Monday, May 02, 2016

Agency officials give views on derivatives enforcement trends

By Lene Powell, J.D.

In a discussion panel hosted by the Practising Law Institute, enforcement officials from the CFTC, SEC, Department of Justice, and other agencies talked about new types of cases their agencies are bringing in the commodities and derivatives space under the Dodd-Frank Act, as well as the issue of individual versus corporate liability.

Commodities insider trading. Ben Singer, chief of the DOJ Securities & Financial Fraud Unit, said most people think of equities when it comes to insider trading, but the same incentives at play in the equities markets also affect the swaps and derivatives markets. The Dodd-Frank Act added a provision involving misappropriation of inside information to the Commodity Exchange Act (CEA), and the CFTC brought its first enforcement action under this provision last year (In re Motazedi).

Singer didn’t think any criminal cases have yet been brought in this area, but anticipates that there will be action over the next year or two from the DOJ. In particular, it’s likely that the DOJ’s work will bring out insider trading in the foreign exchange (FX) space. When traders get market-moving info, they can act on it. But if the information is obtained in violation of a trust or duty to a client, then it can sound in fraud, he said.

Commodities spoofing. In 2013, the CFTC settled its first enforcement action for spoofing, a type of disruptive trading practice specifically made illegal by the Dodd-Frank Act. The CFTC’s order found that Michael Coscia and his firm Panther Energy Trading violated Section 4c of the CEA by placing orders for trades with the intent of canceling them before execution in order to move prices in the direction he desired. The DOJ obtained a guilty verdict in its criminal case against Coscia in 2015, following jury deliberations that lasted only one hour.

The benefit of having the first trial out of the way is that you see what the government has to prove and what the jury instructions will be, said Singer. His office is working on its case against Navinder Sarao, alleged to have engaged in spoofing activity during the May 2010 Flash Crash. The CFTC is also pursuing a case against Sarao. The DOJ has prevailed in the U.K. extradition proceedings. Although there is no specific spoofing statute in the U.K., the court found that the conduct resembled conduct prohibited by other statutes. Given the international nature of the commodities markets, this extradition ruling was an important precedent, said Singer. He hopes it will survive appeals.

Singer thinks there will be an uptick in spoofing cases. At least anecdotally, it seems this conduct is pretty widespread in the markets, he said. In fact, Sarao himself complained about other people spoofing in the markets.

Benchmark manipulation. CFTC Enforcement Director Aitan Goelman said in the benchmark manipulation cases brought by the CFTC and other authorities, a cabal of banks conspired against their customers. He said benchmark manipulation is widespread and “there is no reason to be sanguine about the integrity of any benchmark.” The CFTC is moving through various benchmarks in a seriatim manner, including LIBOR, FX, and ISDAfix.

False statements. Goelman said it’s probably not a surprise that a violation of Section 6(c)(2) of the CEA to lie to the CFTC. However, not all might be aware that it’s also a violation to lie to the exchanges and the National Futures Association (NFA). The CFTC recently issued an order in In the Matter of Galileo Trading, a commodity pool fraud case in which the respondent made false statements to the NFA.

When false statements are made to regulators, said Goelman, “That’s on the record. It counts. People lie to us all the time, and most of the time we can’t prove it. But where we can prove it, we bring those cases.”

SEC derivatives rules. Michael Osnato, chief of the SEC enforcement unit focusing on complex instruments including derivatives, called attention to recently issued business conduct rules for swap dealers, which include requirements for fair dealing and disclosure of conflicts of interest. Although the rules are not effective yet, the unit is gearing up for enforcement. He said that although enforcement has traditionally been reactive, the SEC is building out a surveillance infrastructure that allowing the agency to mine the data for aberrational behavior, so it can pursue a proactive approach.

Individual vs. corporate liability. In 2015, the DOJ issued the “Yates Memo”, which described a renewed focus on sanctions for individual wrongdoers. Singer said it’s not really anything new, but perhaps it got attention, which is useful. It’s probably too early to tell if it has made a real difference, but the DOJ has seen some uptick in the level of cooperation and the specificity of information they are getting with respect to individuals. A recent case against two individual executives at State Street was really driven by the cooperation of the company, he said.

Osnato said that it’s always been a longstanding SEC practice to build cases from the bottom up, and that you can’t bring a fraud case without a laser focus on individuals. Part of cooperation is identifying and remediating any individual bad actors. He said this particular Commission has taken a very aggressive approach to enforcement and staff has to account for what they have done or not done. The SEC always tries to anchor the state of mind in a person. If there’s a feel of collective scienter, that certainly influences the choice of penalties and relief, he said.

Regarding the role of remedial sanctions, Osnato said that the SEC looks to see what compliance measures are already in place, and this factors into penalties. In the LIBOR and FX cases he works on, the SEC works closely with the CFTC to come up with measures that make sense. In other areas, they coordinate with other regulators.

Larry Parkinson, director of investigations at FERC, said his agency builds compliance credit into their penalty program. In particular, they look at compliance culture. Companies often pay a lot of money to have a law firm create a compliance manual, but often the books are left on the shelf. Training is either sloppy or ineffective, he said. When the company is investigated, the compliance manual is trotted out, but it is often accomplishing very little in-house. FERC looks at how knowledge of the rules filters down, and what kind of training program is in place. He said that a culture of compliance doesn’t just happen naturally—it’s driven by an institutional focus on compliance.

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