Gary DeWaal and Associates LLC

The CFTC today filed charges against and settled with FC Stone for failing to maintain adequate customer credit and concentration risk policies during 2008-2009 that allowed one customer account to sustain a loss of approximately US $127 million. The CFTC charged FC Stone under its "failure to supervise" regulation (Rule 166.3), assessed a penalty of US $1.5 Million, and required FC Stone to retain an independent consultant, among other things, to review and evaluate the effectiveness of the Firm's internal controls and procedures regarding credit and concentration liquidity risk.

According to the CFTC, FCMs have an affirmative obligation on an ongoing basis to monitor customers' accounts for illiquid positions. The CFTC claims that, during the relevant period, an FC Stone customer account accumulated a massive position, more than 2.5 million contracts, in relatively illiquid energy option contracts, that the firm inadequately supervised to mitigate the risk. According to the CFTC:

"An FCM that carries positions in thinly traded markets, or positions that represent a large portion of a particular product, should take account of the risks posed by the resulting illiquidity in its analysis of the losses to which it is exposed, and should manage those risks."

(citing, Report on Lessons Learned From the Failure of Klein & Co. Futures Inc., CFTC Division of Trading and Markets, July 2001, p. 5.)

This action, especially in conjunction with the proposed NFA Guidance on FCM internal control systems, should remind FCMs thoroughly to review their risk policies and procedures to ensure that:

1. they are required adequately to monitor on an ongoing basis customer positions for among other things, illiquid positions; and
2. to describe how such monitoring will be conducted and by whom.

For more information, see:
http://www.cftc.gov/PressRoom/PressReleases/pr6594-13
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enffcstoneorder052913.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 May 29, 2013, 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.