Source: https://bridgingtheweek.com/Commentary/PrintCommentary/2513
Timestamp: 2019-04-19 12:49:11+00:00

Document:
Follow-up: California Federal Court Dismissal of CFTC Monex Enforcement Action Upsets Stable Legal Theories (includes My View); and more.
Commodity Trading Firm Sanctioned US $2 Million by CFTC for Various Offenses Related to Cotton Trading Including Violating Speculative Position Limits: Glencore Grain B.V. and Glencore Ltd. collectively agreed to pay a fine of US $2 million to settle charges by the Commodity Futures Trading Commission that, from January 2013 through November 2015, they violated various laws and Commission regulations related to their trading of cotton futures on ICE Futures U.S.
In particular, the Commission alleged that the firm violated speculative position limits on “multiple days” in May and June 2013 and May and June 2014; entered into exchange for related position transactions with each other contrary to IFUS rules, and thus prohibited by law and CFTC rule; and failed to file two reports with it of their physical cotton positions that were accurate as of the last day of May 2013 and May 30, 2014, as required.
The Commission alleged that the Glencore entities violated position limits on the applicable occasions when looking at their positions on an aggregate basis, excluding any bona fide hedging positions which would not be included in a calculation of speculative positions. (Click here to access Commodity Exchange Act § 4a(b), 7 U.SC. § 6a(b) and here for CFTC Rules 150.2 through 150.4.) The Commission said that, because one person – Glencore’s Head of Cotton – directly or indirectly controlled the trading at both entities, positions of the two entities were required to be aggregated.
The Commission also said that, under applicable law, wash sales are prohibited, and futures contracts must be executed openly and competitively unless transacted pursuant to an exchange rule it approved. (Click here to access CEA § 4c(a), 7 U.S.C. § 6c(a) and here to access CFTC Rule 1.38(a).) During the relevant time, noted the Commission, IFUS only authorized EFRPs – a potentially approved form of off-exchange transaction – through independently controlled accounts. (Click here to access ICE Futures Rule 4.06(b)(iv).) Since Glencore Grain and Glencore Ltd. were part of the Glencore plc organization and controlled by the same Head of Cotton, EFRPs between the two entities were not for independently controlled accounts and were thus impermissible, alleged the CFTC.
Finally, persons holding or controlling futures and options positions in cotton that are deemed “reportable” under CFTC regulation are required to file a Form 304 report with it showing the persons’ fixed price cotton positions as of the end of each month it has reportable futures positions and options positions. (Click here to access CFTC Rule 19.00(a)(1).) The CFTC alleged that two Form 304 reports filed by Glencore Grain overstated the quantities of its fixed price cotton cash positions.
Compliance Weeds:CFTC Form 204 (Statement of Cash Positions in Grains, Soybeans, Soybean Oil and Soybean Meal) and Parts I and II of Form 304 (Statement of Cash Position in Cotton – Fixed Price Cash Positions) must be filed by any person that holds or controls a position in excess of relevant federal speculative position limits that constitutes a bonafide hedging position under CFTC rules (the speculative limits are the reportable levels for these purposes). These documents must be made as of the close of business on the last Friday of the relevant month. Form 204 must be received by the CFTC in Chicago by no later than the third business day following the date of the report, while Form 304 must be received by the Commission in New York by no later than the second business day following the date of the report.
Investment Bank Ex-Employee’s Conviction Upheld for Theft of High-Frequency Trading Algorithmic Code: New York’s highest court – the NY Court of Appeals – upheld the conviction of Sergey Aleynikov, a former computer programmer for Goldman Sachs & Co., who was charged in a state court in 2012 with illicitly copying with the intent to use for a new employer, Teza Technologies LLC, Goldman’s proprietary computer code for a high-frequency trading system. Mr. Aleynikov never used the computer code at Teza, however.
Mr. Aleynikov was subsequently criminally charged in September 2012 and convicted by a NY court jury for violating a provision of NY law that prohibits a person from making an unauthorized “tangible reproduction” of secret scientific material. (Click here to access NY Penal Law § 165.07.) However, the New York trial court set aside the jury’s verdict, claiming that source code is not tangible when it is only stored on a computer.
In January 2017, an intermediate appellate court in New York reversed the trial court’s order and remanded the case for sentencing. (Click here to access the relevant court decision.) Acting on Mr. Aleynikov’s appeal, the NY Court of Appeals upheld the defendant’s conviction.
According to the NY Court of Appeals, Mr. Aleynikov, without Goldman’s permission, transferred his then employer’s proprietary source code using his work computer to an unauthorized computer server in Germany on June 5, 2009, his last day of employment at Goldman. This action was expressly prohibited by Goldman policy which precluded employees from removing a copy of source code from the company’s network. Later, Mr. Aleynikov downloaded the source code to his home computer from the Germany-based server. Subsequently, he placed the source code in a Teza website repository for use by Teza.
The NY Court of Appeals said that a “rational jury” could have concluded that the copy of the source code made by Mr. Aleynikov “was tangible in the sense of ‘material’ or ‘having physical form’.” This is because the jury heard evidence that, since source code stored on a computer takes up space on a drive, it is physical in nature. As a result, the court upheld Mr. Aleynikov’s conviction.
Generally, the Framework sets forth the industry-standard risk-based approach to manage cybersecurity vulnerability. The objective of the Framework is to provide all firms a common means to describe their current cybersecurity approach; describe their target state; identify and prioritize opportunities for improvement; assess progress towards achieving the target state; and communicate about cybersecurity risk to internal and external stakeholders.
Persons in charge of cybersecurity programs at financial services firms might use the opportunity of the revised NIST framework to review their firm’s own approach to assessing, managing and communicating about cybersecurity risk to ensure, among other things, it adequately identifies and mitigates against internal risks.
Correction: This article was corrected on May 9 to make clear that Mr. Aleynikov did not use the misappropriated Goldman source code at Teza.
Class Action Lawsuit Filed Against Ripple Labs for Unregistered Sales of Securities: A purported class action lawsuit was filed in a California court against Ripple Labs, Inc. and other defendants for offering and selling unlicensed securities, namely the Ripple digital token – XRP. The named plaintiff, Ryan Coffey, seeks rescission and punitive damages against all the defendants, who also include XRP II, LLC and Bradley Garlinghouse, the chief executive officer of Ripple.
Ripple represents itself as a “digital asset for payments,” claiming it is “the fastest and most scalable digital asset, enabling real-time global payments anywhere in the world.” (Click here to access the Ripple website.) The defendants have not yet filed an answer to the complaint and this lawsuit has not been approved by the court for class action status.
My View: According to published reports, the Commodity Futures Trading Commission and the Securities and Exchange Commission may meet this week to discuss whether Ether, the digital token associated with the Ethereum blockchain, and XRP are securities potentially subject to regulation by the SEC. (Click here, for example, to access a recent article in The Wall Street Journal.) The CFTC has previously suggested that both Ether and XRP are virtual currencies. (Click here to access the October 17, 2015 LabCFTC primer on Virtual Currencies; see footnote, page 5.) FinCEN in its lawsuit against Ripple Labs and XRP 2 also referenced XRP as a virtual currency and, in fact, grounded its lawsuit on the defendants’ exchange activities involving their virtual currency.
To me, a discussion over when a digital token might be a security as opposed to a virtual currency would be very helpful, particularly if it is followed by the issuance of clear guidance and an opportunity to cure for cryptocurrencies that might be forced to change their existing, popular characterization. However, no guidance should be issued without public input. CFTC Commissioner Brian Quintenz indicated that a subcommittee of the Technology Advisory Committee might be formed to consider this issue (Click here for Mr. Quintenz’s opening remarks before the February 14, 2018 Technology Advisory Committee.) This would be a great forum to initiate such conversations.
Notwithstanding the class action lawsuit filed in California, the more common view is that Ether and Ripple are virtual currencies. Ether clearly is the payment mechanism for transactions on the Ethereum blockchain requiring “gas” and is used in some real-world transactions. Ripple likewise was designed and is used as a payment vehicle. Moreover, Ripple was not issued as part of an ICO, and while 60 million Ether tokens were issued as part of the Ether ICO in July 2014 (valued at approximately US $18.4 million), today Ether tokens are exclusively created through mining – just like Bitcoin. Ripple was previously criticized by some for having too few validators to approve blockchain transactions. However, the amount of so-called "validator nodes" was increased to 55 last year.
What was the initial stated purpose for the digital token?
How is the digital token promoted today?
Is the digital token generally regarded as a currency, currency substitute or payment substitute, serving as a medium of exchange, store of value or unit of account?
Do merchants or any third parties accept the digital token for payment? If yes, how widespread? Is the digital token used for payment on a blockchain? If yes, how?
Was the digital token initially issued as part of an ICO or a type of continuous offering? If not, how are new digital tokens currently issued and what is the percentage of ICO and non-ICO derived digital tokens? Was there a pre-sale associated with the ICO (e.g., SAFT)?
What is the governance regarding the blockchain associated with the digital token? Is there a different governance for the token itself? If yes, what is it?
Is the blockchain associated with the digital token centralized or decentralized?
How are transactions involving the digital token validated and recorded on the associated blockchain?
Do holders of digital tokens directly or indirectly have any rights to income? Are there any other rights associated with ownership of the digital token? If yes, what are they?
Follow-up: California Federal Court Dismissal of CFTC Monex Enforcement Action Upsets Stable Legal Theories: The California federal court judge who, at the end of March, tentatively dismissed the enforcement action by the Commodity Futures Trading Commission against Monex Deposit Company and other defendants for alleged fraud in connection with their financed sale of precious metals to retail persons issued a final order confirming the dismissal on May 1.
the CFTC cannot use the prohibition against persons engaging in any manipulative or deceptive device or contrivance in connection with the sale of any commodity in interstate commerce enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act to prosecute acts of purported fraud except in instances of fraud‑based market manipulation.
However, said the judge, “the legislative history of Dodd-Frank supports the Court’s conclusion that Congress did not intend to exclude the sort of conduct that CFTC alleges Monex engaged in from the ambit of the Actual Delivery Exception.” The judge claimed that if he was to follow the CFTC’s position, every financed transaction would violate Dodd-Frank, and the Actual Delivery Exception under law would be nullified.
According to the judge, the CFTC has three basic anti-fraud authorities, and each has a distinct purpose and limitations: § 4b, that solely prohibits fraud and deceptive conduct (click here to access 7 U.S.C. § 6b(a)(2)), § 6(c)(1), that prohibits fraud-based manipulation and § 6(c)(3), that prohibits market manipulation when there is no fraud (click here to access 7 U.S.C § 9(3)).
My View: The court’s ruling on the Actual Delivery Exception appears to make perfect sense. If actual delivery within 28 days of the sale of a commodity excludes from CFTC oversight any commodity sold to a retail person on a leveraged or financed basis except where the seller/grantor of financing is not willing to release all liens or control on the financed commodity – even if the financing or leverage is not paid off – the Actual Delivery Exception is meaningless. This is because, realistically, no lender will release its lien or control on collateral supporting financing until a debt is repaid. It seems improbable that Congress would have drafted a law to create a carve-out from CFTC jurisdiction that realistically would never occur.
The difficulty of the CFTC’s position is highlighted in its proposed interpretive guidance on retail commodity transactions involving virtual currencies issued in December 2017, which parallels the CFTC’s 2013 guidance regarding actual delivery of tangible commodities. (Click here to access a copy of the CFTC’s 2013 guidance and here for a copy of the CFTC’s proposed 2017 guidance.) Both proposed examples 1 and 2 suggest situations where actual delivery might only be deemed to have occurred in financed transactions involving virtual currency for retail persons where the financed virtual currencies were delivered to a wallet not controlled in whole or in part by the seller. However, not being able to exercise control would leave the seller with no effective security interest over collateral it financed even when it has not been repaid. This would render the theoretical ability to sell virtual currencies to buyers on finance subject to actual delivery within 28 days a meaningless option.
If “or” means “or,” the plain reading of the law suggests that either manipulative or deceptive devices are prohibited, not solely deceptive devices that are manipulative.
The judge insisted that, despite this plain language, a holistic view of this statutory provision considering other sections of law, as well as a review of legislative history, leaves no doubt that the use of “or” was likely careless, and the “or” should be read as an “and.” This analysis is well reasoned and sensible, and it is the basis for his view that only fraud-based manipulation may be prosecuted under this provision. Moreover, I believe the CFTC has unfairly used this statutory provision as the wild junkyard dog of its enforcement arsenal without any leash or other restraint. However, I’m intuitively not so sure about the federal judge’s reasoning. Still thinking about this one!
Global Investment Bank Fined US $110 Million for FX Trading by Federal and NY Regulators: The Goldman Sachs Group Inc. agreed to pay a combined fine of US $110 million to the Federal Reserve Board and the New York Department of Financial Services related to allegations that, from 2008 through early 2013, firm traders shared confidential customer information to coordinate with others trading activity in foreign exchange that could improperly affect prices detrimentally for customers for the benefit of traders. Goldman Sachs also agreed to enhance its internal controls for foreign exchange trading as part of its settlement. Both the FRB and DFS acknowledged Goldman Sachs’ full cooperation with their investigation, and that the firm has already instituted improvements in internal controls, compliance, risk management and audit programs related to its foreign exchange business.
CFTC Staff Clarifies Aggregation Requirements of Investor in Commodity Fund: The Division of Market Oversight of the Commodity Futures Trading Commission stated in an Interpretation that an institutional investor in a commodity pool that is not required to aggregate the pool’s futures positions with its own because the investor is a passive investor does not have to aggregate futures positions of a portfolio company the pool is invested in. This is the case even where the institutional investor’s investment in the pool causes it to have a 10 percent or more indirect interest in the portfolio company. The institutional investor that sought Division relief represented that it did not control the pool’s operations or its investment decisions, and did not know “or want to know” if a prospective portfolio company intended to trade futures.
IOSCO and BIS Criticize Some CCPs for Lacking on Risk Management and Recovery Planning: The International Organization of Securities Commissions and the Committee on Payments and Infrastructures of the Bank for International Settlements issued a report noting that some global central counterparties have not yet implemented a number of recommended risk management and recovery planning measures. Among other things, some CCPs only employ one loss allocation tool (i.e., special assessments) as opposed to multiple tools to address uncovered credit losses, as recommended, and some derivatives CCPs and most cash CCPs “continue to lack mandatory rule-based recovery tools to re-establish a matched book (or to otherwise close out a defaulter’s outstanding obligations) and rely only on voluntary, market-based tools.” The regulatory organizations believes CCPs need a “range of tools” to ensure a CCP can establish a matched book.
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 5, 2018. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or other employees.

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