Note to Clients – Weekend Reading
October 6, 2023
Weekend Reading – A selection of regulatory and other relevant developments across the trading and markets industry
SEC v. Ripple Labs, et. al Update: Judge Torres (SDNY) Decision denying SEC Motion for Interlocutory Appeal. Judge Analisa Torres had previously ruled, on July 13th, that (1) Ripple’s programmatic offers and sales of XRP to the general public over crypto asset trading platforms and (2) its other distributions of XRP as a form of payment for services were not securities as a matter of law. See SEC v. Ripple Labs, Inc., No. 20 Civ. 10832, 2023 WL 4507900 (S.D.N.Y. July 13, 2023). Since this was not a final ruling, the SEC sought certification to file an interlocutory appeal of these two rulings and to place its litigation against Ripple on hold pending the appeal. The July 13th ruling was largely based upon an application of the test identified in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) and a review of the totality of the circumstances regarding these two Ripple XRP related activities. On that basis, Judge Torres denied the SEC’s motion for leave to file an interlocutory appeal since it did not involve the need to resolve a controlling question of law about which there is substantial ground for a difference of opinion, and the SEC could not establish that the appeal would materially advance the ultimate termination of its litigation. A copy of Judge Torres’ order can be found here (LINK). Judge Torres indicated that a Trial in this matter is set to begin on April 23, 2024.
CFTC Proposal on Rule 4.7 That Would Impose Increased Disclosure Requirements on Previously Exempt CPOs and CTAs. On October 2, 2023, the CFTC proposed (LINK) several revisions to CFTC Rule 4.7 (17 CFR 4.7), a provision that provides exemptions from certain compliance requirements for commodity pool operators (CPOs) with respect to commodity pool offerings to qualified eligible persons (QEPs) and for commodity trading advisors (CTAs) with respect to trading programs advising QEPs. In a dissenting statement, CFTC Commissioner Mersinger objected to the aspects of the proposal that would “narrow the scope of Rule 4.7 by eliminating a significant portion of the current disclosure exemptions available to 4.7 CPOs and CTAs, thereby imposing universal disclosure requirements to QEPs.” Commissioner Mersinger observed that another aspect of the proposal (which she supported – the proposal to raise the minimum criteria for qualifying as a QEP, and effectively narrow the scope of the exemption) already solves the policy concerns with the appropriateness of the existing disclosure requirement exemptions. More generally, the dissent asserted that the Commission was acting too quickly with the disclosure aspects of the proposal, arguing that they were based on assumptions and speculations regarding the sophistication level of QEPs, rather than on objective and data based research and findings. From a procedural perspective, the dissent argued that the proposal did not adequately indicate the CFTC’s plans for implementing the new rules, such as how they would navigate the impact of the the increase in QEP eligibility criteria on existing exemptions (many of which may no longer qualify). Mersinger concluded her dissent by offering several additional questions for public comment (beyond those that were in the release). Public comments on the proposal will be due 60 days after it is published in the Federal Register.
CFTC Fines a Bank Affiliated Broker Dealer $3 Million for Supervision Failures (Related to Malfunctioned and/or Miscalibrated Disruptive Trading Prevention and Post-Trade Surveillance Tools for Customer Trades) and Material Omissions in a Letter to the CFTC’s Division of Enforcement. The core facts of the underlying trading activity were as follows – (1) in connection with customer orders and trades in an ICE Futures Europe energy futures contract calendar spread, the settling entity’s employed a preventative control to suspend potentially disruptive trading when volatility thresholds were exceeded, but the mechanism malfunctioned and did not suspend trading on a day in December 2017 when it otherwise should have; and (2) the settling entity’s post-trade surveillance program, which was designed to detect potential intentional or reckless efforts to influence the daily settlement price in futures contracts, did not use the correct settlement period for the relevant contract and thus was not properly surveilling for potential disruptive trading activity. The CFTC order also found that the settling entity’s initial letter to CFTC Division of Enforcement regarding this matter omitted material information regarding the preventative control and its malfunction, noting that the settling entity’s letter “did not make any mention of [the preventative control] that should have—but did not—suspend the operation of [the entity’s] trading algorithm on [the relevant day].” (LINK). As noted above, the CFTC imposed a $3 million fine. The CFTC indicated that it worked with the UK financial Conduct Authority on this matter (presumably because the trades involved futures contracts on ICE Futures Europe, a CFTC registered foreign board of trade, not a CFTC registered designated contract market). Interestingly, the settlement order observes, in a footnote, that because the trading occurred on a foreign board of trade, and not a DCM, the trading was not subject to the disruptive trading provisions set forth in Section 4c(a)(5) of the Commodity Exchange Act (7 U.S.C. § 6c(a)(5)).
CFTC Fines Three Bank or Bank Affiliated Swap Dealers Over $50 Million, Collectively, for Swap Reporting and Related Failures; Observes that the $50 Million in Fines Represented Reduced Fine Levels Based on Cooperation and Remediation Efforts of the Settling Entities. Citing millions of un-reported, mis-reported, or improperly reported swaps trades, over several years, the CFTC Division of Enforcement imposed fines on the three settling entities that, in total, exceeded $50 Million. In connection with all three settling entities, the CFTC observed that their cooperation and remediation were recognized in the form of a reduced civil monetary penalty.
Highlights of CFTC Chairman Behnam’s Keynote Remarks at FIA Expo Conference. The text of the October 2, 2023 speech, including 37 detailed footnotes, is available here (LINK). Key quotes. Below, we excerpt and/or summarize several of the key themes.
“My goal for the agency through our enforcement, regulatory, and data efforts is to address the expanding dislocation between regulation and innovation.”
Climate Based Enforcement Focus. Discussing the impacts of weather and particularly El Nino based climate patterns on commodity prices: “For CFTC regulated markets, surveillance staff are monitoring the supply and demand driving price discovery and watching and analyzing trading activities for manipulative, inappropriate, and disruptive conduct that could distort markets and impact consumers.”
General Review of Enforcement Efforts. Discussing enforcement efforts around the fintech economy and innovation: “I have long maintained that our enforcement efforts should focus on the need for a culture of compliance and achieving deterrence. [. . . reviewing the CFTC’s proactive enforcement efforts on decentralized finance entities – ] To suggest that we must wait until victims suffer and cry out for help to be proactive and ensure that critical market oversight, robust cybersecurity and system safeguards, and customer protections are in place undermines our mission and purpose.” He also emphasized the Commission’s continued enforcement efforts around spoofing, retail fraud and FX scams, unregistered entities, and policies and procedures requirements for registered entities.
Rest of 2023 Agenda. “By the end of the year, I anticipate that staff will present the Commission with roughly a dozen additional matters for consideration and public comment and a handful of final rules and orders.”
- “proposed amendments to the swap dealer business conduct standards and documentation requirements to codify into rules long-standing staff no-action positions related to prime broker arrangements and swaps executed with the intention that such swaps be cleared.”
- “proposed rulemaking addressing operational resilience programs for FCMs, swap dealers (SDs), and major swap participants (MSPs) designed to adapt to the risk profiles of those registrants and the ever-evolving nature of the cyber risk landscape while being mindful of how it intersects with other existing cybersecurity requirements.”
- “the Market Participants Division (MPD) will develop and issue guidance regarding the use of third-party service providers to satisfy compliance obligation.”
- “propose codification of routinely provided exemptive letters for account statement reporting deadlines for certain commodity pool operators.”
- “proposal to thoughtfully expand the types of permitted investments of customer funds by DCOs and FCMs under regulation 1.25.”
- “amendments to a rule applicable to DCOs to apply many of the protections currently applicable only to FCM customer funds, such as segregation of funds and acknowledgement letters from depositories, to clearing member funds as well.”
- A proposal that “aims to level the playing field for SIDCOs, Subpart C DCOs, and other DCOs by making certain requirements in Part 39 of the Commission rules applicable to all registered DCOs.”
- “proposed codification of staff no-action letters addressing swap dealer business conduct standards and documentation requirements.”
- Division of Market Oversight proposals on “conflicts of interest and governance for SEFs and DCMs, . . . UPI supplemental reporting fields, and a proposed rulemaking regarding event contracts.”
CFTC Request for Comment on the Impact of Affiliations on Certain CFTC-Regulated Entities. Chair Behnam spoke at length about innovations in markets, stemming from DeFi, AI, and standard WiFi, and the need for the CFTC to be proactive in regulation, rather than reactive. He indicated that the agency s now reviewing the comments on their RFC that raised questions around vertical integration and disintermediation trends in derivatives market structure, and similar issues. “Our duty should firmly be to ascertain the validly innovative and novel market structures before they are permitted to operate as a means for financial risk mitigation.”
About us:
Miller Strategic Partners LLP is a law firm headquartered in New York City. We advise clients on trading and markets regulatory and commercial matters, investigations, and crisis management scenarios.
Key Contacts:
Ryne Miller, Partner (New York)
William Schroeder, Partner (New York)