang, its principal, and a separate Vision guaranteed introducing broker owned by Mr. Chang, Chesapeake Investment Services, also agreed to withdraw their NFA memberships.
   
• SEC Charges Hedge Fund Manager With Retaliating Against Whistleblower and Engaging in Conflicted Transactions: The Securities and Exchange Commission settled charges last week against Paradigm Capital Management, Inc., an investment adviser, and Candace Weir, its founder and president, related to their retaliatory actions taken against Paradigm’s former head trader. These actions came, claims the SEC, after the former head trader reported to the SEC that Paradigm had engaged in principal transactions with an affiliated broker dealer owned by Ms. Weir, without adequate disclosure to or consent from PCM Partners LLP II, a hedge fund client advised by Paradigm. This is the SEC's first case relying on a rule, adopted under Dodd-Frank, that permits it to bring enforcement actions for retaliatory actions against whistleblowers. Ultimately, because of the retaliatory actions, the whistleblower resigned. As part of its settlement, respondents agreed to pay disgorgement, prejudgment interest and a civil penalty totaling in excess of US $2.1 million, as well as retain an independent compliance consultant.
   
• ICE Futures Consolidates Rules Related to Exemptions from Position Limits: As of June 30, ICE Futures USA will consolidate various of its rules related to exemptions from speculative position limits and position accountability levels, and the reporting of so-called reportable positions. ICE Futures will also harmonize the use of certain related defined terms. The new rules also establish requirements for persons seeking an exemption from applicable limits including that the person seeking an exemption provide ICE Futures a representation that it has complied with any applicable federal requirements related to the proposed positions and obtained any Commodity Futures Trading Commission approval, as necessary. The rules apply to both traders and brokers.
   
• Canadian Regulators Announce Amendments to Regulations Governing Investment Funds: The Canadian Securities Administrators have approved rule amendments that impose investment restrictions and operational requirements, as well as enhanced disclosure obligations regarding securities lending activities on non-redeemable investment funds (NRIFs). (NRIFs are funds that typically issue a limited number of shares or units in an initial public offering, and whose shares then trade on an exchange.) Among other things, for NRIFs, the new rules (1) impose concentration limits on the amounts of securities of any issuer a fund may hold; (2) prohibit purchases of real property or obtaining an interest in certain loan syndications or loan participations; (3) limit the amount of securities lending and repurchase activity; and (4) impose a number of requirements on redemptions. To a lesser extent, the amendments impact mutual funds too, including requirements that such funds which are not in continuous distribution must issue a news release if they intend to use specified derivatives, engage in short selling or enter into securities lending, repurchase or repurchase transactions. Subject to ministerial approval, the new rules will come into effect on September 22, 2014, but the implementation of new disclosure requirements for existing NRIFs are subject to a six-month transition period. 
   
• SEC Chair Calls for Fairer Fixed Income Markets: In a speech before the Economic Club of New York last Friday, SEC Chair Mary Jo White called for the use of technology to help improve pre-trade pricing information in the fixed income markets. She lamented that, to date, while it appears that technology has benefically transformed equity markets, it has not helped fixed income investors. Ms. White stated, “I am therefore concerned that in the fixed income markets, technology is being leveraged simply to make the old, decentralized method of trading more efficient for market intermediaries, and its potential to achieve more widespread benefits for investors, including the broad availability of pre-trade pricing information, lower search costs and greater price competition – especially for retail investors – is not being realized.” As a result, she says, the SEC will work with the Municipal Securities Rulemaking Board to finalize a best execution rule for the municipal securities market. The SEC will also work with the MSRB and the Financial Industry Regulatory Authority to develop rules by year-end regarding the disclosure of mark-ups in so-called “riskless principal” transactions related to corporate and municipal bonds. Finally she has asked SEC staff to “…focus on a regulatory initiative to enhance the public availability of pre-trade pricing information in the fixed income markets, particularly with respect to smaller retail-size orders.”

And even more briefly:

• CFTC Conducts Roundtable on Position Limits: The CFTC hosted a roundtable regarding physical commodity derivatives on June 19. Topics included hedging of a physical commodity, the process for non-enumerated exemptions, spot-month limits and conditional exemptions, and aggregation of positions. According to published reports, the roundtable included the first public appearance of Timothy Massad, the new CFTC Chairman.

• Joint Audit Committee Provides Guidance on Financial Information FCMs Are Required to Make Publicly Available Beginning July 12: The Joint Audit Committee clarified last week that when future commission merchants mandatorily begin reporting on their websites certain financial information for the most current 12-month period beginning July 12, that period includes a retroactive rolling period. For example, on July 12, FCMs will be required to post daily segregation, 30.7 and cleared swaps customer statements for the period July 11 2013 through July 10, 2014. (For full details regarding these disclosure requirements, see the article “JAC Issues Guidance on FCM Financial Information Disclosure Requirements” in last week’s Corporate and Financial Weekly Digest from Katten Muchin Rosenman LLP, by clicking here.) 
   
• NFA Proposes Amendments to Enhanced Supervisory Requirements: The NFA has proposed changes to its rules that require certain firms to abide by enhanced supervisory requirements, including requiring them to record conversations with customers, pre-submit promotional material, adopt written supervisory procedures, and operate under a guarantee agreement or with an enhanced level of capital. Typically these are firms with large numbers of associated persons from firms that previously had experienced significant disciplinary issues. The NFA proposes to ameliorate a requirement that automatically triggers enhanced supervision for firms with principals who may have been previously associated with a firm with a significant disciplinary history, and who have subsequently moved to another firm that, as a result, was also subject to such enhanced requirements but received a waiver by the NFA.

• SEC to Host an Open Meeting on the Applicability of Security-Based Swap Dealer and Major Security-Based Swap Participant Definitions to Cross-Border Activities: The SEC will host a public meeting on June 25 at its offices in Washington DC, regarding the application of the definitions of security-based swap dealer and major security-based swap participant to cross-border activities. Unlike the CFTC, the SEC has proposed its cross-border standards as rules. A lawsuit is pending against the CFTC for its issuance of its standards as guidance. (For details regarding the lawsuit against the CFTC, see the article “Three Industry Organizations File Lawsuit Against the CFTC Over Its Cross Border Guidance” in the Bridging the Week edition published December 9, 2013 by clicking here.) 

• Korean Regulator Announces Plans to Further Develop Country’s Derivatives Markets: The Korean Financial Services Commission indicated last week that it will help promote the development of South Korea’s exchange-traded derivatives market focused on professional investors by granting greater autonomy to the Korea Stock Exchange (KRX) and promoting new products. It will also phase-in the use of central clearing houses for OTC derivatives and introduce trade repository systems.

For more information, see:

Canadian Regulators Announce Amendments to Regulations Governing Investment Funds:
http://www.lautorite.qc.ca/files//pdf/reglementation/valeurs-mobilieres/81-102/2014-06-19/2014juin19-81-102-avis-publ-finalacvm-en.pdf

CFTC Conducts Roundtable on Position Limits
http://www.cftc.gov/PressRoom/Events/cftcstaff_061914rtagenda

FCA Pronounces How It Will Address Serious Failings in Firms That Don’t Meet its Conduct Standards:
http://www.fca.org.uk/static/article-type/news/tackling-serious-failings-in-firms.pdf

IOSCO Publishes Results of Survey of Securities Markets Risk Trends:
http://www.iosco.org/research/pdf/swp/SWP5.pdf

Joint Audit Committee Provides Guidance on Financial Information FCMs Are Required to Make Publicly Available beginning July 12:
http://www.wjammer.com/jac/jacupdates/2014/jac1404.pdf

ICE Futures Consolidates Rules Related to Exemptions from Position Limits:
https://www.theice.com/publicdocs/futures_us/exchange_notices/exnotchapter6_june2014.pdf

Korean Regulator Announces Plans to Further Develop Country’s Derivatives Markets
Access through: http://www.fsc.go.kr/eng/wn/list_qu.jsp?menu=01&bbsid=BBS0048

LSE and DTCC Publish Report on Collateral Demand in the Evolving Marketplace:
http://www.dtcc.com/~/media/Files/Downloads/WhitePapers/LSE%20Report.ashx

NFA Proposes Amendments to Enhanced Supervisory Requirements:
http://www.nfa.futures.org/news/PDF/CFTC/InterpNotice_CR2-9_Enhanced_Supervisory_Procedures.pdf

SEC Charges Hedge Fund Manager With Retaliating Against Whistleblower and Engaging in Conflicted Transactions:
http://www.sec.gov/litigation/admin/2014/34-72393.pdf

SEC to Host an Open Meeting on the Applicability of Security-Based Swap Dealer and Major Security-Based Swap Participant Definitions to Cross-Border Activities:
http://www.sec.gov/news/openmeetings/2014/ssamtg062514.htm

SEC Chair Calls for Fairer Fixed Income Markets:
http://www.sec.gov/News/Speech/Detail/Speech/1370542122012#.U6V26hZvl_g

SEC Sues House Committee and Employee to Compel Responses to Subpoenas Related to Insider Trading Probe:
/ckfinder/userfiles/files/SECMemLawSubpoenaEnf%20(1)-2.pdf

US Senate Subcommittee Holds Hearing on High Frequency Trading:
http://www.hsgac.senate.gov/subcommittees/investigations/hearings/conflicts-of-interest-investor-loss-of-confidence-and-high-speed-trading-in-us-stock-markets

See also press release announcing hearing:
http://www.hsgac.senate.gov/subcommittees/investigations/media/subcommittee-on-investigations-to-examine-conflicts-of-interest-investor-loss-of-confidence-and-high-speed-trading-in-us-stock-markets

Vision Financial Markets Barred as NFA Member:
http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seqnum=3943

See also: Resolution of In the Matter of Ace Investment Strategists and Yu Dee Chang:
http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seqnum=3936

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 21, 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. 

All quotations attributable to public speeches are from the prepared texts of the speaker.

---

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