Stay up-to-date with the latest developments in securities law through access to both news and all statutes and regulations. Find relevant corporate filings through a searchable EDGAR database. And...
By Gregory S. Kaufman and Amber S. Unwala
Gregory S. Kaufman is a partner in Eversheds Sutherland, where he focuses on commodities and securities enforcement matters.
Amber S. Unwala is an associate at Eversheds Sutherland focusing on an array of business and commercial litigation matters, including financial services and securities litigation.
Several years ago, we questioned whether the enforcement activities of the US Commodity Futures Trading Commission (CFTC) were poised to settle into a new normal as the financial crisis slipped further away in the rearview mirror. [Gregory Kaufman and Lillian Forero, Return to Normal? Dodd-Frank Authority Has Not Resulted in More CFTC Enforcement Actions . . . Yet! , 47 Bloomberg BNA Sec. Reg. & L. Rep. 605 (March 24, 2015).] In the years that followed the crisis, the CFTC meted out consistent enforcement activity seemingly answering this question in the affirmative. However, this pattern was interrupted in 2017. After three years of initiating an average of 68 enforcement actions, the number dropped to 49 actions initiated in 2017—the first time since 2008 that this number fell below 50. [The source for the number of actions initiated by fiscal year is the CFTC’s online enforcement archive.] In addition to initiating fewer actions, the amount of civil monetary penalties assessed fell sharply. This article analyzes 2017 enforcement activity by the numbers, identifies trends and priorities in these numbers, and looks for potential areas of regulatory focus in the year ahead. In the last decade, the CFTC ensured its status as a key financial regulator through aggressive enforcement. Does it risk undermining that hard-fought-for reputation if it is seen as policing its markets less aggressively? In the words of the late great Tom Petty, when you’ve been flying high, “coming down is the hardest thing.” [Tom Petty and The Heartbreakers, Learning to Fly, on Into the Great Wide Open (MCA Records 1991).]
In order to put 2017 in context, it is helpful to review findings regarding prior enforcement activity. These findings include the following:
Just five years ago, the CFTC initiated a record 102 enforcement actions. What appeared to be a trend towards steadily increasing enforcement activity has instead gone the other way. While it is fair to say that “what goes up must come down,” [Tom Petty and The Heartbreakers, Learning to Fly, on Into the Great Wide Open (MCA Records 1991).] the past year saw 19 fewer cases than the year before and a surprising 53 fewer cases from the high point in 2012. This dramatic drop-off should not be viewed in isolation because no two cases are alike. Some investigations are complex, resource intensive and monetarily more significant than others. Thus, one can also look at the number of actions in the context of civil monetary penalties imposed in those actions. Unfortunately, the news is not much different.
Civil monetary penalties for the years 2012 through 2016 were approximately $475 million, $1.5 billion, $1.8 billion, $3.14 billion and $748 million respectively. In 2017, these penalties were approximately $334 million on 49 actions versus approximately $748 million on 68 actions the year prior.
Why were there fewer enforcement actions initiated in matters of lesser monetary significance in 2017? It could very well be a temporary lull resulting from the CFTC Division of Enforcement largely wrapping up several major manipulation investigations involving Libor, ISDAFix and FX trading. [ In re The Royal Bank of Scotland, CFTC Docket No. 17-08 (Feb. 3, 2017); In re Citibank, N.A.; Citibank Japan Ltd.; and Citibank Global Markets Japan Inc., CFTC Docket No. 16-17 (May 25, 2016); In re Barclays Bank PLC, CFTC Docket No. 15-24 (May 20, 2015).] These investigations were certainly complex, spanned several years, consumed substantial resources, and resulted in billions of dollars in penalties. Another potential factor is that, after years of trying to do more with less, the lack of significant budget increases is finally showing its effects. Yet another potentially contributing factor is the unknown, meaning the Division of Enforcement may well be in the midst of significant confidential investigations, the fruits of which may not be publicly known for months or years. It may be that 2017 better reflects normal activities during times of economic growth. Only time will tell, and waiting is the hardest part. [Tom Petty and The Heartbreakers, The Waiting, on Hard Promises (Backstreet Records 1981).]
The single largest category of cases initiated in 2017 was non-manipulation fraud-based actions. [Fraud-based cases are distinguished from market manipulation cases in this article. While manipulation cases can involve elements of fraud, they are accounted for differently than typical fraud-based cases involving theft or fraudulent schemes.] Of the 49 actions, 20 were in this category. While 2015 might have suggested that the CFTC was finally getting out of the fraud-fighting business with only 26% of the actions being of this nature, 2016 (47% of all actions) and 2017 (41% of all actions) indicate that this was not the case. The CFTC still dedicates substantial resources to investigating and prosecuting civil fraud.
The second largest category of cases involved disruptive trading or, more specifically, spoofing. [Defined by the CFTC as entering bids and offers with the intent to cancel before execution. See Q & A – Interpretive Guidance and Policy Statement on Disruptive Practices, CFTC, http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dtpinterpretiveorder_qa.pdf.] Since the approval of the final order regarding disruptive trading practices in 2013, no more than two spoofing actions were initiated by the CFTC in any year prior to 2017. In 2017, all nine disruptive trading actions involved spoofing. This remarkable jump in cases is clear evidence that investigating spoofing was, and likely still is, a priority of the Division of Enforcement.
The recent trend in actions involving recordkeeping and/or reporting violations suggests that the CFTC’s emphasis on evaluating whether regulated entities are meeting the enhanced recordkeeping and reporting obligations arising from the Dodd-Frank Act remains an enforcement priority. Few recordkeeping and reporting cases were brought prior to 2015, but since, they consistently make up on average 13% of all cases initiated per year.
Finally, the past year serves as yet another reminder that where the CFTC perceives a lack of supervision, it will bring actions for failure to supervise. The five failure to supervise actions brought represented 10% of all actions initiated in 2017. While there were more supervision actions initiated in prior years (e.g., seven in 2013 and nine in 2012), as a percentage of actions initiated, 2017 was a high watermark in the last 10 years.
When it came to prosecuting fraud, spoofing, recordkeeping/reporting and supervision violations in 2017, the CFTC stood its ground and did not back down. [Tom Petty, I Won’t Back Down, on Full Moon Fever (MCA Records 1989).] The same cannot be said for two other key areas of its enforcement responsibilities. In 2017, manipulation and trade practice cases were just another face in the crowd. [Tom Petty, A Face In The Crowd, on Full Moon Fever (MCA Records 1989).]
Manipulation (including attempted manipulation) actions appear to be back to levels that were typical prior to the financial crisis, with just three cases initiated in 2017. What is notable is that all of these settled actions relied on the anti-fraud authority found in Rule 180.1 which prohibits the employment, or attempted employment, of manipulative and deceptive devices. [Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation, 17 C.F.R. Part 180 (2014).] Given that Rule 180.1 applies to conduct occurring after August 2011, this trend of charging manipulation under this anti-fraud standard should be here to stay.
Similarly, only three trade practice enforcement actions were initiated in 2017, representing the lowest number of such cases brought since 2009. Trade practice cases include violations of rules addressing position limits, wash trades, pre-arranged trades, non-bona fide exchange for related position transactions and block trades. All three cases in 2017 involved wash trades. Over the last 10 years, trade practice actions averaged six cases per year. Why so few cases in 2017? Are market participants simply doing a better job of monitoring their trading and preventing violations? Maybe, but not likely. Rather, there appears to be a concerted effort to push these investigations down to the enforcement arms of the futures exchanges. Anecdotally, it appears that the CME Group of exchanges and ICE Futures US are bringing significantly more disciplinary actions involving trade practice violations than they have in the past. For several reasons, it makes sense for the CFTC to rely on the exchanges to police this type of activity. Exchanges sit at the frontline for surveilling this type of conduct, they are more than capable of investigating potential violations, and the CFTC can divert resources to other priorities. These resources appear to have been directed towards spoofing investigations in 2017. However, with fewer fraud, trade practice and manipulation actions brought in 2017, one is left to wonder where else might the CFTC be focusing its limited resources.
Each year there are a number of notable actions or occurrences worthy of special note, and the past year was no different. In 2017, the application of Rule 180.1 in the McVean settled action, and the intersection of self-reporting and credit for cooperation stood out.
In the Matter of McVean Trading & Investments, LLC, et al., the CFTC issued an order settling charges that the Respondents used or employed a manipulative or deceptive device in violation of Rule 180.1, among other charges. [ In re McVean Trading & Investments, LLC, CFTC Docket No. 17-15 (June 21, 2017).] This order appeared to build upon the CFTC’s settlement order in the In re JPMorgan Chase Bank, N.A. matter. [ In re JPMorgan Chase Bank, N.A., CFTC Docket No. 14-01 (Oct. 16, 2013).] The McVean order found that two individuals used straw purchasers for hundreds of long live cattle futures over and above otherwise applicable position limits and, by doing so, intentionally or recklessly used a manipulative or deceptive device to inject false information into the market which had the potential to affect the futures market. [ In re McVean Trading & Investments, LLC, CFTC Docket No. 17-15, at pp 2-3.] By constructing a false image of the market, the individuals were able to control a substantial portion of the market without disclosing their control. [ Id. at p. 6.]
What is notable about the order is not what is in it, but rather what is not. The order did not find fraud, a desire to manipulate the market, or an actual or potential market price impact. Essentially, the order found that the individuals used a manipulative device that had the potential to disrupt the market in violation of Rule 180.1. [ Id. at p. 2.] The order leaves open this question—for what purpose and to what end did these individuals control outsized long futures positions? According to this order and the JPMorgan order, an answer to this question is not necessary to find a violation of Rule 180.1.
By issuing an “Updated Advisory On Self Reporting And Full Cooperation” accompanied by remarks from Director of Enforcement James McDonald, the Division of Enforcement renewed efforts in 2017 to shift incentives in favor of self-reporting and full cooperation. The updated advisory and the Director’s remarks attempt to offer greater transparency about what the Division expects and how meeting those expectations will result in substantially reduced penalties or, in “truly extraordinary circumstances” (e.g., self-reporting misconduct that is pervasive in an industry), decisions not to prosecute. [See Enforcement Advisory: Cooperation Factors in Enforcement Division Sanction Recommendations for Companies (Jan. 19, 2017), http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfadvisorycompanies011917.pdf (Advisory for Companies); Enforcement Advisory: Cooperation Factors in Enforcement Division Sanction Recommendations for Individuals (Jan. 19, 2017), http://www.cftc.gov/idc/groups/public/ @lrenforcementactions/documents/legalpleading/enfadvisoryindividuals011917.pdf.] Implicit in the Director’s remarks is a recognition that the prior cooperation program did not provide sufficient guidance to enable companies to answer the question of “what sort of treatment can we expect” if we self-report. [See CFTC’s online enforcement archive at p. 3.] While the updated advisory still does not provide these answers, it does identify the Division’s expectations of what is necessary in order to receive “concrete benefits.” How do these “concrete benefits” differ from the reduced sanctions identified as the reward in the prior advisory?
Insight may be gleaned from two actions taken by the CFTC in 2017. The first involved the use of non-prosecution agreements by the Commission for the first time, and the Director noted the importance of this tool in the cooperation program. [ See Enforcement Release: pr7581-17.] The second involves a settled matter involving spoofing over a five-year period that resulted in a monetary penalty of $600,000. [ See Enforcement Release: pr7598-17.] In that matter, the settling party self-reported, cooperated and received a “substantially reduced penalty” according to Director McDonald. [ Id.] Given the Division’s focus on prosecuting spoofing and the scope of the settling party’s trading activity, the sanction appears to be less severe than could have been expected absent the self-report.
When potential wrongdoing is identified, “there ain’t no easy way out,” [Tom Petty, I Won’t Back Down, on Full Moon Fever (MCA Records 1989).] and the decision whether to self-report is still a difficult one to make. It remains to be seen if these efforts to reinvigorate the Division’s self-reporting and cooperation program lead to more self-reporting. If the Division can clearly demonstrate that these substantial benefits are attainable, then maybe it will see the shift in self-reporting that it seeks.
With relatively consistent low volatility in the energy and commodities markets, 2018 may turn out to look a lot like 2017. However, events beyond market participants’ control can quickly change that calculation. That being said, there is a court decision on the issue of market manipulation due in 2018 that will be closely dissected. In addition, 2018 may be looked back upon as the year of cryptocurrencies.
While not a case initiated in 2017, the CFTC v. DRW Investments, LLC market manipulation case is awaiting a judge’s decision on guilt or innocence which is expected in 2018. [ United States Commodity Futures Trading Commission v. Donald Wilson and DRW Investments, LLC , No. 13 Civ. 7884 (S.D.N.Y. Nov. 6, 2013).] In this case, the CFTC alleged that defendants made illegitimate market bids in order to increase a contract settlement price and that this bidding strategy changed contract prices to levels that did not accurately reflect legitimate supply and demand. During closing arguments, the judge expressed skepticism in the CFTC’s arguments regarding artificial price market manipulation. The court appeared to be particularly troubled by what it suggested was an attempt by the CFTC to prove objective price artificiality through defendants’ subjective intent. The court stated, “[y]our theory, it seems to me, is that they had intent to affect the price, and because they had intent to affect the price, that means that [defendants’ bids] were illegitimate, which means that the prices were artificial, which is so circular as to be nonsensical.” [Transcript of Record at 751-752, U.S. C.F.T.C. v. Wilson, No. 13 Civ. 7884 (S.D.N.Y. Nov. 6, 2013).] While a judge’s questions are often not accurate predictions of the ultimate outcome, the decision in this case is eagerly awaited.
There is little doubt that virtual currencies will generate significant attention in the future. The CFTC first found that bitcoin and other virtual currencies were properly classified as commodities in 2015. [In re Coinflip, Inc., CFTC Docket No. 15-29 (Sept. 17, 2015).] While there is no overriding federal regulator, the CFTC’s authority over the cryptocurrency market is growing with the introduction of bitcoin futures contracts, thereby giving it jurisdiction over the commodity underlying those contracts.
The physical cryptocurrency markets remain opaque and, with the pseudo-anonymous nature of these coins, the related markets are favored for black market transactions, money laundering and by entities shut out of the global financial system. Not to mention that bitcoin and the accounts that hold it can be stolen or hacked. There is a Wild West feel to this growing market. Nevertheless, the extreme volatility of these coins and their low correlation to traditional asset classes could draw more institutional and individual traders into these markets.
The CFTC is the new sheriff in town and has already expressed “concerns about the price volatility and trading practices of participants in these markets.” [CFTC Statement of Self-Certification of Bitcoin Products by CME, CFE and Cantor Exchange, http://www.cftc.gov/PressRoom/PressReleases/pr7654-17 (Dec. 1, 2017).] The CFTC will be on the lookout for the typical Ponzi schemers, fraudsters and bucket shops. [A Primer on Virtual Currencies, LabCFTC, http://www.cftc.gov/idc/groups/public/documents/file/labcftc_primercurrencies100417.pdf (Oct. 17, 2017).] Insider trading and, particularly, market manipulation, will likely be larger concerns. The CFTC likes to remind the public that “the methods and techniques of manipulation are limited only by the ingenuity of man.” [ Cargill Inc. v. Hardin, 452 F.2d 1154, 1163 (8th Cir. 1971).] This may never be truer as when applied to the crypto-markets.
Tom Petty might have appreciated the rough and lawless feel to these new markets with seemingly “one foot in the grave and one foot on the pedal,” [Tom Petty and The Heartbreakers, Rebels, on Southern Accents (MCA Records 1985).] and no way of knowing which direction they are going to go. For enforcement at the CFTC, 2018 promises to be a year to watch.
Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)