A Spoofing Record Breaker
On August 19, 2020, the Commodity Futures Trading Commission (“CFTC”) issued three orders filing and settling charges against a bank with a provisionally registered swap dealer (the “Firm”) requiring the Firm to pay $127.4 million for spoofing and making false statements, as well as for swap dealer compliance and supervision violations.
The first two orders require the firm to pay a total of $77.4 million to settle an enforcement action arising from manipulative and deceptive conduct that spanned more than eight years and involved thousands of occasions of attempted manipulation and spoofing in gold and silver futures contracts. The firm had been previously penalized $800,000 in 2018 for spoofing, but multiple statements made to CFTC staff during the course of that investigation—on which the CFTC predicated its findings and sanctions—were later proven to be false. This second settlement order addressed those false statements and the scope and nature of the Firm’s wrongdoing that those false statements concealed. The “False Statements Order” and the “Spoofing Order” involved, respectively, a record-setting $17 million penalty for making false and misleading statements to CFTC staff during the CFTC’s initial spoofing investigation and a record-setting penalty of $42 million for spoofing and attempted manipulation. In a parallel action, the Department of Justice announced entry of a deferred prosecution agreement with the Firm. The third “Compliance Order” required the Firm to pay a $50 million civil monetary penalty to settle a separate enforcement action for swap dealer business conduct, compliance, and supervision failures, and making false or misleading statements, and for the Firm to retain an independent monitor.
The settlement proved costly not only to the Firm, but also to individuals within the Firm’s compliance department. The spoofing settlement order highlighted the Firm’s supervisory failures, specifically citing multiple occasions when three senior firm compliance officers knew, or should have known, about the trader’s spoofing activity, yet took no action. According to the settlement, compliance staff had substantial information regarding the unlawful trading activity, yet failed to take any action for three years. As part of the remediation efforts undertaken by the Firm, the three relevant compliance officers’ employment was terminated. This case serves as an important reminder that the affects for failing to diligently supervise employees are not limited to firms, but can also severely impact employees with supervisory responsibilities.
For a more in-depth discussion of spoofing, surveillance, and supervision, we recommend this article.
More on Futures “Insider Trading”
On the CFTC insider trading front, several weeks ago, NYMEX and two previous employees of the exchange agreed to settle charges brought by the CFTC for the repeated leak of confidential trade information to a third-party broker. The consent order requires the parties to pay $4 million, but caps the individuals’ fines at $300,000 and $200,000. In addition, the individuals are subject to a permanent trading ban on commodity interests.
According to the August 3, 2020 consent order, the information passed by the individuals included “the identities of counterparties to specific options trades, whether a particular counterparty purchased or sold the option, whether it was a call or a put, the volume of contracts traded, the expiry, the strike price, and the trade price.” The CFTC’s initial complaint had alleged that they disclosed not only this information, but also the structure of certain transactions, as well as the trading strategies and positions of various market participants. The settlement states that the employees knew or recklessly disregarded that they should not disclose the information, and that the information passed was both non-public and material. A CFTC case against the third-party broker for aiding and abetting the previous exchange employees’ misconduct continues.
James McDonald, Director of Enforcement, praised the settlement:
Today’s settlement sends a strong message that the CFTC will work tirelessly to protect our market participants against unlawful disclosures of their confidential information to ensure that the fairness and reliability of our markets are not compromised.
The settlement is unique, in that this is the first time an exchange has been charged with a violation of the CEA and CFTC regulations for disclosures by their employees of material non-public information. The Enforcement Director emphasized exchange responsibility to supervise their employees, stating: “Like any other employer, commodity exchanges are responsible for violations of the CEA or CFTC regulations by their officials, employees, and agents within the scope of their employment or office.”
While the CFTC’s theory of vicarious liability initially appeared weak, it was sufficient to pass summary judgment. Importantly, it indicates how aggressively the Commission will look to attach liability to employers for the acts of their employees. Under CEA 2(a)(1)(B) and CFTC Rule 1.2, employers are liable for the actions of their employees performed within the scope of their employment. This raises the interesting and troubling possibility that even reasonable supervision of employees’ activities may not be sufficient in protecting an employer from the threat of a vicarious liability enforcement action. To avoid this, employers may need to demonstrate that usage of material non-public information in violation of Rule 180.1 by employees was outside the scope of their employment.
All market participants, including unregistered asset managers, should review their employees’ access to and usage of material non-public information. It may also be prudent to review and update training programs, employee handbooks, written procedures, annual certifications, and employment contracts to ensure they reflect the fact that fraudulent usage of material non-public information by an employee is outside the scope of employment.