July 2015

LEGISLATIVE DEVELOPMENTS IN THIS ISSUE: LEGISLATIVE DEVELOPMENTS...... 1 Congress Exempts End-Users from Margin Requirements ACTIONS TO IMPLEMENT DODD- FRANK...... 3 In January 2015, Congress passed a uncleared swap transaction who use OTHER REGULATORY ACTIONS...... 6 bill, signed by the President, amend- the swap to hedge or mitigate com- CFTC AND CRIMINAL ing provisions in the Dodd-Frank Act mercial risk exempt from the require- ENFORCEMENT ACTIONS...... 7 relating to margin requirements for ment to post initial and variation CME GROUP REGULATORY uncleared swaps. This new law made margin on their uncleared swaps. DEVELOPMENTS...... 9 non-financial counterparties to an CME AND ICE ENFORCEMENT ACTIONS...... 9 House Passes Commodity End User Relief Act NFA REGULATORY DEVELOPMENTS...... 11 On June 9, 2015, by a vote of 246-171, dards” and would impose procedural NFA ENFORCEMENT ACTIONS...... 11 the U.S. House of Representatives requirements on the CFTC that are passed a bill known as the Commod- not imposed on any other indepen- SCHIFF HARDIN ity End User Relief Act. The bill would dent agency. The Administration DERIVATIVES & FUTURES reauthorize the CFTC through 2019, issued a statement opposing passage PRACTICE and it would amend numerous provi- of the House bill and noting that the sions of the Commodity Exchange bill “would unnecessarily disrupt the Act (CEA). The Senate has not yet effective management and operation Carl A. Royal considered the House bill, nor has it of the agency.” Managing Editor proposed its own CFTC reauthoriza- tion bill. The amendments proposed in the Paul E. Dengel House bill fall into three broad cate- Practice Group Leader CFTC Chairman Timothy Massad gories: (1) enhancing customer pro- and the Obama Administration have tections, (2) reforming CFTC opera- Stacie R. Hartman both raised objections to the House tions, and (3) providing relief to end Deputy Practice Group Leader bill. Chairman Massad sent a letter to users of derivatives. Some of the the Chairman of the House Agricul- more significant amendments are Geoffrey H. Coll ture Committee stating that the bill summarized below. Jack P. Drogin would impose “unworkable stan- Jacob L. Kahn Andrew M. Klein Enhancing customer protections Kenneth W. McCracken Michael L. Meyer The House expressed concern that intended to improve the protections Victoria Pool farmers, ranchers, and other users of for futures customers and to restore Kathleen E. Roblez the futures markets lost money as a confidence in the marketplace. It Christine Ayako Schleppegrell result of the failures of M.F. Global, would amend the CEA to provide Michael K. Wolensky Inc. in 2011 and Peregrine Financial that, in the event of a commodity John S. Worden Group, Inc. in 2012. The House bill is broker bankruptcy, cash, securities, Elyse K. Yang

ANN ARBOR ATLANTA CHICAGO DALLAS LAKE FOREST NEW YORK PALO ALTO SAN FRANCISCO WASHINGTON DC July 2015 or other property in the commodity In addition, the House bill would cod- ƒƒRequiring FCMs to follow strict broker’s estate would generally be ify the following customer protection reporting and permission require- treated as “customer property” to the safeguards that were adopted by the ments before moving more than a extent that other customer property CFTC and National Futures Associa- specified percentage of customer held by the commodity broker is tion (NFA) by: funds from one account to insufficient to satisfy the net equity another; and claims of public customers. Thus, this ƒƒRequiring regulators to confirm amendment would give public cus- electronically the customer fund ƒƒRequiring FCMs that become tomers of a commodity broker priority account balances held by futures undercapitalized to report such over the claims of general unsecured commission merchants (FCMs) at fact immediately to their regula- creditors. depository institutions; tors.

Reforming CFTC operations

The House bill would mandate the fol- only by the commissioners’ action. the circumstances under which per- lowing changes to the CFTC’s admin- sons in compliance with foreign istrative procedures: The notice and comment require- swaps regulatory requirements shall ments of the Administrative Proce- be exempt from U.S. swaps require- ƒƒA more rigorous cost-benefit dure Act would apply to CFTC state- ments. analysis for proposed rules would ments of policy, interpretations, or be required. guidance that were voted on by the The House bill also would modify the commissioners. According to the process for seeking judicial review of ƒƒThe CFTC’s division directors legislative history, this provision was CFTC rules. Under the bill, a person would be answerable to the entire included in the bill because of con- adversely affected by a rule adopted CFTC, not just the chairman’s cerns expressed about the CFTC’s by the CFTC could obtain direct office. published guidance on the cross- review of the rule by filing a petition border implications of its swap rules. in the U.S. Court of Appeals for the ƒƒThe CFTC staff would be required A separate section of the bill would D.C. Circuit or in the U.S. Court of to provide proposed exemptive, require the CFTC to adopt rules to Appeals for the circuit where the no-action, and interpretive address (i) what connections to the party resides or has its principal place letters to all the commissioners, United States would require a non- of business. This provision would not just the chairman, for review U.S. person to register as a swap make the process for seeking judicial before issuing such letters. dealer, (ii) which U.S. swap require- review of CFTC rules comparable to ments would apply to the activities of the process used to seek judicial ƒƒCFTC omnibus orders of investi- non-U.S. persons and U.S. persons review of SEC rules. gation would be limited to a finite (and their branches and affiliates) duration and could be renewed outside of the United States, and (iii)

Relief for end-users

The House bill would amend the exception from mandatory clearing. financial entity. CEA in a number of respects in order The bill also would revise the defini- to reduce the regulatory burden on tion of a “financial entity” to make it The bill would require the CFTC to end-users of derivatives. clear that a “commercial market par- adopt rules providing for later public ticipant” (defined to include any reporting of swap transactions in The bill would make it easier for producer, processor, merchant, or illiquid markets that are entered into companies with centralized treasury commercial user of an exempt or by a non-financial entity that is units to qualify for the end-user agricultural commodity) is not a hedging commercial risk.

Schiff Hardin LLP Derivatives & Futures Update | 2 July 2015

Under existing CFTC rules, members The bill would limit the CFTC’s ability pool operator or commodity trading of a futures exchange or swap execu- to define the term “bona fide hedge advisor with respect to the manage- tion facility (SEF) are required to main- transaction” more narrowly than the ment of funds for such organizations. tain certain records. The House bill definition in the CEA. It also would would reduce the recordkeeping bur- provide that hedges of anticipated The bill would revise the definition of den for those members (including business risks would qualify as bona “commodity pool operator” to exclude end-users) who are not required to fide hedge transactions. investment advisers to an SEC-regis- register with the CFTC by eliminating tered investment company, provided the requirement for them to retain The bill would provide exemptions for that the investment company does written and electronic records of pre- charitable organizations such as col- not trade or hold interests in physical trade communications. leges and churches from being commodities. required to register as a commodity

ACTIONS TO IMPLEMENT DODD-FRANK

CFTC Proposes Cross-Border Margin Rules

On June 29, 2015, the CFTC pro- ticipants (collectively, “covered swap lished in the Federal Register. posed rules that would apply its entities”) that are not subject to the margin requirements for uncleared margin requirements of certain The proposed rules are complex and swaps to cross-border transactions. bank regulators. There will be a contain many elements. Below is a The proposed rules would apply to 60-day comment period starting summary of the most important ele- swap dealers and major swap par- when the proposed rules are pub- ments.

(a) Effect on U.S. swap dealers

The CFTC’s margin rules would apply tuted compliance (discussed below) lected from) any non-U.S. counter- to all uncleared swaps of a U.S. cov- would be available with respect to party whose obligations are not guar- ered swap entity. However, substi- initial margin posted to (but not col- anteed by a U.S. person.

(b) Effect on non-U.S. swap dealers

The extent to which the CFTC’s mar- requirements would be the same as swap obligations are guaranteed by gin rules would apply to a non-U.S. for a U.S. covered swap entity. a U.S. person. covered swap entity depends on whether its swap obligations are If the swap obligations of a non-U.S. Uncleared swaps between a non-U.S. guaranteed by a U.S. person or its covered swap entity are not guaran- covered swap entity and a non-U.S. financial statements are consoli- teed by a U.S. person, the CFTC’s counterparty would be excluded from dated with those of a U.S. parent margin rules would apply, but the the CFTC’s margin rules if neither par- company. non-U.S. covered swap entity would ty’s swap obligations are guaranteed by be eligible for substituted compli- a U.S. person and neither party is a U.S. If the swap obligations of a non-U.S. ance unless its swap counterparty is branch of a non-U.S. covered swap covered swap entity are guaranteed a U.S. covered swap entity or a non- entity nor consolidated in the financial by a U.S. person, then the margin U.S. covered swap entity whose statements of a U.S. person.

(c) Substituted compliance

Substituted compliance refers to an the CFTC’s margin rules by complying requirements of a foreign jurisdiction. alternative means of complying with instead with “comparable” margin The CFTC proposes to use an “out-

Schiff Hardin LLP Derivatives & Futures Update | 3 July 2015

come-based” comparability standard rules, regardless of differences in determine consistency with interna- to determine whether the margin specific elements of the rules of the tional standards (the framework requirements of a foreign jurisdiction foreign jurisdiction. In evaluating a issued by the Basel Committee on achieve comparable outcomes and foreign jurisdiction’s margin require- Banking Supervision and the Inter- the same regulatory objectives as the ments, the CFTC would look to rele- national Organization of Securities margin requirements in the CFTC’s vant facts and circumstances to Commissions).

CFTC Issues Final Interpretation on Forward Contracts with Embedded Volumetric Optionality

On May 12, 2015, the CFTC and the address physical factors or regula- graphics or geopolitics. Further, Securities and Exchange Commission tory requirements that reasonably commercial parties are not required (SEC) issued a clarification of their influence demand for, or supply of, to conduct due diligence in order to previously issued interpretation and the nonfinancial commodity.” Thus, ascertain the intent of another party seven-part test concerning the exclu- the focus of the seventh element is to the contract. sion of forward contracts with embed- on the intent of the party with the ded volumetric optionality from the right to exercise the embedded vol- The CFTC is also modifying the fourth definition of a swap and future. umetric optionality at the time the and fifth elements of the seven-part (Embedded volumetric optionality parties enter into the contract. The test to clarify that it applies to forward refers to a feature in a contract in CFTC clarified that the reference to contracts with embedded volumetric which one party can elect to increase “physical factors” in the seventh ele- optionality in the form of both puts or decrease the quantity of the com- ment should be construed broadly and calls. modity to be delivered.) to include any fact or circumstance that could reasonably influence the In response to commenters, the CFTC The CFTC is modifying the seventh parties’ supply of or demand for the clarified that commercial parties may element of the test to provide that the nonfinancial commodity under the choose either to rely on their previous embedded volumetric optionality contract, including environmental good faith characterization of an must be “primarily intended, at the factors, relevant “operational con- existing contract or to recharacterize time that the parties enter into the siderations,” and broader social it in accordance with the CFTC’s inter- agreement, contract, or transaction, to forces, such as changes in demo- pretation.

CFTC Solicits Comment on Cross-Border Implications of Swaps Rules

The CFTC on March 10, 2015 pub- The request for comment stems from but remanded certain rules to the lished a request for comment in the litigation brought by three industry agency to evaluate the costs and ben- Federal Register regarding the cross- associations (the Securities Industry efits of the extraterritorial application border implications of eight swaps- and Financial Markets Association, the of those rules. related rulemakings. In particular, International Swaps and Derivatives the CFTC requested comment as to Association, and the Institute of Inter- Comments were due on or before May whether there are distinct costs and national Bankers) that challenged the 11, 2015. After reviewing the com- benefits associated with application CFTC’s interpretive guidance regard- ments, the CFTC will provide a further of those rules in overseas transac- ing cross-border swaps transactions. response to the Court’s remand order. tions as opposed to domestic trans- The Federal District Court in D.C. In the interim, the rules will remain in actions. largely upheld the CFTC’s guidance, effect.

CFTC Proposes to Reduce Reporting and Recordkeeping Obligations for Commercial End Users of Trade Options

On April 30, 2015, the CFTC issued a would have the effect of reducing ments for trade option counterparties Notice of Proposed Rulemaking that reporting and recordkeeping require- that are neither swap dealers nor

Schiff Hardin LLP Derivatives & Futures Update | 4 July 2015

major swap participants (Non-SD/ agricultural producers, and other rulemaking includes the following MSPs), including energy companies, commercial end users. The proposed actions:

(d) Elimination of Part 45 Reporting for Non-SD/MSPs

Under current CFTC rules, a Non-SD/ year must comply with the reporting vide that a Non-SD/MSP under no MSP trade option counterparty that requirements of the CFTC’s Part 45 circumstances would be subject to has become obligated to report a swap rules. The CFTC proposal would elimi- Part 45 reporting with respect to its transaction within the past calendar nate that requirement and would pro- trade option activities.

(e) Elimination of Form TO Filing Requirement

Currently, a Non-SD/MSP trade option options. The CFTC proposes to delete entering into trade options with an counterparty is required to make an Form TO and eliminate the require- aggregate notional value in excess of annual filing with the CFTC on Form ment to make an annual filing on $1 billion in any calendar year (or, in TO that contains specified informa- such form. Instead, the CFTC would the alternative, a notice that it reason- tion regarding the counterparty and require a Non-SD/MSP trade option ably expects to enter into trade options the types and amounts of physical counterparty to provide a notice by having such aggregate notional value commodities underlying its trade email to the CFTC within 30 days after during the calendar year).

(f) Modification of Recordkeeping Requirements for Non-SD/MSPs

The CFTC proposal would codify relief option counterparty that was granted legal entity identifier (LEI) and provide from certain swap recordkeeping by a 2013 no-action letter, provided such LEI to its counterparty if that requirements for a Non-SD/MSP trade that the Non-SD/MSP must obtain a counterparty is a SD or MSP.

No-Action Relief for Swap Execution Facilities

On April 22, 2015, the CFTC staff covered after a trade has been cleared. granted in a previous letter. Under issued two no-action letters relating In that situation, the counterparties this relief, SEFs are excused from the to transactions executed on a swap may execute a trade to offset the requirements to (i) obtain and main- execution facility (SEF). The first letter cleared trade and also enter into a new tain a library of the bilateral agree- (CFTC Letter 15-24) permits SEFs and trade with the correct terms, provided ments previously entered into by swap designated contract markets to allow that the new trade must be executed counterparties that contain terms that trades that were rejected for clearing and submitted for clearing no later are incorporated by reference in swap as a result of clerical or operational than three days after the erroneous trade confirmations and (ii) report the errors to be resubmitted by the coun- trade was executed. This relief will confirmation data contained in such terparties within one hour after being expire on June 15, 2016. agreements. This relief will expire on notified of the rejection. This letter March 31, 2016. also allows the counterparties to cor- The second letter (CFTC Letter 15-25) rect clerical or operational errors dis- extends no-action relief that was

CFTC Allows Certain Securitization SPVs to Elect End-User Exception

In a letter dated May 4, 2015, the consolidated with, an entity that from Ford Motor Credit Company CFTC’s Division of Clearing and Risk qualifies as a “Captive Finance Com- LLC (Ford Credit), a wholly-owned (Division) interpreted Section 2(h)(7) pany” to elect the end-user excep- subsidiary of Ford Motor Company (C)(iii) of the CEA to permit securiti- tion from mandatory clearing (Ford) that provides financing for the zation special purpose vehicles imposed by Dodd-Frank. The Divi- sale and lease of cars and trucks (SPVs) that are wholly owned by, and sion’s letter responded to a request manufactured by Ford.

Schiff Hardin LLP Derivatives & Futures Update | 5 July 2015

An entity can claim the end-user commercial risks related to inter- owned by Ford Credit, a Captive exception if it is not a “financial entity,” est rate and foreign currency Finance Company; their financial it is using the swap to hedge or miti- exposures; statements are consolidated with Ford gate commercial risks, and it notifies Credit’s; and their sole activity is facili- the CFTC as to how it meets certain ƒƒ90% or more of which arise from tating financing undertaken by Ford financial obligations associated with financing that facilitates the Credit. The Division stated that its entering into non-cleared swaps. purchase or lease of products; interpretation applied to any similarly Entities that qualify as Captive Finance and situated securitization SPV that is Companies are excluded from the wholly owned by, and consolidated definition of “financial entity” for pur- ƒƒ90% or more of which are manu- with, a Captive Finance Company. poses of the end-user exception. In factured by the parent company Accordingly, SPVs that are wholly order to qualify as a Captive Finance or another subsidiary of the parent owned by, and consolidated with, a Company an entity must meet the fol- company. Captive Finance Company are eligible lowing test: to elect the end-user exception in the The Division agreed with Ford Credit same manner that their parent Captive The entity’s primary business is pro- that it was appropriate to consider Ford Finance Company is eligible to elect viding financing; Credit’s SPVs to be primarily engaged the end-user exception. in providing financing for purposes of ƒƒThe entity uses derivatives for the the first prong of the Captive Finance purpose of hedging underlying Company test because they are wholly

OTHER REGULATORY ACTIONS

Proposed SEC and FINRA Rules Would Increase Regulation of Proprietary and Algorithmic Trading Firms

On March 25, 2015, the SEC proposed FINRA, except for a limited exemption FINRA proposes to define primarily an amendment to Rule 15b9-1 under for floor-based dealers consistent with responsible individuals as “one or more the Securities Exchange Act of 1934 the original intent of the rule. The key persons who possess knowledge of that would require active proprietary amendment, if adopted, would ensure and responsibility for both the design of trading firms in securities to become that the trading activities of broker- the intended trading strategy and the members of the Financial Industry dealers active in the off-exchange technological implementation (e.g., Regulatory Authority (FINRA). The pro- market (such as proprietary trading coding) of that strategy, sufficient to posed amendment would narrow a firms) would be subject to the same evaluate whether the resultant product provision of Rule 15b9-1 that currently regulation as other broker-dealers. is designed not only to achieve business exempts a specified class of broker- objectives, but also regulatory compli- dealers from FINRA membership if The SEC’s announcement came just ance.” This would not include junior certain conditions are met. Rule 15b9-1 days after FINRA issued its own pro- developers who write code solely to exempts broker-dealers from this posal aimed at enhancing regulatory implement design or modification requirement if they: (a) are a member oversight of high frequency traders instructions at the direction of another. of a national securities exchange; (b) who are FINRA members. FINRA’s pro- FINRA’s proposal is designed to increase carry no customer accounts; and (c) posed rule amendment would require the scope of trading information that have annual gross income of no more all persons associated with a FINRA FINRA receives, provide market partici- than $1,000 that is derived from securi- member who are primarily involved in pants and investors with more trans- ties transactions effected otherwise the design, development, or significant parency into trading activities, and than on a national securities exchange modification of algorithmic trading require employees at firms engaged in of which they are a member. The pro- strategies to register as “Securities electronic trading to be trained, edu- posed amendment would require all Traders” and therefore be subject to cated, and accountable for their role in broker-dealers to be members of FINRA regulation. algorithmic trading strategies.

Schiff Hardin LLP Derivatives & Futures Update | 6 July 2015

CFTC AND CRIMINAL ENFORCEMENT ACTIONS

Banks Pay $5.6 Billion in Fines and Plead Guilty to Criminal Charges in Connection with Forex Probes

On May 20, 2015, U.S. Attorney Gen- tel” manipulated these exchange rates to the Federal Reserve. eral Loretta Lynch announced that by agreeing to withhold bids or offers five global banks (Citigroup, J.P. Mor- for euros or dollars in order to avoid In connection with the FX investiga- gan, Barclays, RBS and UBS) agreed to moving the exchange rate in a direc- tion, Barclays also settled related plead guilty to criminal charges and to tion adverse to open positions held by claims with the New York State pay $5.6 billion combined in penalties, other members of the group. Department of Financial Services, in order to resolve a long-running the CFTC, and the U.K.’s Financial investigation into whether traders at Four of the banks (Citigroup, J.P. Conduct Authority for a total of these institutions colluded to move Morgan, Barclays, and RBS) pleaded approximately $1.3 billion in penal- foreign currency exchange rates. guilty to conspiring to manipulate ties. The CFTC settlement order prices in the market for U.S. dollars requires Barclays to pay a civil mon- According to authorities, between and euros in the FX spot market, and etary penalty of $400 million, cease December 2007 and January 2013, will pay a combined $2.52 billion to and desist from further violations, currency traders at each of these the U.S. Justice Department (DOJ). and take specified steps to imple- banks – self-described members of a The fifth bank (UBS AG) pleaded ment and strengthen its internal group called “The Cartel” – used coded guilty to manipulating the London controls and procedures, including language and an exclusive online chat interbank offered rate (LIBOR) and the supervision of its FX traders. The room to manipulate foreign exchange will pay a $203 million penalty to the Order states that the $400 million rates. The traders manipulated DOJ, after breaching its December penalty reflects in part that Barclays exchange rates set through two daily 2012 non-prosecution agreement did not settle these charges at an “fixes,” the 1:15 pm European Central related to the LIBOR investigation. In earlier stage of the investigation. Bank fix and the 4:00 pm World Mar- addition, the five banks will pay a kets/Reuters fix. Members of “The Car- total of more than $1.6 billion in fines

CFTC Brings Action Against UAE Traders for Alleged Spoofing

On May 5, 2015, the CFTC filed a those orders. Khara and Salim are monetary penalties, disgorgement of complaint in the Southern District of alleged to have engaged in a violative profits, and trading bans for violating New York against two individuals coordinated trading practice, in the CEA. Pursuant to a consent order alleging disruptive trading practices which Khara placed layered orders on for preliminary injunction, the defen- in violation of Section 4c(a)(5)(C) of one side of the market, while Salim dants are enjoined from engaging in the CEA. The CFTC alleges that Heet would place orders on the opposite spoofing and commodities trading, Khara (Khara) and Nasim Salim side. After other market participants their assets have been frozen, they are (Salim), both residents of the United filled Salim’s orders, Khara allegedly required to provide the CFTC with an Arab Emirates, engaged in spoofing canceled his layered orders. accounting of funds, and they are and aided and abetted each other’s required to allow the CFTC to inspect spoofing by entering orders for Gold The CFTC’s complaint seeks prelimi- books and records. CME also brought and Silver futures contracts on nary and permanent injunctions charges related to this conduct, as COMEX without intending to execute against Khara and Salim as well as civil noted on p.10.

CFTC Uses New Anti-Manipulation Powers in Charging Kraft Food Group

On April 1, 2015, the CFTC filed a LLC (collectively, the defendants) the CEA. This marks the first time complaint alleging that Kraft Food manipulated wheat futures con- the agency has brought a litigated Group, Inc. and Mondelez Global tracts and cash wheat in violation of claim alleging manipulation under

Schiff Hardin LLP Derivatives & Futures Update | 7 July 2015

the relaxed legal standards resulting On June 1, 2015, the defendants what actions deceived the market, from Dodd-Frank. The CFTC exer- moved to dismiss two of the four leaving the defendants without cised its authority under two differ- claims, arguing that the CFTC failed notice of what of their conduct was ent statutory standards for proving to show that defendants specifically unlawful. Regarding the second manipulation: its new, looser stan- intended to create an artificial price count, the defendants argued that dard (recklessness) under Section in the wheat futures market. The the CFTC did not allege (1) that an 6(c)(1) of the CEA and CFTC Regula- defendants argued that the CFTC artificial price existed or (2) that the tion 180.1, and the traditional stan- distorted its antifraud and anti- defendants intended to create an dard (specific intent) under Sections manipulation authorities beyond artificial price. The case is pending 6(c)(3) and 9(a)(2) of the CEA and their statutory confines. Specifically, in the U.S. District Court for the CFTC Regulation 180.2. the defendants argued that the Northern District of Illinois. CFTC’s allegations do not specify

Charges Brought Against UK Trader under New Anti-Manipulation and Disruptive Trading Powers Related to 2010 “Flash Crash”

On April 21, 2015, the CFTC unsealed in London on these charges. intent standard, and as a manipulative its civil complaint alleging that Navin- device, where recklessness is sufficient. der Sarao and his company, Nav Sarao Although this case has gained attention Futures Limited PLC (Sarao Futures), due to the allegations that Sarao played The CFTC further alleges that Sarao manipulated and attempted to manip- a role in contributing to the May 2010 used the layering algorithm and the ulate the intra-day prices of the E-mini “Flash Crash,” it also sheds light on how “flash” spoofing technique throughout contract and engaged in disruptive the CFTC plans to utilize its new anti- the May 2010 “Flash Crash” day to create trading in the E-mini contract in vio- manipulation and disruptive trading an order book imbalance and that this lation of the CEA. Also on April 21, the powers. Specifically, the CFTC has activity contributed to the market con- U.S. Department of Justice unsealed a alleged that the conduct of spoofing, ditions that caused the E-mini S&P 500 federal criminal complaint previously though charged separately under the market intra-day price to fall. This filed in the Northern District of Illinois disruptive trading statute, is also the action marks only the second time the against Sarao, alleging wire fraud, basis of the “manipulative device” in agency has brought a litigated claim commodities fraud, commodities support of the manipulation charges. under the new manipulation standards, manipulation, and “spoofing” in con- This development indicates that the and the first time it has brought disrup- nection with his trading in E-mini agency is willing to charge spoofing tive trading charges in a litigated claim S&P 500 futures on the Chicago Mer- conduct under both its disruptive trad- (the Khara/Salim case was filed shortly cantile Exchange. Sarao was arrested ing authority, which has a specific thereafter).

CFTC Fines Summit Energy Services for Acting as an Unregistered CTA

On January 16, 2015, the CFTC issued (2) does not hold itself out generally to also held itself out publicly as a CTA a settlement order requiring Summit the public as a CTA. on its website by offering “risk man- Energy Services, Inc. (Summit Energy) agement services,” including com- to pay a $140,000 fine for acting as an According to the settlement order, modity trading advice concerning unregistered commodity trading Summit Energy acted as an unregis- natural gas swaps and futures. advisor (CTA), in violation of Section tered CTA from October 2012 to Sep- 4m(1) of the CEA. Section 4m(1) tember 2014 by failing to register with The Summit Energy settlement order requires a person to register with the the CFTC, despite engaging in a for- signals that the CFTC is willing to CFTC if such person is acting as a CTA profit business of advising more than bring enforcement actions for viola- in interstate commerce, unless the 15 clients about the value of or the tions of the CEA, even if the only person: (1) has provided commodity advisability of trading in over-the- instance of misconduct is the failure to trading advice to fewer than 15 per- counter natural gas swaps and natural register as a CTA. Market participants sons in the preceding 12 months and gas futures contracts. Summit Energy should take care to ensure that they are

Schiff Hardin LLP Derivatives & Futures Update | 8 July 2015

in compliance with all aspects of the CEA, including all conditions for any applicable exemption.

CME GROUP REGULATORY DEVELOPMENTS

Rule 524 – Trading at Settlement Contracts

Although several CME Group pants to trade TAS contracts during cluding that he had entered three TAS exchanges (e.g., NYMEX) already had specific time periods, including dur- orders prior to the security status mes- rules similar to Rule 524, CME and ing a prescribed “pre-open” period. sage indicating that the relevant con- CBOT adopted Rule 524 to introduce Participants who attempt to trade TAS tracts had entered the approved “pre- limits on new Trading at Settlement outside of these time frames are sub- open” state. (TAS) contracts effective on June 15, ject to discipline. For example, NYMEX 2015. The rule allows market partici- fined Jason Chi $15,000 after con-

Rule 512 – Minimum Fines for Reporting Violations

On April 7, 2015, CME adopted certain failed to report required information maximum fine levels. The maximum amendments to its reporting rule, Rule the first few times, CME’s new Rule 512 amounts are $5,000 per offense (for 512. The amendments instituted mini- sets a minimum fine of $1,000 when individuals) and $10,000 per offense mum fines for reporting violations. participants repeatedly violate the rule (for companies). Whereas in the past CME might have over a 12-month period. CME must issued warnings to firms when they impose the fine. Rule 512 also sets

CME AND ICE ENFORCEMENT ACTIONS

Aaron King and Nathan King (CME)

CME settled charges against two during the pre-open period, not with tions in the Indicative Opening Price. respondents, Aaron and Nathan King, intent to execute the trades, but rather The two respondents agreed to pay based on improper conduct in the to identify the depth of the order book. $35,000 and $10,000 (plus a 25-day pre-open period, effective May 29, According to CME, the two respon- trading suspension), respectively, to 2015. In particular, CME alleged that dents’ order submissions and near- settle CME’s charges. both respondents submitted orders immediate cancels caused fluctua-

JB Drax Honore, Inc. and JB Drax Honore UK, Ltd. (CME)

CME settled charges against a mem- firms disclosed customers’ nonpublic senting the customers’ orders to the ber firm and its UK affiliate, JB Drax order information to one another trading pit. The two firms agreed to Honore Inc. and JB Drax Honore UK, over nearly a two-year period. In this pay $70,000 and $55,000, respec- Ltd., respectively, effective May 26, way, the respondents were able to tively, to settle CME’s charges, which 2015. According to CME, the two prearrange transactions before pre- focused on failures to supervise.

Port 22 LLC (CME)

CME settled charges against Port 22 February 27, 2015. According to CME’s that caused “aberrant bid and offer LLC, a high-frequency trading group disciplinary notice, Port 22 had oper- prices to be disseminated to the mar- in Chicago, for alleged violations of ated an automated trading system ket.” CME noted that Port 22’s system CME Rules 432.Q and 432.W, effective between June 2013 and June 2014 was modifying existing spread instru-

Schiff Hardin LLP Derivatives & Futures Update | 9 July 2015

ments with “incrementally widening prices,” and that CME had previously ordered Port 22 to pay a fine of $55,000 spreads between the bid and offer notified Port 22 of the problem. CME as part of the settlement.

George Dennis (CME)

CME instituted proceedings and sus- Market Regulation staff. CME’s disci- merits. CME apparently had been pended non-member George Dennis plinary notice, effective April 22, 2015, investigating a potential rule violation, for five years after Dennis, in violation noted that Dennis also failed to answer and claimed that Dennis’ failure to of Nymex Rule 432.L.1, failed to appear the charges against him, and thus cooperate “materially impacted” its for scheduled interviews with CME’s waived his right to a hearing on the investigation.

Heet Khara and Nasim Salim (CME)

Effective April 30, 2015, CME sum- ity. In particular, CME alleged that Notices, one of the two respondents marily denied access pursuant to the respondents entered layered entered the smaller orders while the CME Rule 413 to two United Arab orders for Gold and Silver futures other entered the layered orders. The Emirates residents, Heet Khara and contracts without the intent to trade. respondents then allegedly canceled Nasim Salim (the subjects of the CME alleged that the respondents the layered orders after the smaller CFTC action described above at p.7). entered the layered orders to encour- orders had been filled. CME’s access CME alleged that on multiple trade age market participants to trade denial was effective for 60 days after dates in February through April of opposite smaller orders they had its announcement. 2015, the respondents engaged in entered on the other side of the mar- alleged coordinated spoofing activ- ket. On occasion, according to CME’s

Trevor Gile (ICE)

In the first reported case under ICE’s The disciplinary notice, effective market that were “not made in good new disruptive trading rule, Rule March 27, 2015, noted that the faith for the purpose of executing 4.02(l), ICE found that the respon- respondent’s automated trading sys- bona fide transactions.” According to dent, Trevor Gile (trading as Liger tem had malfunctioned because of a ICE, the respondent failed to identify Investments, Inc.), had violated the “software bug,” and that as a result the software bug prior to activating section of Rule 4.02(l)(2) prohibiting the respondent “caused numerous its automated trading system. ICE the entry of orders not in good faith. order messages to be entered” in the fined Gile $25,000 for the violation.

Igor Oystacher (ICE)

ICE Futures U.S. (ICE) announced would enter buy or sell orders on Oystacher. Nevertheless, it fined the settlement of charges, effective one side of the market at different him $125,000. This was one of the June 5, 2015, against Igor Oystacher price levels and subsequently cancel first cases ICE has prosecuted under (the founder of 3Red Trading in Chi- such orders in close time proximity its new disruptive trading rule, ICE cago), who allegedly engaged in to trades [he] executed on the oppo- Rule 4.02(l). (The respondent in this spoofing-like activity in the Russell site side of the market.” ICE also case had previously settled a disci- 2000 Mini Futures contract in the found that Oystacher’s conduct plinary matter at CME involving fall of 2012. In particular, ICE alleged “may have disrupted the market- similar conduct and similar spoof- that Oystacher “engag[ed] in a pat- place,” but noted that the conduct ing-like charges.) tern of trading activity where he resulted in “no financial gain” to

Schiff Hardin LLP Derivatives & Futures Update | 10 July 2015

NFA REGULATORY DEVELOPMENTS

NFA Proposes to Increase Capital Requirements and to Require Risk Management Programs for Forex Dealers

On May 28, 2015, the NFA proposed charge on FDMs equal to 10% of any the proposed rule. The notice explains changes to its Compliance Rule 2-36 liabilities the FDM owes to (i) counter- that each FDM must establish a risk to (1) increase Forex Dealer Member parties affiliated with the FDM that are management unit and that the pro- (FDM) capital requirements, (2) require eligible contract participants (ECPs) gram must include policies and pro- FDMs to establish a risk management and are not acting as a dealer and (ii) cedures to monitor, manage, and set program, and (3) require each FDM to ECP counterparties not affiliated with tolerance limits for (1) market risk, (2) make publicly available on its website the FDM that are acting as a dealer credit risk, (3) liquidity risk, (4) foreign certain information regarding its (excluding certain banks and trust currency risk, (5) legal risk, (6) opera- business, including discussion of ser- companies). In addition, the proposal tional risk, (7) counterparty risk, (8) vices it offers, administrative, civil, or would impose a capital charge equal risk associated with liability to retail enforcement proceedings against it, to 10% of any liabilities owed by affili- forex customers, (9) technological material risks associated with the FDM ated ECP counterparties acting as risk, (10) capital risk, and (11) “any acting as a counterparty, and particu- dealer to the FDM’s customers. other applicable risks.” Additionally, lar financial information about the the FDMs would be required to do FDM. The NFA also proposed to adopt a stress tests and provide quarterly risk notice in which it would provide exposure reports to senior manage- The proposed capital requirements interpretive guidance on the risk ment and the firm’s governing body. would impose an additional capital management program required under

NFA ENFORCEMENT ACTIONS

NFA Fines JP Morgan and UBS for Violating New Customer Protection Rules

On March 18, 2015, JP Morgan Clear- On the same day, UBS agreed to pay interest amount,” and that UBS did not ing Corp. agreed to pay the NFA the NFA $17,500 to settle charges with obtain written pre-approval of a finan- $17,500 to settle charges that it vio- the NFA that it violated NFA Financial cial principal and submit the pre- lated NFA Financial Requirements Requirements 16(a) and (c). The NFA approval to NFA prior to the transfer of 4(c) and (d). Specifically, the NFA alleged that, on two separate occa- such funds. On the first occasion, the alleged that JP Morgan Clearing sions, approximately $12 million were money was auto-swept from the failed to instruct its depository to transferred from a customer secured account by UBS’s depository and then notify the NFA of changes in the bal- amount funds account to a non- swept back into the account it came ances in some new segregated funds secured amount funds account, that from. On the second occasion, a UBS accounts through the NFA’s daily the transfers were withdrawals of employee transferred the money out confirmation system. more than 25% of the “target residual of the account.

NFA Charges and Suspends Firms for Using Misleading Promotional Materials

On March 17, 2015, the NFA charged with violation of NFA Compliance required records related to the pro- introducing broker Accredited Rules 224-b(1), 223(b)(3), 229(c), motional materials. The NFA alleged Investment Management Corp. 2-210, and 2-213 for using “mislead- that an AIM customer received an (AIM), commodity trading advisor ing and unbalanced” promotional email that suggested an opportunity Primary Assets Management Corpo- materials, including hypotheticals to make remarkable profits from ration (PAMC), and principal and not identified as such, and also price moves that, according to the associated person Peter G. Catranis asserted a failure to maintain email, had a high probability of

Schiff Hardin LLP Derivatives & Futures Update | 11 July 2015

occurring and in which the only dis- potential profits that could be made years. The NFA’s executive commit- cussion of associated risks was at the and risk of loss. tee also issued a Member Responsi- end of the lengthy email after Catranis’ bility Action that suspended McEl- signature. The NFA also alleged that a Similarly, on May 28, 2015, the NFA hannon Group and Worley from NFA PAMC customer received an email that charged commodity trading advisor membership and prohibited them contained hypothetical performance McElhannon Group, Inc. and Phillip from transferring customer funds results that were not clearly identified M. Worley with violating NFA Com- without prior NFA approval. as hypothetical, stated generically that pliance Rules 2-29(a)1, 2-29(b)1, and the performance information was 2-36(b)(1) for allegedly advertising on hypothetical and discussed risk of loss its website that it had experienced a only at the end of the email, and pro- 457% rate of return and only one vided an unbalanced discussion of negative annual return in thirteen

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: ƒƒ Banks ƒƒ Swap dealers ƒƒ U.S. derivatives exchanges ƒƒ Hedge funds ƒƒ Commodity pool operators ƒƒ Trading systems providers ƒƒ Futures commission ƒƒ Commodity trading advisors ƒƒ Forex dealers merchants ƒƒ Proprietary trading firms ƒƒ Foreign brokers ƒ ƒ Introducing brokers and traders ƒƒ End-users ƒƒ Associated persons ƒƒ CME/CBOT/NYMEX traders

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: ƒƒ Futures and other exchange-traded products, ƒƒ Compliance procedures, trading procedures, such as “event” contracts sales practices, recordkeeping and reporting, and anti-money laundering policies ƒƒ OTC derivatives across all asset classes and transaction types ƒƒ Formal and informal investigations and actions before regulatory bodies, including the DOJ, ƒƒ The Dodd-Frank Act’s derivatives title, including CFTC, NFA and CME Group the CFTC’s and SEC’s proposed and final rulemakings and the requirements that apply to ƒƒ Resolution of customer complaints, arbitrations swap dealers, major swap participants, swap and litigations execution facilities and end-users ƒƒ Anti-manipulation and fraud issues ƒƒ Drafting and negotiation of OTC transaction ƒƒ Intellectual property in the financial services documents, including ISDA and EEI master industry, including patents, trademarks, agreements, schedules and annexes copyrights and trade secrets ƒƒ Clearing, collateral, margin and prime brokerage ƒƒ Transactions in cash commodities, including arrangements physical options ƒƒ CFTC, NFA and CME registrations, compliance ƒƒ Formation, merger, acquisition and disposition and rule interpretations of financial services firms ƒƒ Hedge fund and commodity pool formations and regulation, including master-feeder fund structures

Schiff Hardin LLP Derivatives & Futures Update | 12 July 2015

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. Bateman Allan Horwich Carl A. Royal [email protected] [email protected] [email protected] 202.778.6448 312.258.5618 312.258.5707

Geoffrey H. Coll Jacob L. Kahn Christine Ayako Schleppegrell [email protected] [email protected] [email protected] 202.778.6432 312.258.5595 202.778.6421

Ralph V. De Martino Andrew M. Klein Robert B. Wilcox Jr. [email protected] [email protected] [email protected] 202.724.6848 202.778.6415 312.258.5590

Paul E. Dengel Kenneth W. McCracken Michael K. Wolensky [email protected] [email protected] [email protected] 312.258.5614 202.778.6409 404.437.7030

Jack P. Drogin Michael L. Meyer John S. Worden [email protected] [email protected] [email protected] 202.778.6422 312.258.5713 415.901.8764

Paul E. Greenwalt III Victoria Pool Elyse K. Yang [email protected] [email protected] [email protected] 312.258.5702 312.258.5841 404.437.7012

Stacie R. Hartman Kathleen E. Roblez [email protected] [email protected] 312.258.5607 202.778.6476

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.

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© 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 infor- mation 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.

Schiff Hardin LLP Derivatives & Futures Update | 13