Schiff Hardin Derivatives & Futures Update (May 2012)

May 2012

CPO/CTA Issues

CFTC Rescinds Popular CPO exemption

The CFTC adopted a final rule that rescinds the

exemption from registration as a commodity

pool operator (CPO) under CFTC Rule 4.13(a)

(4). Rule 4.13(a)(4) exempts a commodity pool

operator from registration if all investors in the

fund are “qualified eligible persons.” Rule 4.13(a)

(4) imposed no limits on the amount of futures

trading that could be conducted, and was com-

monly relied on by many managers of hedge

funds and funds of funds.

The rescission of CFTC Rule 4.13(a)(4)

became effective April 24, 2012. However,

CPOs that are currently relying on Rule

4.13(a)(4) will have until December 31, 2012

to claim another exemption. Advisers of funds

currently relying on the 4.13(a)(4) exemption

have four options:

• stop trading in commodity futures, retail FX contracts and swaps (other than security-based swaps);

• rely upon a different registration exemption;

• obtain no-action relief from the CFTC; or

• register as a CPO

Depending upon the nature of and investors in a

fund, a number of alternative CFTC exemptions

may be available, including the Rule 4.5 or 4.13(a)

(3) exemptions or Rule 4.7 partial exemption.

The CFTC also amended CFTC Rule 4.5 to impose

new conditions on the ability of mutual funds and

other registered investment companies to effect

transactions in futures and swaps without the

need for CPO registration; imposed new data

reporting requirements under Forms CPO-PQR

and CTA-PR; rescinded the relief provided in CFTC

Rule 4.7(b)(3), under which the annual reports of

certain commodity pools were not required to be

certified; instituted a new requirement that CPOs

and CTAs annually file notices claiming an exemp-

tion from registration; and imposed additional risk

disclosure requirements upon CPOs and CTAs that

engage in swap transactions.

ICI and Chamber sue CFTC Over Fund Adviser Rule

On April 17, 2012, the Investment Company

Institute (“ICI”) and the U.S. Chamber of

Commerce (“Chamber”) filed suit against the

CFTC in the U.S. District Court for the District of

Columbia, challenging the legality of newly

amended CFTC Rule 4.5. The rule, which went into

effect April 24, 2012, and requires compliance by

December 31, 2012, requires certain registered

fund advisers to register as CPOs with the CFTC,

subjecting them to dual regulation by the SEC and

CFTC. The ICI and the Chamber do not challenge

the CFTC’s repeal of Rule 4.13(a)(4), which

exempts many advisers to private funds from

CFTC registrations. The groups seek injunctive

relief preventing implementation of the

amendments to Rule 4.5.

In a 47-page complaint, the ICI and the Chamber

allege that the amendment violates both the

Commodity Exchange Act and the Administrative

Procedure Act because the CFTC did not perform

a proper cost-benefit analysis, failed to provide

interested persons with a sufficient opportunity to

meaningfully participate in the rulemaking, and

offered no justification for the heightened

regulation. In sum, the ICI and the Chamber

allege that the amendment is unnecessary,

redundant and costly.

In This Issue:

CPO/CTA Issues .................. 1

Dodd-Frank Rulemakings .... 2

Volcker Rule ........................ 4

CMe Group exchanges ......... 4

CMe Group enforcement Activity ................................ 5

NFA ..................................... 6

NFA enforcement Activity .... 6

CFTC .................................... 7

CFTC enforcement Activity .. 8

MF Global ............................ 9

energy ................................. 9

schiff HardinDerivatives & Futures

Practice

Matt Kluchenek Managing editor

Paul e. Dengel

stacie R. Hartman

Carl A. Royal

Contributing editors

Craig Bridwell

Jacob L. Kahn

Victoria Pool

2Derivatives & FuturesSchiff Hardin LLP

May 2012

DODD-FRANK RuLeMAKINGs

CFTC Finalizes Definitions

On April 18, 2012 the CFTC finalized the definition of swap

dealer (“SD”), major swap participant (“MSP”) and eligible

contract participant (“ECP”) in a joint rulemaking with the SEC.

CFTC Defines “Swap Dealer”

Under the CFTC's final rule, a “swap dealer” is defined as any

person who:

• holds itself out as a dealer in swaps;

• makes a market in swaps;

• regularly enters into swaps with counterparties as an ordinary course of business for its own account; or

• engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps.

The final rule includes important exclusions—including the so-

called “de minimis” exemption. To qualify for the exemption, the

aggregate gross notional amount of the swaps that the person

enters into over the prior 12 months in connection with dealing

activities must not exceed $3 billion. However, the rule provides

for a phase-in of the de minimis threshold. During the phase-in

period, the de minimis threshold is $8 billion. Two and one-half

years after data starts to be reported to swap data repositories,

CFTC staff will prepare a study of the swap markets. Nine

months after this study, the CFTC may end the phase-in period,

or propose new rules to change the de minimis threshold (either

up or down). If the CFTC does not take action to end the phase-

in period, it will terminate automatically five years after data

starts to be reported to swap data repositories.

CFTC Defines “Major Swap Participant”

Under the CFTC’s final rule, a “major swap participant” is

defined to include:

• any person that maintains a “substantial position” in any of the major swap categories;

• any person whose outstanding swaps create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the US banking system or financial markets;” or

• any “financial entity” that is “highly leveraged relative to the amount of capital such entity holds” and that is not subject to capital requirements established by a federal banking agency and that maintains a “substantial position” in any of the major swap categories.

The two “substantial position” tests account for both cur-

rent uncollateralized exposure and potential future expo-

sure. A position that satisfies either test would be a “sub-

stantial position.” Importantly, the definition of substantial

position excludes positions “hedging or mitigating commer-

cial risk” (and employee benefit plan positions), and the

tests apply to a firm’s swap positions in each of four major

swap categories: rate swaps, credit swaps, equity swaps

and commodity swaps.

The “substantial counterparty exposure” test uses a

calculation that is the same as the method used to calculate

substantial position, but substantial counterparty exposure

includes all categories of swaps and does not exclude

hedging or employee benefit plan positions. The thresholds

as adopted for substantial counterparty exposure are a

current uncollateralized exposure of $5 billion, or a sum of

current uncollateralized exposure and potential future

exposure of $8 billion, across the entirety of a person’s

swap positions.

CFTC Defines “Eligible Contract Participant”

Dodd-Frank amended the definition of “eligible contract

participant” by: (1) providing that, for purposes of retail

forex transactions, the term ECP does not include a

commodity pool in which any participant is not himself an

ECP; (2) raising the monetary threshold that governmental

entities may use to qualify as ECPs from $25 million to $50

million in investments owned and invested on a discretionary

basis; and (3) replacing the “total asset” standard for

individuals to qualify as ECPs with an “amounts invested on

a discretionary basis” standard.

The final rule adopted by the CFTC and SEC further defined

ECP as follows:

• A commodity pool can qualify as an ECP under several tests even if some of its investors are not ECPs, provided that the pool was not structured to permit non-ECPs to engage in retail forex transactions; and

• An entity, which is not otherwise qualified as an ECP, will be treated as an ECP for purposes of a swap that is used to hedge or mitigate a commercial risk in connection with its line of business, provided that all the owners of such entity are themselves ECPs.


May 2012

Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management

On April 9, 2012, the CFTC issued its final rules governing

DCO clearing members’ activities. The rules address

customer clearing documentation, timing of acceptance of

swaps for clearing, and clearing member risk management

for swap transactions.

Customer Clearing Documentation: The rules prohibit tri-

party agreements between customers, SDs, MSPs, and FCMs

that are clearing members, and DCOs that would (1)

disclose to an FCM, SD, or MSP the identity of a customer’s

original executing counterparty; (2) limit the number of

counterparties with whom a customer may enter into a

trade; (3) restrict the size of the position a customer may

take with any individual counterparty; (4) impair a customer’s

access to execution of a trade on terms that have a

reasonable relationship to the best terms available; or (5)

prevent compliance with the rule’s specified time frames for

acceptance of trades into clearing.

Time Frames for Submission and Acceptance for Clearing:

Clearing members, or the DCOs acting on their behalf, must

accept or reject each trade submitted for clearing as quickly

as would be technologically practicable if fully automated

systems were used. This standard requires action in a

matter of milliseconds or seconds or, at most, a few minutes,

not hours or days. This timing rule does not require

automatic trade processing, but it does require that manual

trade processing operate within the same time frame as

automated systems. The rules also require SDs, MSPs,

FCMs, swap execution facilities and designated contract

markets to submit swaps that are required to be cleared to

a DCO as soon as technologically practicable, but no later

than the close of business on the day of execution. Swaps

that are not required to be cleared must be submitted to a

DCO by the close of business on the day after execution or

agreement to clear.

Clearing Member Risk Management: SDs, MSPs, and FCMs

that are clearing members must (1) establish credit and

market risk-based limits on position size, order size, margin

requirements, or similar factors; (2) use automated means

to screen orders for compliance with the risk-based limits;

(3) monitor for adherence to the risk-based limits intra-day

and overnight; (4) conduct stress tests for all positions in

proprietary and customer accounts at least once per week;

(5) evaluate their ability to meet initial margin requirements

at least once per week; (6) evaluate their ability to meet

variation margin requirements in cash accounts at least

once per week; (7) evaluate their ability to liquidate

positions they clear in an orderly manner, and estimate the

cost of the liquidation, at least once per month; and (8) test

all lines of credit at least once per year.

The effective date for FCMs, DCMs and DCOs is October 1,

2012. The effective date for SDs and MSPs is the later of

October 1, 2012, or the date that the SD and MSP

registration rules become effective. The effective date for

SEFs is the later of October 1, 2012, or the date that the

Core Principles and Other Requirements for SEFs rule

becomes effective.

CFTC Proposes exemptions for Foreign Regulators

On May 1, 2012, the CFTC voted to issue a Proposed

Interpretative Statement regarding the confidentiality and

indemnification provisions in the Dodd-Frank Act. The

proposed statement is aimed at ensuring that foreign

regulators have access to data in Swap Data Repositories

(SDRs). Currently, Dodd-Frank requires any regulator—

domestic or foreign—seeking access to data in an SDR to

agree in writing to abide by certain confidentiality and

indemnification requirements. Recognizing the difficulties

foreign regulators may have complying with the rule and the

importance of SDR data to foreign regulatory schemes, the

CFTC determined that it would be unreasonable to apply the

confidentiality and indemnification provisions to foreign

regulators. Accordingly, the CFTC proposes to interpret CEA

Section 21(d) such that its provisions do not apply to SDR

data sought by foreign regulators when the SDR is also

registered, recognized, or otherwise authorized in the foreign

jurisdiction’s regulatory regime and the data has been

reported to a registered SDR pursuant to the foreign

jurisdiction’s regulatory regime. The CFTC is committed to a

cooperative international approach to the registration and

regulation of SDRs and intends to continue cooperating with

foreign regulators in finalizing related rules.

Public comment will extend for 30 days from the date of

publication of the proposed statement in the Federal Register.


May 2012

VOLCKeR RuLe

Federal Reserve: Compliance with Volcker Rule Required by July 2014

The Federal Reserve has clarified that banking entities will have

until July 21, 2014 to conform to the new Section 13 of the Bank

Holding Act of 1956 (the “Volcker Rule”), added by Dodd-Frank

Section 619. Each nonbank financial company will have two

years from the date on which it becomes a nonbank financial

company supervised by the Fed in which to conform.

The Volcker Rule generally prohibits banking entities from

engaging in proprietary trading or from acquiring or retaining an

ownership interest in, sponsoring, or having certain relationships

with a hedge fund or private equity fund, subject to certain

exemptions. It also provides for nonbank financial companies

supervised by the Fed that engage in such activities or have

such interests or relationships to be subject to additional capital

requirements, quantitative limits, or other restrictions.

The Volcker Rule is scheduled to take effect July 21, 2012.

Banking entities and nonbank financial companies will have a

two-year grace period in which to conform their activities to

the rule. The Fed may extend this period in one-year

increments on individual bases, up to three years, if

consistent with the purpose of the rule and not detrimental to

the public interest.

On February 9, 2011, the Fed issued its final rule implementing

the conformance period. Numerous industry participants and

commenters, including SIFMA, Bank of New York Mellon, and

Credit Suisse, requested clarification of this rule, prompting

the Fed to issue a statement of policy on April 19, 2012.

According to this statement, “the Conformance Rule provides

each banking entity with a period of 2 years after the effective

date of section 13 (i.e., until July 21, 2014) in which to fully

conform its activities and investments to the prohibitions and

requirements of section 13 and the final implementing rules,

unless that period is extended by the Board .... The Conformance

Rule also provides a nonbank financial company supervised by

the Board with 2 years after the date the company becomes a

nonbank financial company supervised by the Board to comply

with any applicable requirements of section 13 of the BHC Act,

including any applicable capital requirements or quantitative

limitations adopted thereunder, unless that period is extended

by the Board.”

In the interim, the Fed expects these banking entities to engage

in good-faith efforts to meet the July 2014 deadline, including

self-evaluations of activities and investments for conformance,

developing and implementing a specific conformance plan, and

complying with reporting and recordkeeping rules as adopted by

the relevant agencies.

While the CFTC, SEC, FDIC and Office of the Comptroller of the

Currency have rulemaking authority under the Volcker Rule, the

Fed alone determines the conformance grace period.

CMe GROuP exCHANGes

CMe Announces enhanced Customer Protections

On April 2, 2012, CME Group announced several measures

aimed at enhancing protection of customer segregated funds.

These measures include:

• daily segregated, secured 30.7 and sequestered statements filed through WinJammer by noon on the following day;

• bi-monthly Segregated Investment Detail Reports (SIDRs) reflecting how funds are invested and held; and

• surprise reviews of statements by CME and the Joint Audit Committee.

The daily statement requirement is effective as of May 1,

2012. The bi-monthly SIDR requirement is expected to be

effective July 1, 2012.

CME also announced that it is working with other SROs to

adopt a rule requiring pre-written approval from an FCM’s

CEO, CFO, or designated principal for all disbursements of

customer segregated funds that are not made for the benefit

of customers and that exceed 25% of the excess segregated

funds. The rule will be effective once proposed rule changes

are completed and have received regulatory approvals.


May 2012

CMe expands Anti-Money Laundering Rule

CME amended the anti-money laundering requirements under

CME, CBOT and NYMEX Rule 981 to encompass all applicable

Office of Foreign Asset Control sanctions programs. Rule 981

previously required clearing members to develop and

implement written anti-money laundering programs reasonably

designed to achieve compliance with applicable requirements

of the Bank Secrecy Act. Amended Rule 981 requires clearing

members to develop and implement written compliance

programs reasonably designed to achieve compliance with

applicable requirements of the International Economic Powers

Act and the Trading with the Enemy Act, as well as the Bank

Secrecy Act, and all applicable Executive Orders and regulations

issued pursuant thereto. Amended Rule 981 became effective

April 30, 2012.

CMe Group enforcement Activity

Man Investments Ltd.—Position Limits ViolationsCME ordered Man Investments Ltd. (“Man”) to pay a fine of

$25,000 and disgorge profits of $35,050 for maintaining

November 2011 Feeder Cattle contract positions in excess of

the applicable speculative spot month position limits. Man

maintained 436 contracts on a date subject to a 300 contract

position limit. The decision was issued pursuant to an offer

of settlement in which Man neither admitted nor denied a

rule violation.

Chicago Capital Markets, LLC— Retention of Records

CME fined Chicago Capital Markets, LLC (“CCM”) $15,000 for

failing to properly maintain and provide instant messages

related to the entry of orders on May 6, 2010. A Panel of the

CME BCC found that this failure violated CME Rule 536.H on

the retention of records. The penalty was assessed pursuant to

an offer of settlement in which CCM neither admitted nor

denied violation of any rule.

Robert James Anstey—Prearranged, Pre-Negotiated and Noncompetitive Trades

CME fined Robert James Anstey $50,000 and suspended his

direct and indirect access to all CME Group electronic trading

and clearing platforms for 20 business days for violating Rule

539.C.4. According to a Panel of the CME BCC, on three

occasions between September 2009 and April 8, 2010, Anstey

failed to submit a Request for Quote into the CME Globex

electronic trading platform prior to engaging in pre-execution

communications, and on two of those occasions Anstey also

failed to submit a Request for Cross Order containing both the

buy and sell orders after the entry of a second Request for

Quote. The Panel further found that Anstey engaged in pre-

execution communications and traded without entering a

Request for Cross Order on three occasions between April 23,

2010 and July 2011. The sanctions were issued pursuant to a

settlement offer in which Anstey neither admitted nor denied

rule violations.

Carl Maas—Order Withholding and DisclosureCME fined Carl Maas $7,500 and suspended his access to the

trading floor and his direct access to any electronic trading

or clearing platform owned or controlled by CME Group for

15 business days, following a finding that he had violated

CME Rules 532 (Disclosing Orders Prohibited), 529

(Withholding Orders Prohibited), and 536.A.1. (requiring

every order receive a timestamp). Specifically, the findings

included that Maas had withheld a customer order for over

a minute after receipt of the order, failed to properly time-

stamp the order, and disclosed the terms of the order to

another member prior to relaying the order to the pit, in

February 2009, and disclosed the terms of a customer’s

order to another market participant prior to the exposure of

the order into the pit, in March 2009. The sanctions were

issued pursuant to a settlement offer in which Maas neither

admitted nor denied the violations.

Robb Stewart—Wash Trade and Prearranged Trade Violations

CME fined Robb Stewart $15,000 and suspended direct access

to any trading floor or electronic trading or clearing platform

owned or operated by CME Group for 15 business days,

following a finding that he had violated CME Rules 534 (Wash

Trades Prohibited) and 539.A. (Prearranged, Pre-Negotiated and

Noncompetitive Trades Prohibited). Specifically, a disciplinary

panel found that Stewart had, on one or more occasions

executed a series of trades on the CME Globex electronic trading

platform by pre-arranging transactions in the Live Cattle market

with another member, and by so doing, engaged in indirect

wash transactions in an attempt to freshen the dates of his

previously established positions. Mr. Stewart neither admitted

nor denied the violations, pursuant to an offer of settlement.


May 2012

Nicole M. Graziano—Misallocation of Orders and Fills

CME fined Nicole M. Graziano $250,000, ordered her to pay

restitution of $250,390, and ordered a permanent bar to CME

Group exchange membership, use or access to any CME Group

trading floor or electronic trading or clearing platform, and

affiliation with a broker association, guaranteed introducing

broker, Member or affiliate of a Member registered with any

CME Group exchange, trading platform or clearing platform,

following a finding of violations of legacy CME Rules 432.B.

(fraud), 432.C. (dishonest conduct), and 432.Q. (acts

detrimental to CME). Specifically, after Graziano failed to

answer the charge, a disciplinary panel found that she, on one

or more occasions, had misallocated orders and fills in order to

allocate favorable prices to her personal account orders.

Vladimir Yakovlev—Improper Account Transfers

CME ordered a permanent bar of non-member Vladimir

Yakovlev from CME Group exchange membership, use or

access to any CME Group trading floor or electronic trading or

clearing platform, and affiliation with a broker association,

guaranteed introducing broker, Member or affiliate of a

Member registered with any CME Group exchange, trading

platform or clearing platform, following a finding of violations

of legacy CME Rules 432.B. (fraud) and 432.C. (dishonest

conduct). Specifically, after Yakovlev failed to answer the

charge, a disciplinary panel found that he had executed nine

money pass transactions in a foreign exchange futures

market on the CME Globex Platform in order to move

$11,937.50 from his employer to another’s account.

NFA

NFA to Provide Regulatory services to seFs

NFA entered into agreements with ICAP and Tradition that

pave the way for NFA to perform regulatory services for ICAP

and Tradition’s swap execution facilities (“SEFs”). Although

the agreements are not formal Regulatory Services

Agreements, the agreements establish preliminary frameworks

for exchanging information and developing technology

standards that will enable ICAP, Tradition and NFA to develop

procedures and processes necessary for the SEFs to fulfill

their self-regulatory obligations. NFA anticipates entering into

formal Regulatory Services Agreements with both ICAP and

Tradition upon the issuance of the CFTC’s final SEF rules.

SEFs will have surveillance and other regulatory responsibilities

under the Dodd-Frank Act and the rules and regulations

promulgated thereunder, and the CFTC has proposed allowing

SEFs to contract with a registered futures association, such

as NFA, for regulatory services.

NFA enforcement Activity

Trade Dock Capital—Misleading Promotional Materials

NFA permanently barred Trade Dock Capital LLC from NFA

membership and barred its sole associated person and listed

principal, Dominique Miguel Da’Cruz, for a period of seven

years. Trade Dock Capital is a CTA and CPO located in

Bethesda, Maryland. The NFA Hearing Panel’s decision was

issued pursuant to a settlement offer submitted by Trade Dock

Capital and Da’Cruz. The Panel found that Trade Dock Capital

and Da’Cruz used deceptive and misleading promotional

material; failed to cooperate promptly and fully with NFA and

provided false and misleading information to the NFA during

the audit of the firm; and failed to list the firm’s CEO as a

principal of the firm and improperly delisted another individual

as a principal.

Option Investments, Inc.—Breaches of Customer Duties

Option Investments, Inc. (“OpVest”), a CTA and IB, and two of

its principals, Scott A. Altenburg and Andre Julian, were fined

$75,000 each for failing to observe high standards of

commercial honor and just and equitable principles of trade by

recommending trades to customers that maximized commission

without regard for the best interests of their customers and for

failure to supervise trade recommendations made by associated

persons. Sanctions were also brought against several

associated persons for failing to observe high standards of

commercial honor and just and equitable principles of trade.

The sanctions were issued pursuant to an offer of settlement

in which OpVest, its principals and its associates neither

admitted nor denied the allegations made against them.


May 2012

Gem International Commodities LLC—Breaches of Customer Duties

Gem International Commodities LLC (“Gem”), an IB, was

permanently barred from NFA membership for failure to

observe high standards of commercial honor and just and

equitable principles of trade by recommending trades that

appeared to be designed primarily to maximize commissions

for Gem and its principal, Christine Stankoff. The BCC also

found that Gem and Stankoff failed to disclose to a customer

that futures trading may be too risky in light of his age and

hearing disability, and that they failed to comply with NFA’s

enhanced supervisory requirements. Stankoff was barred from

NFA membership for three years and ordered to pay a $10,000

fine if she reapplies for membership after the three-year

period expires.

FX Currency Traders—Conduct With Non-NFA Registrant and Failure to Supervise

FX Currency Traders, Inc. (“FXCT”), a former forex firm and IB,

was ordered not to reapply for NFA membership or act as a

principal of an NFA member. Jacob N. Martinez, the firm’s

principal and sole owner, was ordered not to reapply for NFA

membership for a period of three years and to pay a $150,000

fine to NFA if he does reapply for NFA membership after the

three-year period expires. The decision was based on an NFA

Complaint filed in October 2011 and a settlement offer in

which FXCT and Martinez neither admitted nor denied the

allegations made against them. The Complaint alleged that

FXCT conducted business with a non-NFA member, which was

required to be registered as an IB with the CFTC but was not.

The Complaint also alleged FXCT failed to carry out its

supervisory duties to ensure that the non-member did not use

misleading and deceptive promotional material to generate

customer leads. The Complaint charged Martinez with failure

to supervise for allowing FXCT to engage in impermissible

business activity and for failing to screen and supervise other

entities with which FXCT did forex business, and manipulating

FXCT’s financial books and records to make it appear as

though the firm was complying with its minimum capital

requirement when it was not.

International Markets Corp.—Misleading Promotional Materials

CPO and CTA Intercapital Markets Corp. (“IMC”) and its

principal, Meixuan Zhang, were ordered to withdraw from NFA

membership and never reapply after the BCC found that IMC

and Zhang failed to cooperate with the NFA during IMC’s audit

and used misleading promotional material to solicit potential

customers through a Web site suggesting that ICM was

authorized to engage in retail forex even though it was not.

CFTC

CFTC Warns FCMs: Amended Filings May Attract Regulator’s Attention

The CFTC’s Division of Swap Dealer and Intermediary Oversight

has advised futures commission merchants that “filing of

amended financial statements may lead the Commission to

question if an FCM is not meeting its obligation to maintain

current books and records as prescribed in Commission

Regulation and/or a lack of adequate internal controls over the

financial closing process and/or the preparation and maintenance

of its books and records.”

This warning apparently was prompted by the “significant

number of amended statements” the CFTC received in 2011.

CFTC Regulation 1.10(b)(1)(i) obligates FCMs to file monthly

financial reports, disclosing financial condition, statements of

income/loss and changes in ownership equity, changes in liabilities

subordinated to claims of general creditors, computation of the

minimum capital requirements, and segregation requirements.

CFTC Regulation 1.18(a) obligates non-SEC registered FCMs

to prepare and keep current “ledgers or other similar

records which show or summarize, with appropriate

references to supporting documents, each transaction

affecting his asset, liability, income, expense and capital

accounts, and in which ... all his asset, liability and capital

accounts are classified ....”

While the CFTC accepts that amendments will be necessary

when the FCM learns of material adjustments after the filing

deadline, some amendments in 2011 were for “adjustments

that should have been known prior to the filing deadline.”

The CFTC encourages CFOs to review their internal controls

over books, records and the financial closing process, and to

ensure compliance with CFTC regulations.


May 2012

CFTC enforcement Activity

Violations of Customer Fund Segregation Requirements

In the wake of MF Global’s failure and the subsequent revelation

that it had failed to properly handle segregated customer funds,

the CFTC has increased its focus on the segregation requirements

in the commodities industry.

On March 13, 2012, the CFTC filed a complaint in the Southern

District of New York charging MBF Clearing Corp. (“MBF”), an

FCM, with violating the requirement that customer funds be held

in segregated accounts. According to the CFTC, MBF held

between $30 million and $60 million in customer funds in a non-

segregated account for more than a year and a half. The CFTC

alleged that MBF failed to properly title the account, and failed to

obtain the necessary paperwork establishing that the funds were

to be held in accordance with the CEA’s segregation requirements.

In addition, the CFTC charged MBF with supervision violations

based on the absence of written policies and procedures at MBF

governing the opening and maintenance of customer segregated

accounts. The CFTC’s lawsuit seeks a civil monetary penalty,

disgorgement of any wrongful profits earned by MBF and

injunctive relief prohibiting MBF from engaging in similar

misconduct in the future.

The case is U.S. Commodity Futures Trading Comm’n v. MBF

Clearing Corp., Case No. 1:12-cv-01830 (S.D.N.Y.).

Similarly, on April 4, 2012, the CFTC initiated and settled an

administrative enforcement proceeding against JPMorgan Chase

Bank, N.A. (“JPMorgan”), a depository institution, for alleged

violations of related segregated funds rules. In particular, the

CFTC’s order (CFTC Docket No. 12-17) found over the course of

approximately two years, JPMorgan had extended intra-day

credit to one FCM on a number of occasions based in part on the

amount of segregated customer funds held by that FCM. In other

words, JPMorgan had allegedly treated customer segregated

funds as though they belonged to the FCM. In addition, the

CFTC’s order found that JPMorgan had refused to release the

FCM’s customer’s segregated funds for more than two weeks in

September 2008. The order found that JPMorgan’s conduct

violated CEA Section 4d(b) and CFTC Rules 1.20(a) and (c).

Though no customer funds were lost, JPMorgan agreed to pay a

civil monetary penalty of $20 million to settle the CFTC’s charges.

Failure to SuperviseDuring the first quarter of 2012, the CFTC continued to bring and

settle cases for supervision violations. On March 13, 2012, the

CFTC announced the initiation and settlement of two separate

enforcement matters – one against Goldman Sachs Execution &

Clearing, L.P. (“GSEC”), and one against FCStone, LLC (“FCStone”)

and Commodity Operations Inc. (“Commodity Operations”). In

the GSEC matter (CFTC Docket No. 12-16), the CFTC’s order

found that GSEC had failed to diligently supervise certain

accounts it carried as an FCM for a particular broker-dealer for

more than two years, during which time the broker-dealer

opened commodity futures trading accounts without registering

as a commodity pool operator, and made misrepresentations to

its customers regarding its relationship with GSEC. The order

found that GSEC had received $1.5 million in fees and

commissions from transactions executed and cleared through the

broker-dealer’s accounts. GSEC agreed to pay a $5.5 million

penalty to settle the matter, in addition to disgorging the $1.5

million it earned in fees and commissions.

The FCStone/Commodity Operations matter (CFTC Docket No.

12-15) also involved supervision violations, but on a much

smaller scale. According to the CFTC’s order in that case, FCStone

and Commodity Operations permitted a floor broker to put on

positions in his account that greatly exceeded the funds on

deposit in the account and to trade the account while it had a

debit balance, contrary to the respondents’ compliance rules. The

broker, whose account had been introduced to FCStone by

Commodity Operations, eventually incurred a margin call of

almost $3 million. FCStone and Commodity Operations agreed to

pay a $260,000 penalty to settle the matter.

ManipulationOn March 14, 2012, the CFTC filed a complaint in the Southern

District of New York charging a former MF Global broker – Joseph

Welsh – with attempted manipulation in the NYMEX palladium

and platinum futures markets on at least 12 occasions from 2006

to 2008. Welsh allegedly entered large market-on-close orders

for his client, Christopher Pia, but waited until the end of the

settlement period to send in the orders in an effort to move

settlement prices. Pia and his former employer, Moore Capital

Management, LP, settled CFTC manipulation suits in 2010 and

2011 based on the same underlying trades for $1 million and $25

million, respectively.

As purported evidence of Welsh’s manipulative intent, the CFTC’s

complaint quotes instant messages and phone conversations

between Welsh and Pia, between Welsh and Pia’s clerks, and

between Welsh and NYMEX floor clerks. The conversations

continued on next page


May 2012

include phrases such as “jack things on the close,” “squeeze

make it ugly,” and “the higher the better.” Welsh also allegedly

told floor clerks to buy at prices higher than the prevailing bid-

ask spread, even if that would violate NYMEX rules.

Welsh filed a motion to dismiss the complaint on April 18, 2012.

The case is U.S. Commodity Futures Trading Comm’n v. Welsh,

Case No. 1:12-cv-01873 (S.D.N.Y.).

Wash SalesOn April 2, 2012, the CFTC filed a complaint in the Southern

District of New York charging the Royal Bank of Canada

(“RBC”) with conducting a massive wash sale scheme in

connection with stock futures contracts traded on the

electronic exchange OneChicago, LLC. According to the

complaint, RBC traded hundreds of millions of dollars’ worth

of narrow-based stock index futures and single stock

futures with two of its subsidiaries from June 2007 to May

2010. The CFTC alleges that these trades were not arms’-

length transactions, but were instead coordinated, fictitious

transactions designed to allow RBC to reap the benefits of

tax credits offered to Canadian companies (like RBC) for

holding U.S. companies’ stocks on particular dividend

dates. The complaint also alleges that RBC made false

statements to CME Group during the latter’s investigation

of RBC’s wash sale scheme. The CFTC’s lawsuit seeks a

permanent injunction preventing RBC from engaging in

similar conduct in the future, an order directing RBC to

make an accounting for all of its profits from the scheme,

and a civil monetary penalty.

The case is U.S. Commodity Futures Trading Comm’n v.

Royal Bank of Canada, Case No. 1:12-cv-2497 (S.D.N.Y.).

MF GLOBAL

The Collapse of MF Global: Lessons Learned and Policy Implications

On April 24, 2012, the Senate Committee on Banking,

Housing, and Urban Affairs conducted a hearing entitled “The

Collapse of MF Global: Lessons Learned and Policy

Implications.” The hearing’s focus was identifying means for

restoring market confidence, improving regulatory oversight

and enhancing protections for customer accounts. According

to Committee Chairman Tim Johnson, “[a]s investigators

seek to recover MF Global customer funds and hold accountable

those responsible for any wrongdoing, this committee will

focus our attention on preventing future abuses and the other

critical public policy issues raised by the collapse of MF Global.”

Update on Trustee’s InvestigationIn addition to contributing suggestions for improving market

confidence and enhancing protection of customer funds, SIPA

Trustee James W. Giddens reported that his office’s

investigation into the whereabouts of missing customer funds

was substantially complete with more than $105 billion in

funds tracked down. Approximately $700 million of the

“missing” customer segregated property is currently part of

the estate of MF Global UK Ltd. Giddens has filed a client

claim with the British administrators of MF Global UK, seeking

the return of that property. More information, including

updates, court filings and claims information, can be found at

MFGlobalTrustee.com.

No Bonuses for MF Global ExecsChapter 11 Trustee Louis J. Freeh disputed media and industry

rumors that Freeh was seeking bonuses for MF Global execs.

Freeh stated that he never created nor intended to create a

formal retention program for MF Global execs. He did, how-

ever, note that existing senior and non-senior executives at MF

Global entities provide valuable support in the investigation

and the closing of MF Global’s affairs.

Î Fast Fact: On April 2, 2012, the CFTC issued an order prohibiting the North American Derivatives Exchange (Nadex) from list-ing or making available for clearing or trading political event derivatives contracts based on the 2012 presidential and other federal elections. CFTC determined that the contracts involve gaming and are contrary to the public interest.


May 2012

eNeRGy

CFTC/FeRC Turf Battle Back in Federal Court

The ongoing dispute over which agency has jurisdiction to

prosecute a trader at the center of the Amaranth Advisors

hedge-fund collapse is now before the U.S. Court of Appeals

for the D.C. Circuit.

Former Amaranth trader Brian Hunter has appealed a final

FERC decision levying a $30 million fine partially on the

contention that FERC lacks jurisdiction to enforce compliance

with rules governing the acts at issue. The CFTC has intervened

in the appeal on Hunter’s behalf.

The underlying acts are Hunter’s alleged attempts in 2006 to

manipulate the natural gas futures market on the New York

Mercantile Exchange. Both agencies have asserted that Hunter

dumped large quantities of these contracts onto the market

during the final 30 minutes of trading, in an effort to suppress

the closing price and thereby benefit Amaranth’s much larger

opposing swaps positions.

Both FERC and the CFTC initiated enforcement actions against

Hunter in 2007, with the CFTC filing an action under the

Commodities Exchange Act in the U.S. District Court for the

Southern District of New York, and FERC filing an administrative

action the following day under the Energy Policy Act of 2005.

Hunter filed his own action for declaratory relief from FERC’s

administrative action, based on lack of jurisdiction, in the U.S.

District Court for the District of Columbia. That case was dismissed.

A FERC administrative law judge determined in 2010 that

Hunter had violated FERC’s anti-manipulation rules. FERC

affirmed this decision in April 2012. Hunter is now appealing

the April 2012 decision.

The CFTC argues in its intervenor’s brief that it has exclusive

jurisdiction over on-exchange futures trading, which includes

Hunter’s trading activity in natural gas futures on the NYMEX,

and that FERC’s jurisdiction is confined to the physical natural

gas markets. FERC has contended that the new anti-

manipulation provision of the Energy Policy Act confers upon it

jurisdiction over activities that otherwise would be outside its

jurisdiction so long as those activities affect transactions within

its jurisdiction; Hunter’s manipulation of the natural-gas

futures market affected the physical natural gas markets and

therefore falls within FERC’s purview.

FERC has not briefed its position in this appeal yet. A final

decision may come later this year. Absent a ruling that helps

delineate mutually exclusive jurisdictions of the respective

agencies, market participants may be subject to the perils of

overlapping regulatory jurisdictions, such as inconsistent

rulemaking and enforcement.

Hunter v. Federal Energy Regulatory Commission, United

States Court of Appeals for the District of Columbia Circuit,

Case No. 11-1477.

Federal Judge in New york Denies Motion to Dismiss CFTC’s Manipulation suit Against Parnon energy

On Apr. 26, 2012, the judge in the CFTC’s latest oil-manipulation

lawsuit, CFTC v. Parnon Energy Inc., denied the defendants’

motion to dismiss the complaint. The CFTC’s complaint alleges

that the defendants, a California-based energy firm (Parnon

Energy), two of its European affiliates (Arcadia Petroleum Ltd.

and Arcadia Energy (Suisse) SA), and two traders, attempted to

manipulate and succeeded in manipulating NYMEX crude oil

futures over a four-month period in 2008. It alleges that the

defendants earned in excess of $50 million by engaging in the

following manipulative scheme: (1) purchasing excessive

amounts of physical WTI crude oil to drive up futures prices, (2)

concurrently establishing a long position in calendar spread

contracts, (3) offsetting their long position in spread contracts

once prices for the prompt month futures contract had

sufficiently inflated, (4) establishing a large short position in

calendar spread contracts at the inflated prices, (5) selling off

the physical oil to deflate prices, and (6) offsetting their short

spread contracts position at the deflated prices.

In their motion to dismiss, the defendants argued that the

CFTC lacked jurisdiction over attempts to manipulate calendar

spreads and over the defendants’ purchases of physical oil,

and that the CFTC had failed to allege a claim for commodities

manipulation under the federal pleading standards. The court

disagreed on all fronts in a 29-page opinion, holding among

other things that the CFTC need not satisfy the heightened

pleading standards of Rule 9(b) of the Federal Rules of Civil

Procedure because its claims did not sound in fraud. On the

crucial issue of price artificiality, the defendants argued that

continued on next page


May 2012

futures prices could not have been artificially high on the days

in question because, according to the available price data,

prices were actually higher on the preceding days. The court

disagreed that this evidence refuted the CFTC’s claims of arti-

ficial prices. It held that while price comparisons are relevant

to the determination of whether prices were artificial, the

CFTC’s allegations – taken as true at this stage in the case –

suggested that the defendants’ conduct had interfered with

basic forces of supply and demand in the oil futures market.

The case is pending before Judge William H. Pauley, III in the

United States District Court for the Southern District of New

York. The case is U.S. Commodity Futures Trading Comm’n v.

Parnon Energy Inc., Case No. 1:11-cv-3543 (S.D.N.Y.).

• Banks

• Hedge funds

• Futures commission merchants

• Introducing brokers

• Associated persons

• Swap dealers

• Commodity pool operators

• Proprietary trading firms and traders

• CME/CBOT/NYMEX traders

• U.S. derivatives exchanges

• Trading systems providers

• Forex dealers

• Foreign brokers

• End-users

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 rulemakings and the requirements that apply to swap dealers, major swap participants, swap execution facilities 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

• 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 financial services industry, including patents, trademarks, copyrights and trade secrets

• Hedge fund and commodity pool formations and regulation, including master-feeder fund structures

• Transactions in cash commodities, including physical options

• Formation, merger, acquisition and disposition of financial services firms

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:


May 2012

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

Craig [email protected]

415.901.8798

Geoffrey H. [email protected]

202.778.6432

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

Andrew M. [email protected]

202.778.6415

Matthew [email protected]

312.258.5563

Michael L. [email protected]

312.258.5713

Debra M. [email protected]

202.778.6474

Victoria [email protected]

312.258.5841

Laura s. [email protected]

202.778.6470

Carl A. [email protected]

312.258.5707

Robert B. Wilcox [email protected]

312.258.5590

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404.437.7030

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415.901.8764

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, Boston, Chicago, Lake Forest, New York, San Francisco and Washington. Our attorneys are

strong advocates and trusted advisers — roles that contribute to many lasting client relationships.

© 2012 Schiff Hardin LLP

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Schiff Hardin Derivatives & Futures Update (May 2012)

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