Friday CME disciplinary notices - 4 notices, $2.465 million in fines - some concerning points in several
.CME issued multiple disciplinary notices Friday - one for $2MM, two in the 100's of thousands, and one for $10,000. The last was for orders placed in the pre-market for spread trades that the CME felt the trader should have known would cross trade based on market size and pricing.
The $2MM dollar fine was for an agricultural firm that reads in a similar fashion to the Kraft case settled in 2019. In this case, the firm of Andersons Inc. registered certificates (i.e., rights to ship physical wheat under a futures contract) in excess of the limited number (600) allowed without "bona fide commercial purpose" and be granted an exemption under from the Market Regulation Department. The notice also points out that The Andersons held over 60% of the open short position in the applicable contract. Finally, the Andersons also sold the product under the contract to local wheat mills for the moth prior to their contracts to suppress demand.
The CME noted that The Andersons, by means of these actions, were able to buy back 1,330 of the 2,000 registered certificates at lower prices than they were originally registered.
Again, the basic format is similar to that described in Kraft - take a position in the futures market and then craft a strategy for disrupting the physical market for delivery of those contracts in a manner that allows the firm to capitalize on the market impacts of caused by their position in the physical market on the futures contract physical delivery mechanisms. So, even though the alleged scheme is not manipulating the trading of the futures contract, it is disrupting the capture of value in the resulting physical delivery mechanism.
For those reasons, the disciplinary comimittee found the actions to violate the following provisions of the "General Offences" Rule (Rule 432) - the notice is here:
"B. 2. to engage in conduct or proceedings inconsistent with just and equitable principles of trade;
Q. to commit an act which is detrimental to the interest or welfare of the Exchange or to engage in any conduct which tends to impair the dignity or good name of the Exchange;
T. to engage in dishonorable or uncommercial conduct."
The second large fine was for actions of Exante Limited - a Malta based fintech firm whose website indicates they are a "Next Generation Investment Company" providing a multi-asset trading platform. Unfortunately, the firm did not do some basic things properly according to the disciplinary committee. The list of problems was extensive:
1. Improper customer set up, resulting in improper account netting - impacting open interest reports from the exchange; and
2. Failure to assign unique Tag50s (a point DCM harps on frequently) to both employees and customers; and\
3. Performing wash trades to transfer positions between clearing firms - another common violation; and
4. Failure to "fully answer regulatory inquiries"
All of this added up to violations warranting a $350K fine for wash trade, Tag50, and failure to supervise violations. The notice is here
The final large fine was imposed on Algolab.com Inc. They operate a proprietary trading shop as well as licensing their software to customers for purposes of entering orders on their behalf. The software allowed orders to exit positions to be entered without regard to market liquidity. The orders "on two occasions" triggered unrelated stop orders, causing additional disruption. These disruptions had the impact of triggering a trading halt on the entire Swiss Franc futures and options trading product group.
More disturbingly, the committee also found, due to "technical reasons", the Algolab product would prioritize Algolab's proprietary trade orders before customer orders - both for entering and existing positions. Algolab also utilized the customer's Tag50 IDs, rather than its own, to enter trades. Algolab was fined $105K - the notice is here
Low energy prices, work from home, and mounting industry bankruptcies - compliance is being stressed
When I have been a Chief Risk Officer in the past, when the book got stressed and I knew traders were under pressure, I started get even more focused. When people are under pressure and fear about losing their job, they become even more likely to "self justify" riskier or more problematic behavior. As many of my clients can attest, I have rephrased the old "seven stages of grief" to the "seven stages of trader misconduct"
But that implies that the trader is going to feel pressured to do "something". And that something can, in some cases, be doing something the regulator says they shouldn't.
Yes, some compliance problems come because someone figured out a way around the edges to make money with less risk - because they cheated. But in many cases, the behavior comes because the trader feels they have nothing to lose - if they don't solve their problem they are going to be fired. And, at that time, the trader's personal risk tolerance to use company resources to bail themselves out becomes close to infinite.
Well, the trader's risk tolerance for a company regulatory risk has the same change. Frequently, the trader is not even thinking about the potential compliance risk - they are already focusing so hard on getting around risk controls. That means it is up to the compliance officer to take up that slack.
The best compliance programs have regular participation by compliance in the risk updates. When books or desks or even business divisions are having a rough stretch, compliance needs to be extra vigilant. When the entire company is at risk, the compliance function has the even tougher task of recognizing that management, in some cases, may encourage market behavior that carries even greater compliance risks.
We are headed for the rough water - it is time to check to make sure you have everything in top shape.
the concept of .A pair of interesting disciplinary actions were posted in the same inquiry yesterday by the CME. A firm was over the spot month limits in soybeans "at more than one clearing member firm. " The position was held over night for multiple days. The overage was in "two different reportable accounts controlled by the customer".
The broker, Goldman Sachs, was fined for "failed to liquidate its pro-rata share of the customer’s position in excess of limits or otherwise ensure that its customer was in compliance with the limits within a reasonable period of time." Goldman had been notified of the overage by the Market Regulation Department and failed to respond. Goldman was fined $15K and the notice is here
Separately but in a linked notice, the customer was found to be 15 contracts (0.19% of the total position) over the position limit in the associated accounts. The notice does not indicate when the customer received notice of the overage. The CME imposed at $25K fine and a $9,720 disgorgement of profits. The notice is here.
During compliance assessments by DCM, we always look to discuss the concept of position aggregation under US exchange rules. This helps to establish the needs for position limits surveillance. There is also a linked concept of allowed disaggregation - an option for establishing with the exchange a right to not have separated accounts linked for position limits. This requires analysis and a filing with the exchange but, as shown here, it can reduce potential compliance exposure as well as reducing position surveillance complexity. It is good practice to examine what accounts are owned by your company, affiliates, and subsidiaries and to consider aggregation requirements and disaggregation options.
One of the points that the consulting and legal communities have settled into agreement on is the likelihood that regulators are likely to do a quick lap around companies that have been trading commodities through the COVID pandemic to make sure nothing glaring is hiding. And one point that is easy for the regulators to look at is your training program. Here are some points to consider:
1. Many companies utilize industry conferences or training firms to provide training - much of it off site. With COVID, has the training been deferred? Any number of firms are doing Zoom or webinar training, that is a good replacement. And if people are doing remote training, how are you keeping company records of training attendance for the regulators - if there isn't a record, it never happened.
2. With the swings in liquidity, have you been trading different products or, more importantly, different exchanges? This is especially important for firms outside the US trading US commodity exchanges. DCM has taught both EU and US exchange regulation classes - it cannot be stressed too much that these are very different worlds. Approaching US regulators and exchanges as if they were EU or UK regulators can be a rude awakening when you realize the rules, enforcement tools, and regulatory philosophies are fundamentally different. In the US, a firm has strict liability for the actions of its employees and agents.
3. Which brings us to our final point about training - it is cheap protection for your company. The DCM blog over the last several years has repeatedly pointed out the CFTC and exchanges penchant for assessing "failure to adequately supervise" penalties. One recurring points in the disciplinary notice is the failure of the company's training to address the issue the employee created.
It would be appropriate to develop a training plan (as opposed to the frequent "once a year" training) that works through the period from 100% remote work through the transition to the "new normal". Best practice would be to engage and include senior management - possibly the board - on the plan and the training and role it out in a measured plan to keep the topics fresh and top of mind.
There are any number of webinars out there on preparing for the post-COVID regulatory inquiry world. DCM wanted to add a little emphasis to the message being sent. One of the simplest and best places we have found to look is the May 28, 2020 guidance issued by FINRA. For those in the commodity space, FINRA is the Financial Industry Regulatory Authority in the US - it is the self regulatory authority ("SRO") for the New York Stock Exchange (formerly the NASD). The piece was only four pages and while focused on some of the regulatory requirements for registered entities, it still has a number of interesting points. Also, the SROs in the US are an avenue for insight into what the regulators are thinking and, frequently, meeting the SRO guidance is a big step up towards meeting regulator expectations.
There were a number of things in particular that seemed good to document if you have undertaken them or to have staff document if they were supposed to take actions. These are:
In sum, this guidance indicates that FINRA doesn't think "supervision as normal" is appropriate in the COVID relote working environment. The simple question is whether a firm has assumed its pre-COVID supervision environment is adequate in the COVID environment. FINRA Is letting you know they don't think that is correct.
You can find the FINRA guidance here
DCM is a commodity and supply chain consulting firm with experience in all aspects of the tradeable commodity environment - from business strategy, trade operations, supply chain analysis for commodities, risk and compliance operations and market entry and exit. Please feel free to reach out to us with questions or assistance, we are happy to talk with industry participants.