How bad can a wash trade violation and Tag50 penalty really be? Permanent ban from the CME markets bad enough?
DCM has stressed again and again and again that wash trades are not just a little issue to sweep under the rug. And trying to be "smart" about how you do it doesn't work. And thinking that because you are not within the physical jurisdiction of the US means you won't get punished. On Friday, the CME issued four related disciplinary notices (CME-19-1100 and NYMEX-19-1100 BC, BC2, and BC3 - notices here, here, here, and here).
All four individuals were disciplined in the same docket though the rules cited were differing.
In one instance, the individual was cited for allowing orders that he knew or should reasonably known were wash trades to be entered on the exchange as well as allowing another individual to use the trader's Tag50 log in. This person also did not respond in writing to the charges and, therefore, waived a right to a hearing on the charges. The penalty - $40K fine and a two year suspension from CME markets from the date the $40K is paid.
In the second instance, the individual failed to appear before the CME Disciplinary Committee or any staff interview in connection with an investigation (the same docket number as the other three individuals). For the failure to respond, the individual was fined $10K and was suspended immediately for a period that would extend for two years from the date the fine was paid.
The third individual was cited for illegally prearranging trades (since the docket is the same as the other three, it may likely be assumed these trades resulted in the wash trades cited above) for the purposes of shifting equity between accounts. The individual was also cited for allowing another person to enter trades utilizing his Tag50 ID. The individual also failed to submit a written answer to charges. This individual was fined $85K and was permanently banned from all CME markets.
The final individual was cited for the same issues - pre-arranged trades to transfer equity and TAG50 violations - as the prior individual as well as failure to supervise her employees. In this instance the penalty was a fine of $85K, a disgorgement of profits of $125,940 and a permanent ban from all CME markets.
It should be noted that these bans now also include any swap execution facility and derivatives clearing organization owned or operated by the CME.
Wash trades have permanently impacted all of these individuals and failure to resppond to the CME has exacerbated there penalties. Wash trades are one of the most straight forward surveillance tools to implement. You should consider having one in place if you have any activity in more that one account with the same beneficial owners.
My wife always talks of a game she and her family played as a child in Ontario - flashlight tag. It was a game where everyone went down to the basement and the person who was it was given a flashlight. All the lights were turned out in a room (or rooms if they were really going for it) with no windows and then the person who was "it" was allowed to turn on the flashlight for a count of ten and then they had to turn it out for sixty seconds. If they could catch someone in the beam and positively identify them - seeing them in the corner of the eye or from dispersed light didn't count - then that person was tagged. Oh, and once the light went out if someone else touched them, they were unfrozen. And, as you imagine, the person who was it could here lots of scurrying, giggling, and the occasional curse while the light was out. Everyone was guessing when the light would come back on.
As you might imagine, people running around in the dark tended to run into things they didn't see - rarely were there any major injuries but bumps and bruises galore. And the infrequent opened forehead or even a broken leg. This was not only the people hiding but the person who was it was also moving during the sixty second and could run into something. Just because the company is getting in position to conduct oversight doesn't mean they can't run into a problem (or regulator) they didn't see coming.
I am taken by how that is so similar to an underfunded and under-resourced compliance department for a firm trading in financial products for commodities or even physical commodities in some jurisdictions. The compliance officer has a small little flashlight and a lot of places to sweep with that little beam.
But this actually points out a number of ways to look at compliance that can reduce the danger of running into bad things. Central to this, do a risk analysis - how many rooms are there? Can I close and lock some doors so no one can go into those rooms (maybe a list of authorized products and exchanges reduces the area to surveil)? Do I know where the corners are where I can't shine the light easily?
And then comes the next thought process - how do I get more flashlights and more constant light? If I have a flashlight in every corner and they all go on at the same time, there are no shadows. What are the axes of risk and how do I align oversight to them? Are there corners that I just don't have to worry about that much and I can save time and expense rigging lights?
Finally, what do I need? Do I really need flashlights that shine 24/7 or can I have them on once a day to look at all the track for the prior day and is that enough? Do I have to sit there and shine them and watch them 24/7 to keep someone from running into something (and can I actually do it in a way that isn't just making everyone move at a crawl - i.e. without having compliance be an absolute drag on success)?
Just a little light fun and thought exercise to maybe joggle your thinking about how trade compliance can be viewed and enabled.
DCM provides practical risk and compliance advisory and review services for clients in the tradeable commodity space (energy, agriculture, and metals) who transact inn these markets -whether as producer, marketer, trader, or procurement and end user. Happy to chat if you are looking for a different perspective on these problems.
There were two disciplinary notices issued in the last two days by CME that help point out the issue. The first is a position limits violation, the notice is here. The violations occurred on May 26 and 27, 2020. This type of exceedance of the position limit would have been evident in exchange surveillance scans before the open of business the next day. That means that the initial activity of the exchange oversight group would have occurred before the end of May, 2020. This means that the time from the beginning of the inquiry to resolution was eight months. Let's be conservative and say that real activity to defend this activity (meaning in house general counsel was now engaged, as well as head of desk, in determining what would happen) didn't start until the end of June. Outside counsel was likely to be brought in by the end of July, if not earlier.
This means that senior executives have been burdened with this issue for over half a year. Outside counsel was likely to be engaged for the same time. If this didn't run over a million dollars in hard and soft costs I would be surprised (and I expect that number to be way too low as it is). Add into that the reduced efficiency caused on the trading desk and the firm for that time and the cost escalates further.
yes, the fine was only $25,000 with a $72,318 disgorgement but look at the overall cost. Keeping these things from happening or being able to self-report and shortcut this proceeding would have saved an order of magnitude reduction in costs.
The second case is here. This is another case where desk staff used a fake EFRP to move positions between two accounts rather than using a back office transfer at the exchange (which does the same thing and is legal). The trade in question was executed on March 6, 2020 and the fine was $25,000. The same analysis can be looked at as above - this case took an additional two months more. This would just increase the costs.
The real analysis for the value of compliance programs and systems that work is that hidden cost of the internal and external effort to analyse and defend the disciplinary action. The exchanges expect a significant effort to address the activity and root causes for a violation or they can become more assertive in their disciplinary action - up to an including significant suspension from access to their market.
You should examine your activity on exchange markets in the US and think about how quickly and completely you could identify an issue such as these and rectify them. If you couldn't, you should consider enhancing your program to avoid the hidden costs of an exchange disciplinary action.
DCM provides compliance program reviews and controls testing for the commodity markets. Please drop us a note if you would like to have a chat.
. ICE issued a notice today (here) that it will support a manual order indicator in order messages at Tag 1028. The Tag will be effectuated as of February 19. This is not a field that is mandatory for inclusion in the order but the notice does state:
"The initial usage of this tag is not mandatory but will be required by the Exchange at a later date. "
There is also an FAQ available from ICE here. This will be an important peice of information to discuss with your IT departments to make sure that this is populated properly when you adopt it.
A couple initial points from the FAQ that will help companies:
"Individuals submitting orders via WebICE and ICE Mobile will not have the ability to provide the manual order indicator (Tag 1028). Those orders will automatically be populated as “Y” in Tag 1028. "
"All orders entered by FIX Clients without Tag 1028 populated after the effective compliance date will not be rejected from the trading system but may be subject to regulatory review and enforcement in accordance with this FAQ and Exchange rules"
And the definition of a manual trade could be considered a little narrow:
"Generally, a manual order is one that is submitted to ICE’s ETS by an individual “button pusher” (e.g., mouse, keyboard, touchscreen), whose terms are not modified by an algorithm after submission and are submitted to the ETS without delay. "
The FAQ clarifies that auto-spreader or hitting send on a system that then "employs functionality that controls the submission of the order(s) to ICE’s ETS+ means the trade is an automated, not manual trade.
You should review with you compliance office or consultants as to what this means for messages in your trading. If you use CME Globex, you should already have gone through this excercise to make sure your manual/automated trade tag is correct on your orders.
ICE Futures Europe issued a disciplinary notice last week to a firm for not following their procedures for entering two crossing orders for execution. Just like in the US, a broker must enter one side and then wait a period of time (for ICE Futures Europe, that is five seconds) before entering the other side. In this case, the broker did not wait the required time and trades executed without other market participants having the stated time to execute the orders away from the cross.
That is not an uncommon scenario for a summary action by the disciplinary committee for a US exchange. It is the settlement in this case that indicates the differences.
First, the fine was for £60,000 - that is much greater than allowed for a summary disciplinary action by US exchanges in most cases. Second, the fine was reduced to £40,000 - which represents a "discretionary discount" for early settlement. That type of early payment discount is never noticed in the US even if it happens. Finally, ICE Futures Europe noted that one employee had already received additional training.
There was also no "failure to supervise" action singled out in the notice - this "failure to supervise" has been a common addition to a disciplinary action, especially where there are indications that an employee had not been sufficiently trained regarding their interaction with the market.
This is both a good example of the differences that a US firm has in dealing with non-US futures, such as the base Brent contract in oil, as well as an illustration of how the US disciplinary actions differe for firms trading US futures, such as WTI.
There are a lot of questions coming as to what will the new administration do regarding commodity compliance in the next two years (figuring things could change with the results of the midterms in 2022). What anyone can tell you for sure is they don't know. But I d think there are some tea leaves:
1. Gary Gensler as Head of SEC - to say Gary's tenure as head of the CFTC was contentious, especially regarding the implementation of Dodd Frank, would be appropriate. As head of the SEC with Democratic majorities in both houses and at least discussion of getting rid of the filibuster rules in the Senate, the potential for more turmoil on the part of parties under SEC regulation could be significant. And if the SEC gets more aggresive, the CFTC may have pressure to follow.
2. The CFTC had previously significantly increase enforcement staffing. If there is a more pro-regulation bent on Capitol Hill, this could get even more impactful.
3. The current Senate Agriculture Committee members from the Democratic side could be considered fairly moderate. One Republican lost her rce and will not be on. There are likely to be two more Democrats on the committe and who they are could have a real impact on the CFTC - both from philosophy but also from a budgetary point of view. Imagine if the Democrats were to give the CFTC the budget they asked for in 2020? The rquest was $315 million, the CFTC got $284 million.
4. In light of the Senate Agriculture Committee and the budget, the CFTC has asked for the ability to collect "user fees" - they have never been allowed to. In comparison, the SEC charged $129.80 million in user fees in 2020. The 2021 budget from the current administration has requested over $77 million in user fees. That would be a distinct change in the CFTC financing base.
I have focused not on what the Biden Executive branch would do what rather what the Senate Agricultural Committee - the real power in the CFTC world - might do.
ICE Europe revised their Section E (Disciplinary) of their Rules Nov 30 - you should understand the changes
ICE Europe issued a number of changes to their rule book (Sections A through G and Sections Y, Z, and Trading Procedures) last week. We will address some of the other sections and their changes in the future. We did want to note a couple salient points regarding the Section E changes:
This will cover US entities trading such products as Brent futures so it would be valuable to review this and other changes. We will look at the Trading Regulations in our next post.
One CME disciplinary notice gives all the basics for block trades - and makes a case for brokered blocks only
Friday, COMEX issued a disciplinary notice (here) that makes a good case for why companies should consider only allowing traders to make brokered block trades. The staff at the disciplined firm:
1. "reported execution time of the block trade was the time the spread leg prices were determined rather than the time of the trade consummation";
2. "failed to report block trades to the Exchange within the required time period following execution"; and
3. "improperly combined separately negotiated and executed trades on one ticket "
The block trade rules specifically state that a block trade is consummated when the spread value is agreed to, regardless of whether the individual legs have been priced and that the reporting time for the trade starts to run at that time. In addition, each individually negotiated block trade has to be reported separately - part of the rationale is to assure each block meets the rules for a valid block trade, including traded volume.
No surprise, the COMEX also found a failure to advise and train staff. The fine was $60,000.
This can be avoided by only executing block trades through a broker. Like is the case in many other circumstances, the broker has responsibility for assuring compliance with exchange rules and lessens the company burden for compliance (and risk of compliance failure). Unless there is a compelling reason for direct block trade execution, consider requiring all blocks to go through a broker.
The CME, earlier this month, issued a number of disciplinary orders about the same issues we have covered multiple times in this blog - wash trades, spoofing, and failure to supervise. We will look at these cases but a note about how DCM choses what to cover on this blog.
There have been a number of very large cases - nine or ten digit fines (without the decimal point) - in the last couple months. They have not, for the most part, been covered here. The reason for this is the majority of our clients (yes, we have worked with and continue to work with some of the largest trading entities in the world) are shops that are entering markets or entering US markets in a smaller manner. Those multi-year, global expanse cases tend to be met with "that isn't us and we never intend to be that" response. The "it can't happen here" is a very valid response for these strategies.
But the $30K or $100K fines for small companies - these resonate. And the purpose of this blog is to give the smaller firms - even those that seem themselves solely as hedgers and not "traders" - examples of behavior or practices that are on their scale. If that scale translates into more effective supervision and appropriately scaled compliance and risk operations, that has achieved the purpose of this blog. So, climbing down off the soapbox and back into compliance review, the notices of interest are:
1. A firm was fined $25K for "failure to supervise" in reagrds to staff entering trades "executed opposing buy and sell orders in December 2019 Silver Options for which there was common beneficial ownership on both sides of the transactions." The intent? Executing " buy and sell orders with the knowledge and intent that the orders would trade opposite one another, for the purpose of closing positions." The finding was the firm "failed to properly advise and train its employees as to relevant Exchange rules and Market Regulation Advisory Notices (“MRANs”) regarding wash trading." Traders may be tempted to use wash trades to shift positions between books - especially using an affiliate book to stash the trades - to manage risk limits. There is no better way to point out the limits of your risk analysis (and put the CRO in jeopardy) than to get a fine for shifting positions. This scenario has happened enough times to be on every compliance officers radar - and yet still we see this issue. There can be fairly simple ways to detect this - it just takes allocating resources and effort to detect this. The notice is here.
2. A prop trading company was fined $200K (split 50/50 by NYMEX and COMEX) for failure to supervise the actions of its traders. The traders hit the trifecta - they shared TAG50 IDs (trader log in IDs) which is a significant issue for exchanges, they spoofed markets over a one year period, and they failed to answer the charges of the disciplinary committee. That last is a common item we see from non-US based clients - we are in country X, they don't have jurisdiction over us. As this blog has harped on multiple times - they have jurisdiction the second you sign your brokerage agreement. You cannot trade US futures markets on US exchanges without accepting US jurisdiction in your brokerage agreement. Accept that the exchange and CFTC jurisdiction is global (and when we have space stations with people trading there it will be interplanetary). The fine ,as noted was $200K and the firm was barred from trading any CME market for five years. The COMEX notice is here.
Again, these aren't the big splashy cases but the do represent what the average participant in the market can be facing in their activities if they don't manage their compliance risk.
A number of disruptive trading fines from CME last week and a couple wash trade fines today (one of note). The disruptive trading fines are illustrative because they all point to two things that all traders (and firms) should keep in mind:
1. Any order placed on the market has to be reasonably executed within the standing liquidity in the market. If the trade is really big (doesn't even have to be flash crash big, that can be disruptive trading); and
2. There is a reason the exchanges have made block trades available - they are a mechanism to allow large trades to be executed without disrupting the market.
In the first case, Interactive Brokers was fined $275K across CBOT, NYMEX, and COMEX with $100K going to CME (the CME notice is here). The exchange response was based on:
"IB implemented customer order routing functionality that bypassed CME Group market integrity controls. Specifically, in several cases, this functionality enabled its customer orders to avoid protection points applied to all market orders by CME Group’s Globex platform in reckless disregard for the adverse impact on the market. These protection points are designed to prevent extreme price movements and other market disruptions"
"IB caused various Equity and Agricultural markets, including the E-mini Nasdaq-100, E-mini S&P 500, Nikkei/Yen, Live Cattle and Cash-settled Butter futures markets, to experience price, liquidity and trade volume aberrations and Velocity Logic events."
You can't just find a way to get trades executed any way you want - that is not how the exchanges work.
The second case is a smaller incidents that still resulted in a $40K fine - notice here. The CME did point out one specific case:
"For example, on April 18, 2016, (the company) entered a 100-lot sell market order into a Live Cattle market that displayed 33 contracts in aggregate at the top five book levels on the opposite side of the market. R&B’s order was filled across 19 unique prices. Within one second, R&B continued to enter multiple market orders that caused additional significant and disruptive price breaks in the market in a short period of time."
Here is a case where a block trade size order was 3 times the top five resting orders on the other side of the book. The CME found that to be "disruptive"
The final disruptive trading case was an $85K fine - the notice is here. It has the combination of disruptive trading with that all too present "failure to supervise" kicker. In this case, it was failure to supervise an automated trading system.
"Specifically, during this time period, an (company) automated trading system (“ATS”) engaged in a pattern of activity wherein it entered multiple opposing orders at various price levels near the start of the pre-open, provided significant liquidity to the order book in these markets, and then subsequently cancelled all or a majority of the orders near the end of the pre-open just prior to the no-cancel period, causing impacts to the Indicative Opening Price (“IOP”) and/or fluctuations in the bid-offer spread."
The company was notified by Market Regulation of the issue, made changes and redeployed the system with the same continuing flaw. The CMA followed up with:
"The Panel also found that (the company) failed to diligently supervise its ATS in the conduct of its business relating to the Exchange."
The last settlement to note is a pair of wash trade notices. The point I wish to note is the fines were $25K for the trader for the wash trade and $85 for the company for the trade and for failure to supervise - the company notice is here. Two takeaways here:
1. This was a single 9,762 options wash trade between two affiliates accounts - trades of this size might show up on someone's alerts; and
2. The trade was done to "alleviate margin pressure" which should have been likely to flag a risk alert.
Both of these point to potential breakdowns in oversight on the compliance and risk side. This is just one more opportunity to point out the interconnection between risk and compliance as complementary, not competing, functions.