Gary DeWaal and Associates LLC

Gary DeWaal's Bridging the Week: September 16 to 20 and 23, 2013

Valuable Lessons Learned    Bridging the Week   
Published Date: September 23, 2013

During the week of September 16 to 20, 2013, the biggest news was the coordinated enforcement actions by four international regulators against JP Morgan related to its London Whale incident. But what also was big news was that the US Commodity Futures Trading Commission was not among the regulators joining in this coordinated enforcement action -- for now. Why?

However, the JP Morgan matter was just the tip of the iceberg in a very hectic week featuring many interesting US litigation developments, new regulatory requirements, regulatory proposals, and an important speech by the CEO of the UK Financial Conduct Authority -- all potentially impacting a wide-range of industry participants worldwide.

These matters – all covered in this week's Bridging the Week – include:

Video version:

Article version:

Four Regulators Sue JP Morgan; Why Was the CFTC Not the Fifth?

Last week JP Morgan consented to and was assessed fines by four international regulators totaling US$ 920 Million related to what has been colloquially referred to as the "London Whale" trades during 2012.These trades caused the Bank to suffer losses of US$ 6.2 Billion. The four regulators were the Financial Conduct Authority in the UK (GB£ 137,610,000 (US$ 220 Million); the US Federal Reserve Bank (US$ 200 Million); the US Office of the Comptroller of the Currency (US$ 300 Million), and the US Securities and Exchange Commission (US$ 200 Million).

According to a Form 8-K filed by the Bank with the SEC on September 19, apparently three regulator investigations related to this matter continue, ones conducted by Massachusetts Securities Division, the US Commodity Futures Trading Commission and the US Department of Justice. The Bank has disclosed, in fact, that the CFTC has provided a so-called "Wells" notice to it notifying the Bank that the Commission staff intends to recommend an enforcement action related to the London Whale incident. JP Morgan has indicated that it will respond to the CFTC's notice in due course.

Previously, the US Attorney for the Southern District of NY filed criminal charges, and the Securities and Exchange Commission filed civil charges against two JP Morgan employees -- Julien Grout, and his supervisor, Javier Martin-Artajo -- for over-valuing certain trading positions they initiated to hide the trading losses that are at the heart of the London Whale incident.

The facts of the London Whale incident are relatively well known by now, and both the FCA's and the SEC's settlement orders provide detailed insight into the breakdown of internal controls at JP Morgan that gave rise to the Firm's issues as well as the delay in uncovering the Firm's issues.

Another article on this website provides my detailed analysis of lessons learned from this matter, as well as my caution regarding the CFTC's expansive new anti-manipulation authority post Dodd Frank. Check it out at:

Valuable Lessons Learned: I don't think it's uncommon for firms to underestimate, initially, the potential seriousness of problems. This is why it is critical that the employees (or their direct supervisors) potentially responsible for a problem not to be the persons entrusted to investigate the problem. Surely such employees need to be questioned and even, perhaps consulted, but where there are potentially material issues, it is important for senior management to obtain a view of the potential problem and other analyses from impartial persons. Similarly, allowing traders to mark their own trading positions or input their own trades into internal systems must be avoided.

DRW Investments Sues the CFTC to Avoid a Possible Enforcement Action

DRW Investments, a Chicago-based proprietary trading firm, and its principal, Don Wilson, filed a complaint in federal court in Chicago seeking to prevent the Commodity Futures Trading Commission from filing an enforcement action against them for unlawful manipulation related to certain orders they placed during January through August 2011.

The relevant orders involved interest rate swap (IRS) futures contracts cleared by the International Derivatives Clearinghouse (IDCH). This matter arises, according to the complaint, following a CFTC investigation into these orders, and notice to plaintiffs that an enforcement action is imminent.

During the relevant time, DRW placed orders for IRS futures contracts both through a voice broker and through IDCH's electronic trading platform; these orders were for different prices than prices prevailing for over the counter IRS transactions. "This was because," says the Complaint, "DRW believed, based on its analysis of the economic difference between the two derivatives, that the IDCH Contracts should be trading a different price than those of the comparable uncleared OTC swap." IDCH apparently based its daily settlement prices, during the relevant time, on DRW's electronic orders. The Complaint suggests that the basis for the CFTC's complaint against it will be the CFTC's belief that DRW's orders were placed purposely to affect the settlement price "at something other than a fair and reasonable value."

The Complaint argues that the "CFTC's theory of liability depends upon a novel and legally untenable claim," and that the matter "…is ripe for adjudication because the filing and pendency of an enforcement action…would subject DRW to hardship and cause it immediate and irreparable harm."

Amended Complaint filed by MF Global Holdings Litigation Trustee against John Corzine and Other Principals

Less than a week after both John Corzine and Edith O'Brien filed on September 10, 2013, motions to dismiss the CFTC enforcement actions against them related to the MF Global collapse and misuse of customer funds in October 2011, the Litigation Trustee for MF Global Holdings (Holdings) filed an amended complaint naming John Corzine, Bradley Abelow, and Henri Steenkamp. According to the Trustee, the defendants' design and implementation of highly leveraged transactions in foreign debt to enhance the Firm's "apparent profitability" constituted breaches of their fiduciary duties of care and loyalty. For this, the Trustee seeks an unspecified amount of damages against the defendants.

(Mr. Corzine was the former Chairman and CEO of Holdings and CEO of MF Global Inc. (MFGI; formerly registered as a futures commission merchant with the CFTC), Mr. Abelow, the President  of Holdings at the time of its collapse and previously its Chief Operating Officer since September 2010, and Mr. Steenkamp, Holding's Chief Financial Officer at the time of the Firm's collapse, and previously Group Controller and Chief Account Officer.)

The defendants' decision to invest specifically in European sovereign debt instruments, shortly after Mr. Corzine joined the Firm in 2010, ultimately led to the Firm's collapse and MFGI's misuse of customer funds, argues the Trustee. According to the amended complaint:

"Defendants embarked on their scheme without informing themselves (or the Board) of the true risks and without adequate processes and controls despite the fact that, throughout their tenures, they were repeatedly warned by internal auditors, risk managers and outside consultants that the [Firm]'s systems, controls and procedures were inadequate.

In his Memorandum of Law in support of his Motion to dismiss the CFTC's enforcement action against him filed the on September 10, Mr. Corzine acknowledged that he recommended "strategic investments," including in European sovereign debt, but that "[t]he risks attendant to the [investment] strategy were at all times disclosed to and approved by the Board of Directors of [Holdings], and that "[a]t no point in time was Mr. Corzine made aware of any failure in MFGI's systems and controls that were designed to protect customer funds."

The Amended Complaint by the Litigation Trustee was filed in the United States Bankruptcy Court in New York City, while Mr. Corzine's and Ms. Obrien's Motions to Dismiss were filed in the United States District Court in New York City.

US SEC Charges 23 Firms in Connection with Unlawful Short Sales related to Initial Public Offerings; Simultaneously Issues a Risk Alert

The US Securities and Exchange Commission commenced and settled enforcement actions against 22 firms, alleging that they unlawfully engaged in short sales, within a restricted period -- generally five days before a public offering -- and then purchased the relevant securities during the public offering. This conduct is prohibited by SEC Rule 105 of its Regulation M. An additional firm was sued by the SEC for this conduct, but did not settle.

The 22 firms represent a cross section of the managed money industry, a pension plan administrator, and a non-US based firm, among others.

In connection with these matters, the 22 settling firms paid US $14.4 Million in fines and disgorgement of profits.

Simultaneously, the SEC issued a Risk Alert reminding investment advisers, investment companies and broker dealers to ensure they have adopted and implemented robust controls to ensure compliance with Rule 105 that prohibit purchases of securities in follow-on and secondary offerings when the purchaser engaged in short sales of the same securities during specified time periods before the pricing of the offering. Intent is not required for a Rule 105 violation. There are some limited exceptions to the prohibitions under Rule 105, however.

US CFTC and US NFA Sue and Simultaneously Settle with a Retail Foreign Exchange Dealer for Practices that Amount to "Heads I Win, Tails I Win Too" Practices

Both the US CFTC and US NFA sued and settled with FXDirectDealer LLC, a NY-based retail foreign exchange dealer and futures commission merchant related to the Firm's customer order entry system that, after a customer placed an order, in the case of an interim price move (i.e., slippage), rounded off the transaction in a way that routinely benefited the Firm and not the customer. Previously, NFA had charged the Firm with violations of its anti-money laundering requirements; this complaint was settled too.

The CFTC charged FXDirectDealer with failure to supervise and required the Firm to reimburse impacted customers US$ 1.83 Million and pay a fine of US$ 914,121, while NFA also required the Firm to reimburse impacted customers related to the FX slippage offense, and pay an additional fine of US$ 1.1 Million in connection with both offenses.

And briefly:

Valuable Lessons Learned: Firms now should be amending their policies and procedures, as well as investigating and obtaining technology that will permit them to comply with this taping requirement -- particularly in connection with mobile telephones and other means of electronic communication (e.g., Skype). It probably is not sufficient solely to prohibit all communication with clients on company-issued cell phones, because it is likely to happen on private cell phones instead without taping, and in such case, not only will requisite conversations likely not be taped (despite the requirement), but there will be no company records of any kind related to such conversations, unless by happenstance. Because of this, firms should consider, as part of their policies and procedures, to require all employees to certify at least annually that they did not have relevant communications with customers on un-taped personal cell phones, or by other digital or electronic means.

For questions or assistance, do not hesitate to contact Gary DeWaal and Associates at (212) 382-4615 or at:

For more information, see:

CFTC: In the Matter of Susan Butterfield
CFTC Request for Public Comment re: CME EFRP Rule Amendments:
FCA: CEO Martin Wheatley Address to ISDA:
FINRA Recruitment Compensation Proposal:
FXDirectDealer regulatory actions:
ICE Clear US Notice: September 16, 2013 (50% of guaranty fund deposit required in cash):
JP Morgan regulatory actions:
National Futures Association CFTA Quarterly Recordkeeping Requirement:
SEC: SEC v. Fredrick D. Scott (USDC EDNY):
SEC Announcement regarding short sale charges and settlements with 22 firms in connection with public offerings; Risk Alert of Rule 105 Compliance
SEC proposed rule regarding public company CEO compensation:

Copies of the following documents are available on request to
CFTC v. MF Global, Inc., MF Global Holdings, Ltd., Jon S. Corzine and Edith O'Brien: Memorandum of Law in Support of Defendant Jon S. Corzine's Motion to Dismiss Counts I and IV of the Complaint
DRW Investments LLC and Donald R. Wilson, Jr. v. US Commodity Futures Trading Commission: Declaratory Judgment Complaint
Nader Tavakoli, as Litigation Trustee of the MF Global Litigation Trust v. Jon S. Corzine, Bradley L. Abelow and Henri J. Steenkamp: First Amended Complaint and Demand for Jury Trial

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 September 21, 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.


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