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January 2015

ACTIONS TO IMPLEMENT DODD-FRANK

Congress Amends Swaps “Push-Out” Provision

The Dodd-Frank Act contained a provision that

prohibits federal assistance (including FDIC

insurance) to any insured depository institution

that is a swap dealer with respect to certain swap

activities. In practical terms, this provision would

have required large banks to “push out” those

swap activities to a separate affiliate that is not

covered by FDIC insurance. In December,

Congress amended this provision (over the

objection of Senator Elizabeth Warren and others)

as part of the appropriations bill needed to fund

the federal government. President Obama signed

the bill into law on December 16, 2014.

Under the original Dodd-Frank legislation, banks

were permitted to engage in certain derivatives

transactions, such as swaps based on interest

rates and currencies, but were required to “push

out” other types of derivatives transactions such

as credit default swaps, commodity swaps, and

equity swaps. The amendment allows banks to

engage in all types of derivatives transactions

except for “structured finance swaps” that are

based on asset-backed securities.

Revised Margin Rules for Uncleared Swaps Proposed

On October 3, 2014, the CFTC published

proposed rules in the Federal Register to

establish minimum initial and variation margin

requirements for uncleared swaps entered into

by swap dealers and major swap participants

(MSPs). The CFTC proposal is substantially

similar to the proposal recently promulgated by

five federal banking regulators. The CFTC’s rules

will apply to firms that are not overseen by the

banking regulators.

Notably, the CFTC proposal would not require

non-financial end users to post margin for

uncleared swaps. Because such entities

generally use swaps to hedge commercial risks,

the CFTC believes that they pose less risk of

default than financial entities. (In January 2015,

Congress adopted an amendment to the Dodd-

Frank Act to provide an exception for non-

financial companies from the requirement to

post margin on uncleared swaps.)

When margin is required to be posted, the CFTC

proposal would require the initial margin

collateral to be held in segregated accounts at

an independent custodian. Rehypothecation of

the margin collateral would be prohibited.

The CFTC requested comments on all aspects of

its proposed rules, including how they should

apply to cross-border transactions in which one

or both counterparties are non-U.S. persons.

The closing date for comments was December

2, 2014. As of December 3, over 200 comments

had been received.

In a related development, the CFTC Division of

Swap Dealer and Intermediary Oversight issued

an interpretation on October 31, 2014 regarding

certain notification requirements with respect to

the posting of margin for uncleared swaps.

Under the CFTC’s rules, a swap dealer or MSP

must provide annual notification to each

counterparty of its right to require segregation

of initial margin. The interpretation clarifies that

In This Issue:

ACTIONS TO IMPLEMENT DODD-FRANK ...................... 1

OTHER CFTC REGULATORY ACTIONS ............................. 4

CFTC AND CRIMINAL ENFORCEMENT ACTIONS ..... 6

NOTEWORTHY LITIGATION DEVELOPMENTS .................. 8

CME GROUP REGULATORY DEVELOPMENTS ................ 10

CME GROUP ENFORCEMENT ACTIONS ........................... 11

NFA REGULATORY DEVELOPMENTS ................ 12

NFA ENFORCEMENT ACTIONS ........................... 13

Schiff HardinDerivatives & Futures

Practice

Carl A. Royal Managing Editor

Paul E. Dengel Practice Group Leader

Stacie R. Hartman Deputy Practice Group Leader

Geoffrey H. Coll

Jack P. Drogin

Jacob L. Kahn

Kenneth W. McCracken

Michael L. Meyer

Victoria Pool

Christine A. Schleppegrell

Michael K. Wolensky

John S. Worden

Elyse K. Yang

2Derivatives & FuturesSchiff Hardin LLP

January 2015

the notification is not applicable if no initial margin is required

to be posted by the counterparty. It also provides that a swap

dealer or MSP may, under certain conditions, rely on negative

consent to satisfy its obligations to receive from its counterparty

(a) confirmation that the counterparty received the annual

notification and (b) the counterparty’s election to require or

not require segregation.

Application of Dodd-Frank to Cross-Border Transactions

In general, Dodd-Frank applies to cross-border swap

transactions only when the transactions have a direct and

significant connection with U.S. activities or effect on U.S.

commerce. The CFTC in 2013 approved interpretive guidance

describing how the CFTC will apply Dodd-Frank regulations to

cross-border transactions. In addition, the CFTC staff in Staff

Advisory No. 13-69 took the position that a transaction

between a non-U.S. swap dealer and a foreign client is subject

to the CFTC’s swap rules if the swap is arranged, negotiated,

or executed by personnel or agents of the non-U.S. swap

dealer who are located in the United States. The position taken

in the Staff Advisory is controversial, and it has never been

enforced by the CFTC. The CFTC has issued a series of

no-action letters that extended the date when non-U.S. swap

dealers would be required to comply with it. The most recent

no-action letter was issued on November 14, 2014, and it

extends the compliance date until September 30, 2015.

CFTC’s Cross-Border Guidance Survives Industry Lawsuit

Three industry associations – the Securities Industry and

Financial Markets Association, the International Swaps and

Derivatives Association, and the Institute of International

Bankers (collectively, the Associations) – filed a lawsuit in

federal court in the District of Columbia challenging the CFTC’s

interpretive guidance regarding cross-border swap transactions.

Procedurally, the Associations argued that the CFTC failed to

comply with the Administrative Procedure Act (APA) notice and

comment requirements. The court rejected that argument

because the CFTC guidance was non-binding and thus not

subject to the APA requirements. Substantively, the Associations

argued that the CFTC exceeded its authority under Dodd-Frank

to regulate non-U.S. swap dealers. The court disagreed and

granted, in part, the CFTC’s motion to dismiss, while remanding

select rules to the agency to assess the costs and benefits of

the extraterritorial application of those rules. The court

allowed the rules to remain in effect during the CFTC’s

consideration of costs and benefits.

Relief Extended for Inter-Affiliate Swaps

The CFTC’s rules that require mandatory clearing for certain

swaps contain an exemption for swaps between affiliated

entities, provided that certain conditions are met. One of the

conditions requires that swaps between one of the affiliated

entities and an unaffiliated counterparty be cleared. However,

it is impractical to meet that condition when the counterparty

is not located in the United States because most foreign

jurisdictions have not yet implemented a mandatory clearing

requirement for swaps. Accordingly, the CFTC has issued

no-action relief to allow affiliated entities to rely on this

exemption even when their swaps with foreign counterparties

are not cleared. In a recent no-action letter dated November

7, 2014, the CFTC extended the expiration date for such relief

from December 31, 2014 until December 31, 2015.

Mandatory Trading Requirement for Swaps in Package Transactions

Dodd-Frank requires that all swap transactions subject to

mandatory clearing must be executed either on a designated

contract market (DCM) or a swap execution facility (SEF),

except where no DCM or SEF makes the swap “available to

trade.” In early 2014, the CFTC certified that certain interest

rate swaps and certain credit default index swaps were

“available to trade.” As a result of the CFTC’s certification,

bilateral, over-the-counter transactions in those swaps are

unlawful, unless an exception (such as the end-user exception)

is available.

Application of the mandatory trading requirement is more

complicated for transactions in swaps that are combined with

transactions in other financial instruments and executed as a

single “packaged” trade. If at least one of the components of

a packaged trade is a swap that is subject to the mandatory


January 2015

trading requirement, the CFTC has taken the position that the

entire package must be executed on an exchange or a SEF.

However, in recognition of the fact that the exchanges and

SEFs are not prepared operationally to trade certain of such

package transactions, the CFTC has issued no-action relief in

this area. In a no-action letter dated November 10, 2014, the

CFTC granted relief from the mandatory trading requirement

for the swap components of the following types of package

transactions until the dates specified below:

• For packaged trades in which at least one swap

component is subject to mandatory trading and

the other components are either (a) CFTC-

regulated swaps not subject to mandatory clear-

ing, (b) swaps not subject to exclusive CFTC

jurisdiction, or (c) non-swap instruments (with

certain exclusions), the requirement will become

effective on February 15, 2015.


component is subject to mandatory trading and

the other components are agency mortgage-

backed securities, the requirement will become

effective on May 15, 2015.


component is subject to mandatory trading and the

other components are futures contracts, the require-

ment will become effective on November 14, 2015.


component is subject to mandatory trading and the

other components are bonds newly issued and sold

in the primary market, the requirement will become

effective on February 12, 2016.

CFTC Expands Hedging Choices for Government-Owned Utilities

On September 17, 2014, the CFTC approved an amendment to

the de minimis exception from the definition of “swap dealer”

with respect to certain swaps entered into with government-

owned utilities. Under rules adopted in 2012, a firm is excluded

from the definition of “swap dealer” if its level of swap dealing

activity during the preceding 12-month period did not exceed

a specified threshold known as the de minimis threshold. The

general de minimis threshold was initially set at $8 billion of

aggregate notional amount of swaps so that only firms dealing

with large numbers of swaps would be required to register.

However, the original CFTC rule also provided a separate and

much lower de minimis threshold of $25 million for swaps

entered into with “special entities.” Government-owned gas

and electric utilities are deemed to be “special entities” under

the CFTC’s rule. This threshold had the effect of limiting the

types of firms willing to enter into swaps with special entities

only to large banks that were registered as swap dealers.

Under the amended rule, swaps with utility special entities

would count against the larger $8 billion general de minimis

threshold rather than the smaller $25 million threshold,

provided that the swaps are used for hedging a utility special

entity’s risk in connection with (i) the generation, production,

purchase, or sale of natural gas or electric energy; (ii) the

supply of natural gas or electric energy to a utility special

entity; (iii) the delivery of natural gas or electric energy

service to customers of a utility special entity; (iv) the fuel

supply for the facilities or operations of a utility special entity;

(v) compliance with an electric system reliability obligation; or

(vi) compliance with an energy, energy efficiency, conservation,

renewable energy, or environmental statute or regulation

applicable to a utility special entity.

CFTC Clarifies Test for Forwards with Volumetric Optionality

In November 2014, the CFTC and SEC proposed a clarification

of their previously issued interpretation and seven-part test

concerning the exclusion of forward contracts with embedded

volumetric optionality from the definition of “swap.” The

interpretation was designed to guide the commercial energy

market on how to maintain the forward nature of their

contracts (actual delivery of the commodity) while allowing the

flexibility needed by energy companies and utilities to exercise

the option to add or remove volume to the underlying quantity

of product to be delivered in response to market demand.

The most important clarification proposed was to the seventh

element of the test, which would be restated as follows: “The

embedded volumetric optionality is primarily intended, at the

time that the parties enter into the agreement, contract, or

transaction, to address physical factors or regulatory

requirements that reasonably influence demand for, or supply


January 2015

of, the nonfinancial commodity.” This new language is meant

to clarify that (1) the embedded volumetric optionality must be

intended at the time of execution of the agreement, contract

or transaction to address any physical factors or regulatory

requirements that reasonably influence supply or demand; (2)

the parties must have some degree of influence or control over

physical or regulatory requirement factors affecting supply and

demand as opposed to these factors being completely “outside

their control”; (3) the “physical factors” should be construed

broadly to include any fact or circumstance that would

reasonably influence supply or demand issues – including

environmental factors, “operational considerations,” and

broader social forces such as demographics or geopolitics; and

(4) electric demand response agreements would meet the

regulatory requirement within the meaning of the seventh

element (emphasis added to reflect the fundamental aspects

of the modifications in the interpretive proposal).

The public comment period ended on December 22, 2014, and

a decision by the CFTC is expected in early 2015.

OTHER CFTC REGULATORY ACTIONS

CFTC Extends Comment Period for Proposed Position Limit Rules

In 2013, the CFTC proposed new rules for position limits that

would establish spot-month and all-months position limits for

futures, options, and economically equivalent swaps on 28

physical commodities. The CFTC also published proposed

amendments to its rules for determining when positions held

by two or more related entities should be aggregated for the

purpose of complying with the position limit rules. These

issues were discussed at a meeting of the CFTC’s Agricultural

Advisory Committee on December 9, 2014. In order to permit

commenters to address issues raised at that meeting, the time

for commenting on the proposed rules was extended until

January 22, 2015.

CFTC’s “Residual Interest” Requirement Becomes Effective

In 2013, the CFTC approved new rules designed to enhance

protections for customers. One such rule requires futures

commission merchants (FCMs) to hold sufficient proprietary

funds (a “residual interest”) in customer segregated accounts

and Part 30 secured accounts to reasonably ensure that the

firms are properly segregated and secured at all times, and to

cover margin deficiencies in customers’ trading accounts.

Effective as of November 14, 2014, the residual interest rule

requires FCMs to use their own funds to cover any individual

customer margin deficits outstanding as of 6:00 p.m. (Eastern

Time) on the business day following the trade date.

The original CFTC rule required its staff to conduct a study to

address cost-related questions, to solicit public comments, and

to conduct a public roundtable. The CFTC then would consider

whether to modify its schedule for phasing in the residual

interest requirement. If the CFTC took no action, the time by

which customer margin deficits are to be calculated would be

accelerated automatically, effective as of December 31, 2018,

from 6:00 p.m. on the business day following the trade date

to the time of the first daily settlement, which typically occurs

in the early morning on the business day following the trade

date. However, at a meeting on November 3, 2014, the CFTC

Commissioners voted to propose an amendment to the CFTC

rule that would remove the automatic acceleration of the time

for calculating customer margin deficits if no action is taken

before December 31, 2018. If this amendment is adopted, the

current time for making that calculation would remain in effect

unless and until the CFTC determines to change it through a

separate rulemaking. Comments on this proposed amendment

are due on or before January 13, 2015.

CFTC Provides Guidance and Grants Extension of Time for CCO Annual Reports

The Division of Swap Dealer and Intermediary Oversight

issued CFTC Staff Advisory No. 14-153 on December 22, 2014.

The Advisory provides guidance to FCMs and swap dealers on

what should be included in the annual compliance report to be

prepared by the firm’s chief compliance officer (CCO). Although

the Advisory does not mandate a specific organization or

approach, it does suggest a number of “best practices” for CCO

annual reports. One suggestion is that the report include a

summary chart that (1) identifies the applicable regulatory

requirements, (2) identifies which of the firm’s written policies

and procedures (WPPs) address each such requirement, (3)

contains a cross-reference to the specific section of the


January 2015

relevant WPP, (4) assesses the effectiveness of the WPP in

meeting the regulatory requirements, and (5) describes the

method used by the firm to assess the WPP’s effectiveness.

Concurrently with issuing the Advisory, the CFTC staff also

granted an extension of time to certain firms for filing the CCO

annual report. The CFTC’s rules ordinarily require the CCO

annual report to be filed within 60 days of the firm’s fiscal year

end. However, for FCMs and swap dealers that have a fiscal

year ending on or before January 31, 2015, the report can be

filed within 90 days of the firm’s fiscal year end. In addition, if

a firm is unable to submit its report within that time period, it

will be allowed another 30 days to do so, provided that the firm

notifies the CFTC of any material non-compliance events no

later than the end of the original 90-day period.

CFTC Proposes Amendments to Relax CTA Recordkeeping Requirements

A CFTC rule requires commodity trading advisors (CTAs)

who are members of a DCM or a SEF to record all oral

communications related to transactions in commodity

interests (i.e., futures, options on futures, and swaps) and

related cash and forward transactions. On November 3,

2014, the CFTC Commissioners voted to propose an

amendment to that rule to eliminate the requirement for

CTAs to record such oral communications. The proposed

amendment also would eliminate, for all market participants,

a requirement that records of oral and written communications

must be linked to particular commodity interest transactions.

The comment period for the proposed amendment ends on

January 13, 2015. In addition, the CFTC staff has granted

no-action relief in this area that will expire on the earlier of

(i) final CFTC action on the proposed amendment or (ii)

December 31, 2015.

Family Offices Obtain No-Action Relief

The CFTC staff in 2012 granted no-action relief to family

offices from the requirement to register as a commodity pool

operator (CPO), provided that certain conditions were met. In

a letter dated November 5, 2014, the CFTC staff expanded

the no-action relief so that family offices are not required to

register as a CTA either, again provided that certain conditions

are met. It should be noted that this relief is not self-

executing. To qualify for the relief, a family office must file a

claim with the CFTC to elect the relief. The claim will be

effective upon filing if it is accurate and complete.

CFTC Eases Advertising Ban for Hedge Funds

Congress in 2012 enacted the so-called JOBS Act, which was

intended to spur job growth by easing regulation of

investments in privately-held companies, including hedge

funds. In 2013, the SEC adopted rule amendments to permit

an issuer of securities to engage in general solicitation or

advertising in offering its securities to purchasers who are

accredited investors. However, certain exemptions from the

CPO registration requirements in CFTC rules applied only if

interests in the commodity pool were not marketed to the

general public. The CFTC staff granted exemptive relief to

permit general solicitation or advertising of commodity pool

interests under specified conditions comparable to those

contained in the SEC’s rules. A CPO seeking this exemptive

relief must file a notice with the CFTC. The relief will be

effective upon filing, provided that the notice is materially

complete and accurate.

CPOs Permitted to Delegate Certain Responsibilities

In a no-action letter dated October 15, 2014, the CFTC staff

provided a streamlined process by which the CPO of a

commodity pool (the Delegating CPO) can delegate the

responsibility to register as a commodity pool’s CPO to

another entity (the Designated CPO). Among other conditions,

the Delegating CPO must execute a legally binding document

in which it delegates all of its investment management

authority with respect to the commodity pool to the Designated

CPO. This relief is self-executing, without the need to submit

any filing to the CFTC.


January 2015

CFTC AND CRIMINAL ENFORCEMENT ACTIONS

Criminal Indictment in “Spoofing” Case

The CFTC first used its new authority under amended Section

4c(a)(5) of the Commodity Exchange Act (CEA) regarding

disruptive trading in a July 2013 settlement with Panther

Energy Trading LLC and Michael J. Coscia. The CFTC order

found that, from August 2011 through October 2011, the

respondents engaged in the disruptive practice of “spoofing” in

18 futures contracts traded on four exchanges. In particular, it

found that the traders had utilized an algorithmic trading

program designed to place bids and offers and then quickly

cancel them before execution.

In October 2014, the U.S. Attorney in Chicago sought and

received an indictment against Coscia for the alleged spoofing

conduct. The indictment is for six counts of spoofing and six

counts of fraud and could bring a total of 25 years in prison. In

December 2014, the defense filed a motion to dismiss the criminal

charges arguing that the spoofing statute is unconstitutionally

vague and that there was no notice that this type of conduct was

unlawful. While the new authority under the CEA defines spoofing,

there is considerable disagreement on the scope of the definition

as there is no generally accepted meaning of the term in the

futures markets. The case is still pending.

The fact that criminal charges have been brought indicates that

disruptive trading, along with manipulation and fraud, is likely to

be a focus of future enforcement actions.

CFTC Settles Attempted Manipulation with “Spoofing” before it was “Disruptive Trading”

The CFTC settled an attempted manipulation case involving

conduct similar to “spoofing” in the wheat futures market against

Eric Moncada and two proprietary trading firms, BES Capital LLC

(BES) and Serdika LLC (Serdika), in October 2014. The alleged

violative conduct occurred in 2009, before Section 4c(a)(5) was

amended to make “spoofing” a specific offense under the CEA.

After the CFTC was granted summary judgment against Moncada

on charges of fictitious sales and non-competitive transactions,

the parties settled the attempted manipulation charges for a

$1.56 million civil monetary penalty and permanent trading and

registration bans.

Per the consent order, Moncada engaged in three trading tactics

as part of his scheme: (1) manually placing and immediately

cancelling numerous large-lot orders with the intent that the

orders not be filled, but instead to create a misleading impression

of liquidity in the market (aka “spoofing”); (2) placing these large-

lot orders in a manner to avoid being filled by the market; and (3)

placing small-lot orders on the opposite side of the market with

the intent of taking advantage of any price movements caused by

his large-lot orders. The court had denied summary judgment on

the issue of attempted manipulation, but noted its “[agreement]

with the CFTC that the most compelling inference one might draw

from the trading records is that Moncada was indeed trying to

manipulate the market.” The significance of this case lies not only

in the apparent absence of any direct evidence (e.g. emails,

instant messages, testimony, etc.) that Moncada acted with

specific intent for the orders not to be filled, but also in the court’s

apparent willingness to agree with the CFTC that sufficient

evidence of the defendants’ intent may be derived from the

defendants’ pattern of trading alone.

MF Global Holdings Settles with CFTC

On December 23, 2014, the CFTC obtained a consent order

from the federal court against MF Global Holdings Ltd. for

$1.212 billion in restitution (or the amount necessary to

ensure that customer claims of its FCM subsidiary, MF Global

Inc., are paid in full) plus $100 million in civil monetary

penalties. The CFTC’s amended complaint charged that MF

Global Holdings controlled MF Global Inc.’s operations and was

responsible for its unlawful use of customer funds, its failure

to notify the CFTC immediately when it knew or should have

known of the deficiencies in its customer accounts, the filing of

false statements in reports with the CFTC regarding the

customer accounts, and the use of customer funds for

impermissible investments in securities. The restitution

obligation of MF Global Holdings is joint and several with the

restitution obligation of MF Global Inc., which was ordered to

pay the same amount. The civil monetary penalties are to be

paid to the CFTC only after the claims of customers and certain

other creditors have been satisfied.

Related CFTC litigation against former MF Global Chief

Executive Jon Corzine and former Assistant Treasurer Edith

O’Brien is still ongoing.


January 2015

Alleged Manipulation of Benchmark Cases Settled

• LIBOR cases – The CFTC filed and settled three

actions in 2014 on charges of manipulation, attempt-

ed manipulation, and false reporting of market infor-

mation relating to LIBOR and other interest rate

benchmarks. The CFTC imposed more than $580

million in civil monetary penalties and required inter-

nal controls improvements to strengthen the bench-

mark setting process within the banks - Lloyds’

Banking Group, PLC ($105 million penalty), RP Martin

Holdings Limited and Martin Brokers (UK) Ltd. ($1.2

million penalty), and Coöperatieve Centrale Raiffeisen-

Boerenleenbank B.A. (Rabobank) ($475 million

penalty). The orders stated that the banks’ traders

coordinated their trading and price submissions with

traders at other banks in an attempt to manipulate,

and to successfully manipulate, LIBOR rates.

• FX Fix cases – The CFTC filed and settled actions in

2014 against five banks that allegedly attempted to

manipulate the global foreign exchange (FX) bench-

mark rates to benefit their own trading positions or

those of certain traders. The five banks were Royal

Bank of Scotland plc (RBS), Cibibank, N.A., JPMorgan

Chase Bank, N.A., UBS AG, and HSBC Bank plc.

The RBS order described conduct (which is typical of

the conduct found in all five cases) in which RBS trad-

ers coordinated their trading with traders at other

banks to manipulate FX benchmark rates, including

the World Markets/Reuters Closing Spot Rates (WM/R

Rates), which is one of the most widely referenced

rates in the United States and globally. The WM/R

Rates are calculated multiple times a day, including at

4 p.m. London time, based on actual trades, bids, and

offers extracted from a certain electronic trading

system during a one-minute window called the “fix

period.” The traders used private electronic chat

rooms to plan their attempts to manipulate by

disclosing confidential information on positions, alter-

ing positions to accommodate their collective inter-

ests, and agreeing to trading strategies.

CFTC Settles Oil Manipulation Case

The CFTC settled a manipulation case in August 2014 involving

crude oil futures against Parnon Energy Inc., Arcadia Petroleum

Ltd., Arcadia Energy (Suisse) SA, Nicholas Wildgoose and

James Dyer. The complaint alleged that the defendants took

advantage of a tight physical market by executing a trading

strategy designed to affect NYMEX crude oil futures contract

spreads by knowingly amassing a dominant and controlling

position in physical West Texas Intermediate (WTI) crude oil.

Specifically, the CFTC alleged that the defendants held the

physical position until after futures expiry with the intent to

affect NYMEX crude oil spreads and then sold the physical

position during the “cash window” at a loss. The complaint

further alleged the defendants hoped to profit by buying WTI

futures spreads prior to widening the spreads through their

manipulation and by then selling WTI futures spreads prior to

dumping their physical WTI crude oil position. The defendants

agreed to pay a $13 million civil monetary penalty, limit their

physical market trading, and maintain records and audio

recordings for three years, among other undertakings.

CFTC Files Complaint to Enforce Settlement Order

In another action involving oil futures, the CFTC filed a complaint

to enforce a settlement order regarding an attempted manipulation

of crude oil futures at NYMEX and for violations of position limits

against Daniel Shak and his former company, SHK Management

LLC. The order had found that on certain trading days,

respondents were “banging the close” in the WTI oil futures

contracts. In November 2013, the respondents had agreed to a

$400,000 civil monetary penalty, trading bans and restrictions,

including prohibiting Shak from trading futures contracts in any

market during the closing period for a period of two years.

On September 30, 2014, the CFTC filed a federal suit charging

Shak with violating the terms of the settlement order. The CFTC

alleged that Shak violated the prior settlement order by trading

two June 2014 gold futures contracts during the closing period.

The complaint specifically alleged that Shak failed to report this

violation to the CFTC or his FCM until being confronted by the

FCM. The CFTC is seeking additional civil monetary penalties

against Shak for this alleged violation of the prior order. This

action indicates that the CFTC will closely monitor compliance of

its settlement orders and take quick action to enforce them.


January 2015

Prearranged or Fictitious Trading Still in CFTC Crosshairs

The Commission filed and settled charges against several

respondents for prearranged trades that constituted

fictitious sales.

• In re FirstRand Bank, Ltd. and In re Absa Bank,

Ltd. – Two separate CFTC orders charged FirstRand

Bank and Absa Bank with prearranged noncompeti-

tive trades from June 2009 to August 2011. The

orders alleged that the respondents prearranged

noncompetitive corn and soybean futures trades on

the CBOT through telephone conversations where

they agreed upon the product, quantity, price, direc-

tion, and timing of those trades before entering

them into the market as close to the same time as

possible. Both FirstRand Bank and Absa Bank agreed

to pay a $150,000 civil monetary penalty to settle

the charges, with the CFTC noting their cooperation

with the investigation.

• In re Fan Zhang – The CFTC issued an order

settling charges of prearranged noncompetitive

trades with Fan Zhang. Specifically, the Commission

order found that Zhang transferred trading profits

between two separate accounts by intentionally

placing buy and sell orders for the same price,

volume, and expiration month in CME’s Las Vegas

Housing Market and Cash-Settled Cheese futures

contracts and CBOT’s Ethanol futures contract. The

order alleged that one of the accounts was held in

the name of FZIC, LLC, which was an investment

club 50 percent owned by Zhang, and the other

account was held in the name of Zhang’s mother,

which realized a $200,000 profit. Zhang agreed to

pay a $250,000 civil monetary penalty.

CFTC Sues Defense Attorney for Aiding and Abetting Client’s Fraud

On September 9, 2014, the CFTC filed a complaint in federal

court in Florida alleging that Florida-based attorney Jay Bruce

Grossman willfully aided and abetted multiple clients in their

operation of illegal and fraudulent precious metals schemes.

The complaint alleged that Grossman’s clients claimed to sell

physical precious metals such as gold, silver, platinum,

palladium, and copper to retail customers on a leveraged or

financed basis, when in fact they never owned or possessed

any of the physical metals. The CFTC had previously obtained

judgments against Grossman’s clients in connection with these

activities. The complaint alleged that Grossman was well-

versed in the inner workings of his clients’ business and was

aware that they did not sell or store physical metals. Further,

the complaint alleged Grossman aided his clients in their

schemes by his actions that led customers to believe the

clients’ claims were legitimate and complied with the law. The

complaint alleged that Grossman drafted fraudulent customer

forms and made material misrepresentations regarding the

true nature of his clients’ business to customers and to both

federal courts and the CFTC.

While the CFTC has, on rare occasions, brought legal

actions against defense attorneys for being involved in a

fraud, this action marks the first use of the CFTC’s new

authority under Section 6(c)(1) of the CEA and CFTC

Regulation 180.1. The CFTC charged Grossman with aiding

and abetting his clients’ intentional or reckless use or

employment of a manipulative or deceptive device in

connection with false representations in connection with the

sale of a commodity in interstate commerce.

NOTEWORTHY LITIGATION DEVELOPMENTS

Two Private Lawsuits Against U.S. Bank Stemming from Peregrine Fraud Move Forward

In the fall of 2014, the federal court in Chicago allowed two

purported class actions against U.S. Bank to proceed arising

from Peregrine Financial Group’s misappropriation of more

than $215 million from customer segregated funds held in

accounts at U.S. Bank. One case was brought by a class of

individual customers, and the other by Fintec Group, Inc., on

behalf of a class of brokers. Although the court dismissed

certain claims in the customer class action lawsuit, it

allowed the case to proceed because it found that a fiduciary

relationship arose between the customers and U.S. Bank

when the customers deposited funds in a customer

segregated account held at U.S. Bank. As a result, the

claims of fraud by omission and breach of fiduciary duty will

proceed to discovery.


January 2015

In the second lawsuit, Fintec, an introducing broker, brought a

class action on behalf of brokers who placed customer orders

or deposited securities with Peregrine, but never received

commissions and/or return of security deposits. Fintec brought

two claims under the CEA: (1) that U.S. Bank was liable for

aiding and abetting Peregrine’s violations of the CEA; and (2)

that U.S. Bank was directly liable to Fintec for U.S. Bank’s

violations of the CEA. The court allowed Fintec to proceed on

both CEA claims against U.S. Bank because it found that the

claims satisfied the plain language of the CEA’s limited private

right of action. In allowing the CEA aiding and abetting claims

to proceed, the court determined that U.S. Bank had facts

before it that should have led U.S. Bank at least to inquire as

to whether Peregrine’s use of the funds in the customer

account was proper. After finding the allegations of U.S. Bank’s

knowledge to be sufficient based on the “conscious avoidance

doctrine,” the court allowed the CEA claims to proceed to dis-

covery, with intent issues to be resolved at summary judgment

or trial.

In related litigation, the CFTC and U.S. Bank settled the

action brought by the CFTC alleging that U.S. Bank improperly

had used Peregrine customer funds as security for guaranties

of loans made to Peregrine and its owner. The terms of the

settlement are confidential.

Sentinel Bankruptcy Trustee Loses Case Against Bank of New York Mellon

In the latest development in a case stemming from the failure

and bankruptcy of Sentinel Management Group, a U.S. district

court in Chicago rejected the arguments made by the Sentinel

bankruptcy trustee that Bank of New York Mellon (BNYM) should

be required to return collateral that it had held to secure loans

made to Sentinel. Before its failure, Sentinel used hundreds of

millions of dollars in customer assets to secure overnight loans

at BNYM used to fund large repo transactions. Sentinel did this

even though FCMs are required to keep customers’ funds in

segregated accounts and not allow the funds to be used for

other purposes. When Sentinel failed during the credit crisis of

2007, the bank was in a secured position, but Sentinel’s cus-

tomers lost millions.

In an appeal from an earlier ruling in this case, the Court of

Appeals for the Seventh Circuit remanded the case to the district

court to consider two issues: (1) what BNYM knew before Senti-

nel’s collapse and (2) whether BNYM’s failure to investigate Sen-

tinel rose to the level of negligence, recklessness, or deliberate

indifference. The district court concluded that the evidence did

not show that BNYM knew or believed that Sentinel engaged in

misconduct before it collapsed and that the doctrine of equitable

subordination should not be applied because BNYM’s inquiry,

although possibly negligent, was insufficient to establish “inequi-

table conduct.” The court also noted that Sentinel’s misconduct

had not been detected by either NFA or the firm’s auditors.

Trading Firms are Victims of Trade Secret Theft

• Trader Steals Source Code from Trading Firm.

In the fall of 2014, a federal grand jury in Chicago

indicted a futures trader, David Newman, who now

faces three counts of theft of trade secrets for steal-

ing files containing computer source code and

programs from his employer. Newman allegedly

downloaded more than 400,000 files onto a flash

drive, and quit his job after working at his firm since

2004. Newman then started his own business, WH

Trading, which claims to specialize in next genera-

tion trading tools. Each of the three counts carries a

maximum penalty of 10 years in prison.

• Citadel Employees Steal Proprietary Software.

An ex-Citadel LLC employee pled guilty to stealing

proprietary trading strategy and algorithms from two

companies. Prior to working at Citadel, Mr. Yihao Pu

downloaded source code and other files to his personal

computer and resigned the following day. Next, Mr. Pu

joined Citadel, where he again copied proprietary

software. In an effort to hide his actions when

confronted, Mr. Pu erased data from his computer and

threw computer equipment in a sanitary canal. A

colleague of Mr. Pu, Mr. Sahil Uppal, pled guilty to

obstructing justice by assisting Mr. Pu.

Offshore Conduct Insufficient to Sustain Private Suit Under CEA

The Second Circuit Court of Appeals upheld the district court’s

dismissal of an action brought under the CEA by a Russian

citizen residing in Russia involving investment contracts that

were signed in Russia. The Second Circuit found that “the CEA

creates a private right of action for persons anywhere in the

world who transact business in the United States, and does not


January 2015

open our courts to people who choose to do business

elsewhere.” In reaching its conclusion the court emphasized

that (i) plaintiff’s investment deal was signed, sealed, and

delivered in Russia, where the parties resided; (ii) the sales

materials were written in Russian; and (iii) plaintiff’s investment

contracts were signed in Russia.

FCM Found to Have Liquidated Customer Account in Bad Faith

In a CFTC reparations proceeding decided in October 2014, the

judgment officer ruled that Gain Capital Group (Gain), a

registered FCM and retail forex dealer, wrongfully liquidated a

customer’s account in order to cover a margin deficit. The

customer did not dispute that his account was undermargined,

but he argued that Gain should have liquidated just one USD/

CHF forex contract (rather than all four contracts) to cover the

deficit. Gain asserted that its account agreement with the

customer gave it discretion to liquidate “any or all open

positions” in the account if the account had a margin deficit.

The judgment officer agreed with the customer that liquidating

one contract would have been sufficient, and he ruled that

Gain acted in bad faith by liquidating additional contracts and

thus violated its duty to the customer under Section 4d(a)(2)

of the CEA. This decision appears to be in conflict with other

cases upholding an FCM’s right to take action under its account

agreement at its discretion to protect itself against the risk of

a customer failing to meet his margin obligations.

CME GROUP REGULATORY DEVELOPMENTS

CME Adopts New Rule 575 (Disruptive Practices Prohibited)

To expand upon the Dodd-Frank Act amendments to Section

4c(a) of the CEA, the CME adopted a new Rule 575, effective

September 15, 2014, to prohibit multiple types of disruptive

practices. Whereas Section 4c(a) of the CEA prohibits three

specific “disruptive practices”—(1) violating bids or offers, (2)

intentional or reckless disregard for the orderly execution of

transactions during the closing period, and (3) spoofing—CME

Rule 575 is much broader. First, it requires that all orders be

entered “for the purpose of executing bona fide transactions”

and that all “non-actionable messages” (e.g., requests for

quotes, the creation of User Defined Spreads, and administrative

messages) be entered “in good faith for legitimate purposes.”

Second, it identifies the following broad list of prohibited

practices:

1. No person shall enter or cause to be entered an order

with the intent, at the time of order entry, to cancel

the order before execution or to modify the order to

avoid execution.

2. No person shall enter or cause to be entered an

actionable or non-actionable message or messages

with intent to mislead other market participants.


actionable or non-actionable message or messages

with intent to overload, delay, or disrupt the systems

of the Exchange or other market participants.


actionable or non-actionable message with intent to

disrupt, or with reckless disregard for the adverse

impact on, the orderly conduct of trading or the fair

execution of transactions.

Rule 575 applies to open outcry as well as electronic trading,

and during all market states (including pre-open periods).

To accompany Rule 575, the CME issued Market Regulation

Advisory Notice on August 29, 2014 (the Advisory Notice).

Included in the Advisory Notice are 22 Frequently Asked

Questions and answers, including a lengthy list of factors that

CME may consider in deciding whether a participant’s conduct

violates Rule 575, and definitions of the more nebulous

phrases used in Rule 575 (e.g., “orderly conduct of trading or

the fair execution of transactions”). Also included in the

Advisory Notice is a “non-exhaustive” list of nine examples of

conduct prohibited under Rule 575. The examples are quite

specific, and should prove useful to firms and individuals

trading on CME.

Although the CFTC did not adopt CME’s Advisory Notice, and

was not required to do so, it did make minimal edits before the

guidance was re-released on September 15, 2014. Thus, it is

arguable that, by failing to change anything else in the market

regulation advisory, the CFTC has at least implicitly approved

its content.

Other exchanges have adopted similar rules. ICE Futures

U.S. and ICE Futures Canada adopted rules, effective on

January 14, 2015, that prohibit certain specified disruptive

trading practices.


January 2015

CME Market Regulation Advisory Notice on Rule 534 (Wash Trades Prohibited)

On December 17, 2014, CME released a revised Market

Regulation Advisory Notice (the December 17 MRAN) on Rule

534 – Wash Trades Prohibited. The revised notice, which

became effective on January 2, 2015, made several changes

to the prior advisory notice on Rule 534.

First, the December 17 MRAN amended the answer to

Frequently Asked Question No. 8. This question asks whether

market participants may “freshen” position dates without

violating the prohibition on wash trades. CME revised the

answer to this question to reflect its decision, effective January

2, 2015, to eliminate the existing prohibition on “freshening”

positions in Live Cattle Futures.

Second, the December 17 MRAN amended the answer to

Question No. 9. This question asks whether block trades

between different accounts with the same or common

beneficial ownership violate the wash trading prohibition.

Previously, the answer to this question stated that block trades

between accounts with common beneficial ownership were

permitted under certain circumstances. As revised, however,

the notice stated that block trades between accounts with the

“same beneficial ownership” (i.e., both accounts are 100%

owned by the same owners) are strictly prohibited. Where

accounts share common beneficial ownership (i.e., less than

100% ownership in common), block trades between them are

permitted if the trades and the parties meet the conditions set

forth in the notice (which have not changed).

On December 24, 2014, just one week after the December 17

MRAN was released, CME issued a revised version of the MRAN

that restored the original answer to Question No. 9 and

therefore apparently reversed the change in policy reflected in

the December 17 MRAN. It thus appears that block trades

between accounts with common beneficial ownership (including

100% ownership in common) are permissible under Rule 534

so long as all of the conditions set forth in the answer to

Question No. 9 are met. The CME is expected to revisit this

issue early in 2015.

Finally, the December 17 MRAN amended the answer to

Question No. 11. This question asks about the circumstances

under which trading opposite a party’s own order on an

exchange’s electronic platform will violate the prohibition on

wash trades in Rule 534. Although CME’s Globex system

previously incorporated Self-Match Prevention (SMP)

functionality, CME rolled out new SMP enhancements effective

December 21, 2014 and January 11, 2015 that, among other

things, allow customers to dictate whether their resting or

aggressing orders should be cancelled in the event of a self-

match. The revised notice reflects the new aspects of CME’s

SMP functionality.

CME GROUP ENFORCEMENT ACTIONS

CME Sanctions Member for Spoofing Activity

Effective November 28, 2014, CME member Igor Oystacher

settled a CME Group disciplinary proceeding based on alleged

spoofing activity in July 2011 on COMEX and NYMEX. According

to the notice of disciplinary action, the COMEX and NYMEX

Business Conduct Committee (BCC) panels found that

Oystacher had entered bids and offers in multiple futures

contracts without the intent to actually complete any

transactions. Oystacher then cancelled the bids and offers

before execution. Similarly, the panel found that Oystacher

had placed “iceberg” orders at or near the best bid/offer on

one side of the market, and had subsequently placed large

orders on the opposite side of the market. Oystacher then

cancelled the large orders once trading had stopped on his

iceberg order, “often less than a second after they were

entered.” Due to the size of his non-iceberg orders and the

limited time during which they were exposed to the market,

the panel concluded that Oystacher had entered them with the

intent to cancel them before execution – i.e., to “spoof.”

Oystacher agreed to pay a total fine of $150,000 for his

conduct on both exchanges, and to serve a one-month bar

from membership and access privileges.

System Failures Result in Firms Being Fined by CME

Group Exchanges

A number of firms were fined by the CME Group related to

breakdowns in their automated trading systems:

• Credit Suisse Securities (USA) LLC settled a CME

Group disciplinary proceeding for alleged violations


January 2015

of Rule 432. A panel of the CME’s BCC found that

Credit Suisse’s automated trading system (ATS)

rapidly entered and executed buy and sell orders of

different sizes in several futures contracts on January

31, 2012. The entries and executions, which were

triggered by an erroneously quoted stock price,

caused “higher than usual volume” in the contracts

at issue. The BCC Panel found that Credit Suisse

lacked sufficient controls to prevent erroneous third-

party data from impacting the operation of its ATS.

Credit Suisse agreed to settle the matter for

$150,000 without admitting or denying the

allegations.

• 303 Proprietary Trading, LLC (303 Trading) agreed to

pay a fine of $75,000 related to excessive messages

sent by its proprietary trading system during two

seconds on May 8, 2013. According to CME, 303

Trading’s system failure resulted in over 27,000

resend messages, CME’s initiation of a port closure,

and the failure of a Globex gateway. CME claimed

that 303 Trading’s failure was caused by its failure to

conduct sufficient testing or simulation on its ATS “to

ensure its suitability for sending administrative

messages on Globex.”

• Traditum Group LLC was fined $35,000 because of

the failure of an ATS purchased from a third-party

vendor that malfunctioned and caused 3,540 one-lot

round turn transactions in December Canadian dollar

futures contracts during approximately two minutes

on November 10, 2011, which represented a signifi-

cant volume spike in the futures contract.

NFA REGULATORY DEVELOPMENTS

NFA Bans Credit Card Funding of Futures and Forex Accounts

Effective on January 31, 2015, futures and foreign exchange

(forex) accounts may not be funded by a credit card or any

other electronic method tied to a credit card (e.g., Paypal).

NFA members may continue to fund futures and forex

accounts through electronic means, for example, through

direct withdrawals from a bank account with which a debit

card is associated. However, before an intermediary accepts

customer funds, it must be able to identify whether the funds

are coming from a financial institution or a credit card. The

NFA instituted this new rule to protect customers, because

credit cards inherently allow easy access to borrowed money.

NFA President Dan Roth explained that individuals should use

only risk capital to fund their forex and futures accounts,

noting that the forex and futures markets are “both high-risk

and volatile.”

Annual Affirmation Requirement for Entities Currently Operating Under an Exemption or Exclusion from CPO or CTA Registration

On December 3, 2014, the NFA published a notice in which it

provided guidance on the annual affirmation requirement for

entities currently operating under an exemption or exclusion

from CPO or CTA registration, including answering a few

FAQs. The CFTC requires any person that claims an exemption

or exclusion from CPO registration under CFTC Regulations

4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5), or an

exemption from CTA registration under Regulation 4.14(a)

(8), annually to affirm the applicable notice of exemption or

exclusion within 60 days of the calendar year end (which is

March 2, 2015 for this affirmation cycle). Failure to affirm any

of the above exemptions or exclusions by March 2, 2015 will

be deemed to be a request to withdraw the exemption or

exclusion and, therefore, result in the automatic withdrawal

of the exemption or exclusion on March 2, 2015.

In the FAQs, the notice provides information on how to

update NFA records regarding inactive pools and what to do

if an exemption or exclusion no longer applies. It also

explains that new exemptions filed during the affirmation

period do not need to be affirmed until the end of calendar

year 2015. Affirmation or withdrawal of an exemption or

exclusion will be published on NFA’s BASIC system.


January 2015

NFA ENFORCEMENT ACTIONS

FCM Pays $200,000 Fine to NFA for Doing Business with Unregistered CPO

The NFA brought an administrative action against Forex Capital

Markets LLC (Forex Capital) for doing business with an unreg-

istered entity that the NFA determined was required to register

as a CPO member. Forex Capital carried an account held in the

name of Revelation Forex Fund LP (the Fund). The Fund’s gen-

eral partner was RFF GP LLC (RFF), which was not registered

as a CPO. Forex Capital initially decided not to open an account

in the name of the Fund because RFF was not registered as a

CPO. However, after RFF filed a notice with the NFA in which it

claimed that RFF was exempt from CPO registration under the

de minimis exemption, Forex Capital opened the account. To

qualify for that exemption, (1) the Fund must have traded only

a small amount of futures, swaps, and forex, and (2) any

investments in the Fund may not be marketed as affording an

opportunity to trade in commodity interests.

NFA determined that the Fund did not qualify for that exemp-

tion and that RFF therefore was required to register as a CPO.

NFA also stated that Forex Capital had sufficient information

about the Fund’s activities so that it should have known that

RFF was ineligible for the exemption. This decision suggests

that NFA believes that firms have a duty to inquire about the

legitimacy of exemptions claimed by their clients, even when

the exemption is filed with NFA.

A LEADER IN DERIVATIVES AND FUTURES

Schiff Hardin’s Derivatives and Futures team advises a broad spectrum of domestic and international market participants and users on all aspects of exchange-traded futures and over-the-counter (OTC) derivatives. With respect to both strategic and day-to-day issues, we represent:

• Banks

• Hedge funds

• Futures commission

merchants

• Introducing brokers

• Associated persons

• Swap dealers

• Commodity pool operators

• Commodity trading advisors

• Proprietary trading firms

and traders

• CME/CBOT/NYMEX traders

• U.S. derivatives exchanges

• Trading systems providers

• Forex dealers

• Foreign brokers

• End-users


January 2015

Our deep understanding of the futures and OTC derivatives markets makes us uniquely qualified to help clients respond to the convergence of these markets as mandated by the Dodd-Frank Act. Our attorneys have extensive familiarity with the following subjects:

• Futures and other exchange-traded

products, such as “event” contracts

• OTC derivatives across all asset

classes and transaction types

• The Dodd-Frank Act’s derivatives

title, including the CFTC’s and

SEC’s proposed and final rulemak-

ings and the requirements that

apply to swap dealers, major swap

participants, swap execution facili-

ties and end-users

• Drafting and negotiation of OTC

transaction documents, including

ISDA and EEI master agreements,

schedules and annexes

• Clearing, collateral, margin and

prime brokerage arrangements

• CFTC, NFA and CME registrations,

compliance and rule interpretations

• Hedge fund and commodity pool

formations and regulation, includ-

ing master-feeder fund structures

• Compliance procedures, trading

procedures, sales practices,

recordkeeping and reporting, and

anti-money laundering policies

• Formal and informal investigations

and actions before regulatory

bodies, including the DOJ, CFTC,

NFA and CME Group

• Resolution of customer complaints,

arbitrations and litigations

• Anti-manipulation and fraud issues

• Intellectual property in the finan-

cial services industry, including

patents, trademarks, copyrights

and trade secrets

• Transactions in cash commodities,

including physical options

• Formation, merger, acquisition and

disposition of financial services

firms

Our collaborative, comprehensive approach to legal services ensures that our clients receive the full benefit of our regulatory, transaction, tax, ERISA and litigation experience.

We invite you to contact any member of our group to explore how we might serve you.

Marguerite C. [email protected]

202.778.6448

Geoffrey H. [email protected]

202.778.6432

Ralph V. De [email protected]

202.724.6848

Paul E. [email protected]

312.258.5614

Jack P. [email protected]

202.778.6422

Paul E. Greenwalt [email protected]

312.258.5702

Stacie R. [email protected]

312.258.5607

Allan [email protected]

312.258.5618

Jacob L. [email protected]

312.258.5595

Kenneth W. [email protected]

202.778.6409

Michael L. [email protected]

312.258.5713

Victoria [email protected]

312.258.5841

Mark S. [email protected]

202.778.6443

Kathleen E. [email protected]

202.778.6476

Carl A. [email protected]

312.258.5707

Christine A. [email protected]

202.778.6421

Robert B. Wilcox [email protected]

312.258.5590

Michael K. [email protected]

404.437.7030

John S. [email protected]

415.901.8764

Elyse K. [email protected]

404.437.7012


January 2015

ABOUT SCHIFF HARDIN LLP

Schiff Hardin LLP is a general practice law firm representing clients across the

United States and around the world. We have offices located in Ann Arbor,

Atlanta, Chicago, Dallas, Lake Forest, New York, San Francisco and Washington.

Our attorneys are strong advocates and trusted advisers — roles that contribute

to many lasting client relationships.

© 2015 Schiff Hardin LLP

For more information visit our Web site at www.schiffhardin.com.

Attorney Responsible for Content: Carl A. Royal, Managing Editor

This publication has been prepared for general information of clients and friends

of the firm. It is not intended to provide legal advice with respect to any specific

matter. Under rules applicable to the professional conduct of attorneys in various

jurisdictions, it may be considered advertising material. Prior results do not

guarantee a similar outcome.

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