UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
|In the Matter of||)||CFTC Docket No. 99-12|
|REFCO, INC.,||)||ORDER INSTITUTING PROCEEDINGS|
|Respondent.||)||PURSUANT TO SECTIONS 6(c) AND|
|)||6(d) OF THE COMMODITY EXCHANGE|
|)||ACT, MAKING FINDINGS AND|
|)||IMPOSING REMEDIAL SANCTIONS.|
The Commodity Futures Trading Commission ("Commission") has reason to believe that Refco, Inc. ("Refco") has violated Section 4g of the Commodity Exchange Act, as amended ("Act"), and Commission Regulations 1.35(a-1)(2) and 166.3 promulgated thereunder. Therefore, the Commission deems it appropriate and in the public interest that public administrative proceedings be, and they hereby are, instituted to determine whether Refco engaged in the violations as set forth herein and to determine whether any order should be issued imposing remedial sanctions.
In anticipation of the institution of these administrative proceedings, Refco has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Without admitting or denying the findings herein, and without any adjudication on the merits, Refco acknowledges service of this Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Act, Making Findings and Imposing Remedial Sanctions ("Order"). Refco consents to the use of the findings contained in this Order in this proceeding and in any other proceeding brought by the Commission or to which the Commission is a party.1
The Commission finds the following:
This matter arises out of trade allocation by a broker/dealer and registered introducing broker (who also acted as an unregistered commodity trading advisor) (the "IB"). The IB had discretionary trading authority over approximately seventy Refco, Inc. ("Refco") customer accounts. From at least January 1995 through December 1995, the IB typically placed orders for thousands of treasury bond futures and options contracts per day through a salesman and clerks working at the Refco Treasury bond desk on the floor of the Chicago Board of Trade ("CBOT"). The IB placed a substantial number of these orders without providing account identification. After the orders were executed, the IB assigned those trades to customer accounts, directing positions as he chose. The IB also moved trades between accounts after trades had been assigned and, sometimes, cleared.
Refco, a registered futures commission merchant ("FCM"), failed to comply with Commission Regulations and CBOT rules regarding order taking and recordkeeping in handling customer orders, in violation of Section 4g of the Act and Commission Regulation 1.35(a-1)(2). Refco also failed to administer a proper supervisory system to oversee the process of order taking and the receipt and changing of customer identification on orders. Refco also had a number of indications of the improper handling of trades which it failed to investigate properly. Refco therefore also violated Commission Regulation 166.3.
Refco, Inc. is an Illinois corporation whose principal place of business is located at 111 West Jackson Boulevard, Chicago, Illinois 60604. Refco is now, and was at all times relevant, registered with the Commission as a FCM, pursuant to Sections 4d and 4f of the Act, 7 U.S.C. §§ 6d and 6f, and at all relevant times was, and is, a clearing member of most futures exchanges, including the CBOT.
1. Handling of Order Identification
From at least January 1995 through December 1995, the IB had discretionary authority over approximately seventy futures customer accounts traded through Refco.2 The IB traded almost exclusively Treasury bond ("T-bond") futures and options contracts for his customers' accounts through Refco.3 During this time period, the IB called in orders for thousands of trades to the phone clerks at Refco's phone desk. The IB did not immediately give, and Refco's phone clerks did not immediately obtain, account identification for a substantial number of these trades.
After the orders were executed without account identification, the IB allocated the trades among his customers by telling Refco's phone clerks which account numbers to assign to which executed trades. From at least January 1995 through December 1995, the IB also at times allocated trades among his customers by instructing one of the Phone Clerks to order Refco's checkout or corrections department to change the account identification for T-bond futures and options trades. Refco's checkout and corrections departments accepted the account number changes solely on the basis of the IB's authority over the accounts without determining if such changes were the results of errors.
2. Indications of the Improper Handling of Trades
Refco received various indications of the improper handling of trades in the IB's accounts. Starting in at least January 1995, Refco began receiving warning letters from the CBOT for submitting trades late for clearing in excess of the thresholds established by the CBOT. In February 1995, after the first CBOT letter that threatened to fine Refco, Refco's vice president of Chicago floor operations traced a significant portion of Refco's late trade problem to the salesman handling the IB's trades. Nonetheless, the problem of late trades by Refco, including those attributable to the IB's conduct, continued through at least October 1995.
In April 1995, representatives of one of the IB's former customers met with representatives of Refco and raised issues relating to the trading in the customer's account during 1994. That customer's account statements showed practically all losing trades from January 1994 through April 1994, and all winning trades from May 1994 through June 1994, when it closed its Refco account. 4
In early June 1995, Refco's margins supervisor saw profit and loss figures on a report, which caused him to question whether trade allocation may have taken place in accounts traded by the IB. 5 Because of the disparities in the report, Refco's director of compliance reviewed several days of floor order tickets for the IB's accounts, looking only for the most obvious signs of trade allocation, i.e., cross-outs. He did not look for other indicia of trade allocation. The director of compliance reported to Refco's chief operating officer ("COO") that he did not find any such cross-outs. Although the director of compliance did not find any crossed-out account numbers on the IB's orders, he did find some canceled trades without account numbers, which he did not report to the COO until months later.
In October 1995, Refco's vice president of Chicago floor operations told Refco's COO that the IB was not giving account numbers for his trades. The vice president of Chicago floor operations and Refco's floor manager observed the phone clerks taking the IB's orders for a few minutes each day for the next two weeks. Nevertheless, until he stopped trading for his customers on December 1, 1995, 6 the IB continued his practice of placing trades without giving account numbers.7
3. Supervisory System
Refco had inadequate systems, reports, policies and procedures to detect possible trade allocation by financial advisors among their discretionary customer accounts. While reports existed that showed the results in different accounts, such as the report discussed above and its "Monthly P&S and Commissions Recap by Salesman" report, Refco did not utilize such reports for compliance review purposes.
Refco delegated its duty to supervise the phone clerks taking the IB's orders to the salesman in charge of its trading desk despite the fact that the salesman's compensation was tied to the number of contracts traded. The more trades that the IB placed, the more income the salesman received.
When the IB requested an account number change, Refco's checkout and corrections departments accepted the IB's request to assign the trade to accounts and never checked the original floor order ticket to determine if a legitimate error had occurred requiring the change, instead relying solely on the IB's trading authority over the accounts. The IB took advantage of the situation by moving trades to allocate profits and losses among his customers' accounts. Refco did not clearly establish and enforce a policy for the checkout and corrections departments to examine the original floor order ticket before moving trades between accounts.
Refco also failed to administer its own supervisory procedures. For example, Refco's Chicago floor and clearing operations failed to report directly to Refco's COO, as they were required to do under Refco's supervisory structure.8
D. Legal Discussion
1. Refco Failed to Record Account Numbers on its Floor Order Tickets
Section 4g of the Act requires that FCMs, introducing brokers, floor brokers, and floor traders make and produce records relating to their or customers' transactions and positions as required by the Commission. Commission Regulation 1.35(a-1)(2) requires members of contract markets to prepare a written record of a customer order immediately upon receipt on the floor of an exchange, including the customer account identification and order number. Account numbers were not written on a substantial number of Refco floor order tickets immediately when orders were placed, in violation of Section 4g of the Act, 7 U.S.C. § 6g (1994), and Commission Regulation 1.35(a-1)(2), 17 C.F.R. § 1.35(a-1)(2) (1998). Under the Act, the FCM is held responsible for the recordkeeping of its employees. See In re GNP Commodities, Inc., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,360 at 39,217-18 (CFTC Aug. 11, 1992), aff'd sub nom, Monieson v. CFTC, 996 F.2d 852 (7th Cir. 1993) ("GNP").
2. Refco Failed to Supervise Diligently
Commission Regulation 166.3 imposes on registrants an affirmative duty to supervise their employees and agents diligently by establishing, implementing, and executing an adequate supervisory structure and compliance programs. The duty to supervise...include[s] the broader goals of detection and deterrence of possible wrongdoing by [registrant's] agents." Lobb v. J.T. McKerr & Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,568 at 33,444 (CFTC Dec. 14, 1989). "In appropriate circumstances, a showing that the registrant lacks an adequate supervisory system can be sufficient to establish a breach of duty under Rule 166.3." In the Matter of Thomas W. Collins, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,194 (CFTC Dec. 10, 1997) (citing In the Matter of First Nat'l. Trading Corp., [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,142 (CFTC Jul. 1994)). Moreover, the existence of violations that should have been detected by a diligent system of supervision is independent proof of a failure to supervise. See In re Paragon Futures Ass'n., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. ¶ 25,266 at 38,850 (CFTC Apr. 1, 1992). The violations which occurred must be of a type that should be detected because of their nature or because they have occurred repeatedly. Id.
Refco failed to supervise diligently its handling of commodity interest accounts in at least the following ways, in violation of Commission Regulation 166.3, 17 C.F.R. § 166.3 (1998).9 First, Refco's supervisors either failed to investigate or inadequately investigated questionable activity after it had been brought to their attention. See GNP, supra, ¶ 25,360 at 39,219 (discussing "the importance of a line supervisor's duty to investigate questionable activity after that activity is brought to the supervisor's attention.").
In addition, Refco had inadequate systems in place to detect trade allocations by the IB, as well as the failure of those entering the orders for execution to insist upon account identification at the appropriate time and the failure of the checkout and corrections departments to seek adequate explanation for the movements of trades between customer accounts. The lack of an adequate supervisory system, without more, is a breach of Refco's duty to supervise under Commission Regulation 166.3. See Collins, supra, ¶ 27,194. Refco's violations were of a type that should have been detected by its supervisory system because of both the nature and frequency of the violations. See In re Paragon Futures Ass'n., supra, ¶ 25,266 at 38,850 (existence of multiple non-technical violations serves as independent proof of a registrant's failure to supervise). Moreover, Refco's violations in failing to assign account identification to thousands of trades before execution and moving trades between customer accounts had serious consequences.
Refco's delegation to a salesman of the supervision of the phone clerks taking the IB's orders also was flawed. Indeed, the fact that the salesman's compensation was based directly upon the number of contracts traded by Refco's customers gave him a strong disincentive to enforce compliance. See In the Matter of First Nat'l Trading Corp., [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,142 at 41,786 (CFTC Jul. 1994) (an FCM created a major disincentive to compliance when it entrusted compliance to branch managers whose compensation was tied to sales).
Refco's checkout and corrections departments never checked the original floor order ticket to determine if a legitimate error had occurred when the IB requested an account number change. Refco failed to supervise diligently these departments by not clearly establishing and enforcing a policy for the checkout and corrections departments to examine the original floor order ticket before moving trades between accounts.
Finally, in late 1994, Refco reorganized its supervisory structure so that most of Refco's departments, including Refco's Chicago floor and clearing operations, were supposed to report directly to Refco's chief operating officer. However, Refco's revised reporting chain was not followed. See Collins, supra, ¶ 27,194 (citing In re Paragon Futures Ass'n., [1990-1992 Transfer Binder], Comm. Fut. L. Rep. (CCH) ¶ 25,266 at 38,850 (CFTC Apr. 1, 1992)) (If a supervisory system is in place, then the registrant must diligently administer it).
IV. FINDINGS OF VIOLATIONS
Based on the foregoing, the Commission finds that Refco violated Section 4g of the Act, 7 U.S.C. § 6g (1994), and Commission Regulations 1.35(a-1)(1) and 166.3, 17 C.F.R. §§ 1.35(a-1)(1), 166.3 (1998).
V. OFFER OF SETTLEMENT
Refco has submitted an Offer of Settlement in which, without admitting or denying the findings herein, it:
A. Admits the jurisdiction of the Commission with respect to all matters set forth in this Order;
1. a hearing;
2. all post-hearing procedures;
3. judicial review by any court;
4. all objections to participation by any member of the Commission's staff in the Commission's consideration of the Offer;
5. all claims which they may possess under the Equal Access to Justice Act, 5 U.S.C. § 504 (1994) and 28 U.S.C. § 2412 (1994), as amended by Pub. L. No. 104-121, Sections 231-32, 110 Stat. 862-63 (1996), and Commission Regulations Part 148, 17 C.F.R. § 148.1 et seq. (1998), relating to, or arising from, this action; and
6. any claim of double jeopardy based upon the institution of this proceeding or the entry in this proceeding of any order imposing a civil monetary penalty or any other relief;
C. Stipulates that the record basis on which this Order is entered consists solely of this Order and the findings to which they have consented in the Offer, which are incorporated in this Order;
D. Consents to the Commission's issuance of this Order, which makes findings and:
1. orders Refco to cease and desist from violating Section 4g of the Act and Commission Regulations 1.35(a-1)(2) and 166.3;
2. orders Refco to pay a civil monetary penalty in the amount of Six Million Dollars ($6,000,000) within ten (10) days of the date of this Order; to make such payment by electronic funds transfer to the account of the Commission at the United States Treasury, or by U.S. postal money order, certified check, bank cashier's check or bank money order, made payable to the Commodity Futures Trading Commission and sent to Dennese Posey, Division of Trading and Markets, Commodity Futures Trading Commission, 1155 21st Street, N.W., Washington, D.C. 20581; and to simultaneously transmit a copy of the cover letter and of the form of payment to Geoffrey Aronow, Director, Division of Enforcement, Commodity Futures Trading Commission, 1155 21st Street, N.W., Washington, D.C. 20581; and that if payment is not made in accordance with the requirements of this paragraph, the Order shall be vacated and the proceeding reinstated as to Refco; and
3. orders Refco to comply with its undertakings as set forth below and in the Offer.
Accordingly, IT IS HEREBY ORDERED THAT
A. Refco shall cease and desist from violating Section 4g of the Act, 7 U.S.C. § 6g, and Commission Regulations 1.35(a-1)(1) and 166.3, 17 C.F.R. §§ 1.35(a-1)(1), 166.3;
B. Refco shall pay a civil monetary penalty in the amount of six million dollars ($6,000,000) within ten (10) days of the date of this Order; shall make such payment by electronic funds transfer to the account of the Commission at the United States Treasury, or by U.S. postal money order, certified check, bank cashier's check or bank money order, made payable to the Commodity Futures Trading Commission and sent to Dennese Posey, Division of Trading and Markets, Commodity Futures Trading Commission, 1155 21st Street, N.W., Washington, D.C. 20581; and shall simultaneously transmit a copy of the cover letter and of the form of payment to Geoffrey Aronow, Director, Division of Enforcement, Commodity Futures Trading Commission, 1155 21st Street, N.W., Washington, D.C. 20581; and if payment is not made in accordance with the requirements of this paragraph, the Order shall be vacated and the proceeding reinstated as to Refco; and
C. Refco shall comply with the following undertakings:
1. The Study:
(a) Refco undertakes to pay $1 million to a fund ("Fund") which will be used for an industry-wide study of issues associated with order transmission and entry procedures for exchange-traded futures and options and the diligent supervision of the order transmission and entry process by commodity professionals ("Study").
(b) The Fund will be administered, and the Study overseen, by individuals approved by the Commission (the "Administrators"). The Administrators will include representatives of the National Futures Association and the Futures Industry Institute. Those organizations will be asked by the Commission to recommend, within 15 days after the entry of this Order, individuals from their organizations to serve as Administrators. Once such individuals are identified and approved by the Commission, they will be asked to provide to the Commission shortly thereafter the names of any additional individuals they would recommend to serve as Administrators. The Commission may appoint as Administrators individuals not so recommended.
(c) The Study will be performed according to a plan that will be subject to the prior approval of the Commission. The plan, which the Administrators will be asked to submit to the Commission within 110 days of their appointment, shall set forth the goals of the Study, the nature of the substantive work to be performed, and the institutions and individuals to be involved in performing the work and the roles they will play. The Study will include an evaluation of the relevant issues both in the current exchange environment and as they are and will be arising in electronic order transmission, entry and trading systems. It is expected that the Study will include input from industry professionals and other participants in the relevant markets and from academic and other observers of the relevant markets and industry. It is expected that the Study will include a survey and systematic normative evaluation of industry practice, resulting in the recommendation of "best practices" that firms, their employees and other professionals should employ so as to bring industry performance in such matters to the highest attainable level of customer protection and market integrity. The Commission will retain the ability to exercise its discretion at any time to modify the plan for the study and its execution, including the goals, timing, budget, and personnel associated with it.
(d) The Administrators shall authorize the expenditure of money from the Fund in furtherance of the completion of the Study. The Administrators will be asked to submit the findings of the Study, along with any supporting material, to the Commission within 12 months from the date on which the Commission notifies the Administrators of the Commission's approval of the Study plan. If there is money remaining in the Fund when the Study is completed, the Administrators may recommend to the Commission uses for the remaining money consistent with the underlying purposes for which the Fund is being created. The Commission, at its sole discretion, shall decide on the disposition of any such remaining money, which may include directing its payment to the United States Treasury as an addition to the civil monetary penalty otherwise being assessed under this Order.
(e) Refco undertakes not to seek or accept any reduction in or credit towards any payment or contribution otherwise due or owing, now or in the future, to any of the Administrators or any recipient of money from the Fund, based on the fact of Refco's contribution of money to the Fund.
2. The Internal Review:
(a) Refco shall designate Dennis Klejna, Esq., Refco's General Counsel, as a consultant ("Consultant") to review and make recommendations concerning Refco's compliance policies and procedures related to its handling of trades by its trading floor and back office personnel as may be necessary to conform such procedures to the requirements of the Act, the Commission Regulations and board of trade rules, and to prevent recurrence of the type of conduct discussed in this Order. Such recommendations shall include a procedure by which the compliance department engages in a regular process of review of trades and maintains a record of that review.
(b) Refco shall cooperate fully with the Consultant, including requiring the cooperation of Refco employees or other persons under its control. Refco shall place no restrictions on the Consultant's communication with Commission staff.
(c) Refco shall require the Consultant to prepare a Report setting forth his findings, analysis and recommendations as to the matters described above.
(d) Refco shall require the Consultant to deliver the Report within three months after the issuance of this Order to Refco and the Division.
(e) Refco shall adopt all recommendations in the Report within six months after its issuance; provided, however that as to any of the Consultant's recommendations that Refco determines is unduly burdensome or impractical, Refco may suggest an alternative procedure designed to achieve the same objective, submitted in writing to the consultant and the Division staff. The Consultant shall reasonably evaluate Refco's alternative procedure. Refco will abide by the Consultant's determination with regard thereto and adopt those recommendations deemed appropriate by the Consultant. Within six months after the issuance of the report, Refco shall, in a letter to Division staff, attest to, and set forth the details of, its implementation of the recommendations contained within the report.
3. Public Statements: Neither Refco nor any agents acting under its authority or control shall take any action or make any public statement denying, directly or indirectly, any finding in the Order creating, or tending to create, the impression that the Order is without a factual basis; provided, however, that nothing in this provision affects the testimonial obligations of Refco or its right to take contrary factual or legal positions relating to any proceeding in which the Commission is not a party. Refco will take all steps necessary to assure that all of its agents, attorneys, and employees understand and comply with this undertaking.
|By the Commission.|
|Jean A. Webb|
|Secretary to the Commission|
|Commodity Futures Trading Commission|
|Dated: May 24, 1999||--------------------------------------------------------|
1 Refco does not consent to the use of its Offer, the findings to which it has consented in its Offer, or this Order, as the sole basis for any other proceeding brought by the Commission other than a proceeding brought to enforce the terms of this Order. Nor does Refco consent to the use of the Offer or this Order by any other person or entity in this or any other proceeding. The findings to which Refco has consented in the Offer as contained in this Order are not binding on any other person or entity named as a respondent or defendant in this or any other proceeding.
2 Not all of the accounts were actively traded.
3 Virtually all of the customers had designated their accounts to be used for hedging cash market transaction in U.S. Treasury obligations.
4 Other than this contact, there apparently had not been any other complaints to Refco concerning the handling of trades from the IB's customers, who regularly received account statements from Refco detailing their futures and options trading.
5 This report could have allowed Refco to compare profit and loss results among all of the IB's customer accounts.
6 Shortly before then, Refco had placed his accounts on "liquidation only" status.
7 Refco also repeatedly accepted, without comment, letters from the IB required in connection with his claim to exemption from registration as a Commodity Trading Advisor, see Section 4m (1) of the Act, in which he represented that he advised fifteen or fewer persons, at a time when Refco's compliance department knew that he exercised discretionary authority over well in excess of 15 accounts.
8 Since the events underlying this matter, among other personnel changes, Refco has appointed a new President, Chief Operating Officer, and its first General Counsel in approximately fifteen years, to whom the compliance function now reports directly.
9 In so finding, the Commission is not proceeding on the basis that the IB was an agent of Refco.