JOSEPH B. DIAL, COMMISSIONER
COMMODITY FUTURES TRADING COMMISSION
REGULATORY UPDATE AND ENFORCEMENT HIGHLIGHTS
ASIA-PACIFIC FUTURES REGULATORS' FORUM
DECEMBER 4, 1996
PART ONE: REGULATORY DEVELOPMENTS
A.CFTC Responds to Possible Impact of Trading in Copper by the Sumitomo Corporation on U.S. Markets and Traders
Background -- On June 13, 1996 the Sumitomo Corporation informed the CFTC and the U.K. Securities and Investments Board ("SIB"), prior to its public announcement, that a Sumitomo trader had engaged in unauthorized trading resulting in a 2.6 billion dollar loss. Prior to this announcement, the CFTC asked for and received express assurances from Sumitomo that Sumitomo Corporation would stand behind its positions and its obligations. While Sumitomo's recent copper futures positions were held on the London Metal Exchange and not on any U.S. market, the CFTC was concerned about any resulting volatility on U.S. exchanges, particularly on the New York Mercantile Exchange. Well prior to the announcement, since January 1996, the CFTC and the SIB had been engaged in an investigation of a number of issues relating to the copper market in general. For obvious reasons, I cannot comment on the investigation itself, which is ongoing. I would, however, like to highlight two other initiatives generated by recent events involving copper:
Physical Delivery Conference -- The Sumitomo incident demonstrated that trading in physical delivery commodity markets involving international commodities, international participants and in many cases foreign delivery points can raise special market integrity and surveillance concerns. Accordingly, the CFTC co- hosted a conference on physical delivery markets in London (with the SIB and the Japanese Ministry of International Trade and Industry) on November 25-26, 1996, to which representatives from 15 other jurisdictions were invited. The purpose of the meeting was to discuss market practices and surveillance, information sharing and coordination, and contract specification issues relating to futures markets.
CFTC/SIB Proposal to Facilitate Information Sharing -- Our recent experience sharing information on copper and during the Barings crisis revealed that during such critical events conflicts can arise as to the scope of information necessary to address the event in question. As a result, at the September 1996 annual meeting of the Technical Committee of IOSCO the CFTC and SIB presented a proposal to develop guidelines to facilitate the process by which information is shared under existing MOUs. The purpose is to provide specific guidance as to the types of information that regulators could be expected to share relative to specific market events. The Technical Committee determined to take this project forward through its Working Party on Secondary Markets.
B.International Futures Regulators and Exchanges Sign New Information Sharing Agreements
Declaration and Exchange MOU -- Fifteen international futures regulators have now signed the Declaration on Cooperation and Supervision of International Futures Exchanges and Clearing Organizations ("Declaration"). Australia was one of the original signatories to the Declaration, announced on March 15, 1996 in Boca Raton, Florida. Also on March 15, 1996, 49 international futures exchanges and clearing organizations signed a complementary Memorandum of Understanding and Agreement ("Exchange MOU"). Five additional exchanges have since signed the MOU.
Purpose of these Agreements -- The Declaration and Exchange MOU are at the core of developments contemplated in the recommendations agreed at the May 1995 meeting in Windsor, England convened by the CFTC and the SIB. They establish mechanisms whereby the occurrence of certain agreed triggering events affecting an exchange member's financial resources or positions will prompt the sharing of information.
C.CFTC and SIB Transmit Final Report on Windsor Accomplishments to IOSCO
The CFTC and the SIB transmitted their "Final Report from the Co-Chairmen of the May 1995 Windsor Meeting to the Technical Committee of IOSCO (August 1996)." The Report provides the perspective of the CFTC and the SIB on the substantial progress that has been made in implementing the May 1995 Windsor Declaration initiatives. The Final Report concludes that significant concrete steps have been taken in a remarkably short period of time to implement the Windsor recommendations, including large exposure information sharing, market crisis procedures, enhanced transparency of market protection and procedures, and client asset protection measures. These measures will minimize the systemic effects of a market disruption and enhance existing regulatory safeguards.
D.CFTC Develops Proposal to Facilitate Use of the Internet by CTAs and CPOs
In August, the CFTC published a request for comments concerning the use of electronic media, particularly the internet, by Commodity Pool Operators ("CPOs"), Commodity Trading Advisors ("CTAs"), and associated persons. The release, structured as interpretive guidance, was intended to assist CPOs and CTAs in applying the Commodity Exchange Act ("CEA") and CFTC regulations on the use of electronic media for purposes of soliciting customers and delivering disclosure documents, reports and promotional materials. The release seeks comment concerning a variety of issues relevant to the use of electronic media by commodity professionals, including the proposed electronic filing program, the application of the CFTC's recordkeeping requirements to electronic media, procedures for electronic delivery of disclosure documents, the cross-jurisdictional implications of the internet, and related issues.
E.Commission Analyzing Results of Audit Trail Tests
Background -- Since 1987, the CFTC has required futures exchanges to capture the one-minute execution time for each trade or side of a trade. The CEA requires that the audit trail system of each large-volume exchange must capture unalterable, continual, independent, and automatic or similarly reliable audit trail trade execution times. The system also must sequence all trades in a precise manner, to the extent practicable. These provisions apply unless the Commission determines that there are circumstances beyond the control of the contract market which prevent compliance.
Status -- The CFTC is in the process of conducting tests of various contract markets, and other contract markets will be tested shortly. On August 12, 1996, the CFTC issued a report which found that the two largest U.S. exchanges, the CME and CBOT, had made significant improvements in their systems but had failed to establish the required 90 percent verifiability of time and sequence. The CME and CBOT are required to achieve 90 percent verifiability by January 1, 1997. The CFTC intends to assess the audit trail systems of several other exchanges over the next year.
F.Two Tier Process for Contract Market Designation Relating to Contract Terms and Conditions
The CFTC recently proposed amending its rules relating to review and approval of applications for contract market designation and proposed exchange rule changes in order to streamline the CFTC review process. Specifically, the Commission has proposed a procedure whereby exchanges which have already been designated as a contract market may request fast-track review for contracts which do not raise novel regulatory issues. Under the proposed rule, applications for designation of certain cash-settled contracts will be deemed to be approved ten days after receipt, unless the exchange is notified otherwise. All other fast-track designation applications will be deemed to be approved, unless the exchange is notified otherwise, 45 days after receipt. The Commission also proposed a similar fast-track review of proposed amendments to contract terms or conditions, which would provide a 45 day fast- track automatic approval in addition to the already-existing 10 day approval process.
G. Courts Hear Two Cases Involving Interpretation of the Treasury Amendment
Background The CEA provides, in a provision known as the "Treasury Amendment," that the CFTC does not have jurisdiction over transactions in foreign currency, unless such transactions involve the sale thereof for future delivery conducted on a board of trade. The CFTC has taken the position that the Treasury Amendment cannot be read so as to place outside the CFTC's jurisdiction the offer and sale to the public of off-exchange foreign currency futures transactions. The scope of this amendment has been the subject of several apparently contradictory court decisions during the past few years.
Current Status -- In an October 1996 decision, CFTC v. Frankwell Bullion Ltd., the 9th Circuit Court of Appeals rejected the CFTC position that the defendants had engaged in the offer and sale of illegal, off-exchange foreign currency futures contracts and held that the Treasury Amendment excludes from CFTC jurisdiction all foreign currency futures not traded on a formally organized exchange. On November 13, 1996, the U.S. Supreme Court heard oral arguments in another case, Dunn v. CFTC, involving a challenge to the CFTC's interpretation of the Treasury amendment, as applied to currency options. A decision is expected by early spring. The CFTC has been involved in discussions with the Treasury Department on ways to resolve this issue, and Congress may consider the possibility of a legislative clarification to the Treasury Amendment.
H.CFTC Holds Symposium on Internal Controls
On June 24, 1996, the CFTC held a symposium on internal controls and risk management practices, which was designed to elicit a wide spectrum of viewpoints concerning the risk management practices and internal controls of end-users, brokers and dealers of financial instruments. A videotape of the event can be ordered through the CFTC home page on the internet.
I.CFTC Holds Exchange Order and Trade Automation Roundtable
On October 16, 1996, the CFTC held a symposium which brought together a diverse group of experts and market users to share their views on exchange automation issues. The roundtable consisted of three expert panels, which attempted to identify obstacles and benefits that market users believe are of primary importance with respect to exchange automation. The roundtable also reviewed the practicability of further automating order delivery and trade transmission systems.
J.CFTC Hosts 1996 Training Seminar for Foreign Regulators at its Chicago Regional Offices
The CFTC's annual training seminar for foreign futures authorities took place in October 1996 in Chicago, Illinois. The seminar was attended by approximately 78 persons representing 47 organizations from 27 foreign countries. During this year's seminar, special emphasis was placed on, among other things, issues related to the oversight of electronic markets, CFTC's large trader reporting system, special monitoring issues related to contract expiry and the design and launching of new contracts.
PART TWO: ENFORCEMENT DEVELOPMENTS
A. Two new cooperative arrangements with foreign regulators
The CFTC signed its 13th cooperative enforcement arrangement in September of this year. The New Zealand Securities Commission and the CFTC signed a Memorandum of Understanding (MOU) on September 16, 1996. Last October, the CFTC and the Hong Kong Securities and Futures Commission (SFC) signed an MOU, as well as a Declaration on cooperation and supervision of cross-border investment management and managed futures activity. The Declaration is intended to establish procedures for the CFTC and SFC to assist each other in oversight of commodity trading advisors and pool operators doing business in Hong Kong and the U.S., within the framework of the MOU.
B. Highlights of the CFTC's Enforcement Program
1.Enforcement Actions Raising Important Factual and Legal Issues
The CFTC filed a number of actions over the past year which have a significant impact not only with regard to the specific facts of the case, but in the guidance they provide to the marketplace as to the CFTC's stance on certain forms of misconduct.
a.Financial Audit of a Futures Commission Merchant:
In re Deloitte & Touche (filed Sept. 25, 1996)
The CFTC exercised its authority to sanction an individual auditor in connection with the audit of a CFTC registrant. The CFTC filed an action against Deloitte & Touche, a major U.S. accounting firm, and a former partner of the firm who supervised the audit of a CFTC-registered FCM. Separately, in 1995, the CFTC had filed and simultaneously settled an action against the FCM and two individuals on charges of, among other things, failure to maintain required net capital, operating while undercapitalized, and filing reports with the CFTC which contained wilfully false statements. In re First Commercial Financial Group (filed May 2, 1995)
The CFTC settled the case on the day it was filed, finding that (1) the partner failed to conduct the audit of the FCM in accordance with generally accepted auditing standards and failed to investigate properly and report on material inadequacies in the FCM's internal controls, and (2) Deloitte was liable for the partner's violations. Deloitte agreed to pay a $100,000 civil monetary penalty and to comply with certain undertakings. The former partner agreed to the entry of a cease and desist order and a CFTC censure pursuant to the CFTC's Regulations.
This case sends a clear message to accounting firms and professionals that the CFTC pays attention to the way they discharge their obligations and responsibilities with respect to registered entities.
b. Manipulation: In re Fenchurch Capital Management (filed July 10, 1996)
A registered CTA and CPO, Fenchurch Capital Management, Ltd., was charged with manipulation involving the Ten Year U.S. Treasury Note futures contract. The CFTC simultaneously filed and settled this action, finding that Fenchurch attempted to and did manipulate the value of its position on this futures contract by cornering the available supply of the cheapest-to-deliver notes. Fenchurch exacerbated the tightness in the supply of the cheapest-to-deliver notes by increasing its position and intentionally withholding the notes from the market with no legitimate economic purpose.
Terms of Settlement Without admitting or denying the CFTC's findings, Fenchurch consented to a cease and desist order and to various undertakings related to its Treasury market trading. It also agreed to (1) conduct a review of its policies and procedures and, if necessary, to amend those policies and procedures, and (2) to pay a civil monetary penalty of $600,000 which also satisfies Fenchurch's obligations under a related SEC consent order of permanent injunction.
c. Antifraud: In re Oster Communications, Inc. (filed June 20, 1996)
The CFTC filed and simultaneously settled an administrative action against Oster Communications, Inc., a firm which is not registered with the CFTC in any capacity. The settlement order finds that Oster violated anti-fraud and CTA registration provisions in connection with the sale of a computer software trading system owned by another firm: JDI Limited, Inc. The CFTC's order finds that Oster joined JDI in the sale, marketing and support of a trading system owned by JDI, by, among other things, supplying JDI with computer hardware and software and commodity quotes at no charge, distributing promotional material and collecting names and addresses of prospective customers, and leading customers to believe that both JDI and Oster were engaged in the development and marketing of the trading system. The firms' joint activity resulted in an independent registration obligation on the part of each due to their joint activity, notwithstanding the fact that Oster and JDI are independent firms. Oster consented to the entry of a cease and desist order and agreed that it would not provide, directly or jointly with others, advice concerning commodity futures and options contracts without being registered.
Additional charges were filed against Oster to amend the complaint in a related injunctive action, alleging that Oster acted as an unregistered CTA and violated the anti-fraud provisions of the Act and CFTC Regulations in connection with its relationship with JDI. In settling these charges, Oster consented to an order of permanent injunction and to disgorge at least $670,000 for the benefit of defrauded customers. CFTC and the State of Florida v. JDI Limited, Inc.
2.Enforcement actions filed in rapid response to ongoing illegal activity, including activity on the Internet
As part of the CFTC concentration on bringing enforcement actions to halt ongoing allegedly unlawful activity, we instituted a number of cases within weeks or even days of discovering the suspected illegal activity. Many of these cases involve CTAs and/or CPOs who are not registered with the CFTC, but who were acting in a capacity that requires registration and who were suspected of violating the anti-fraud provisions of the CEA and CFTC's Regulations in connection with their CTA/CPO activities. This year, for the first time, the CFTC brought actions against unregistered CTAs and/or CPOs for activities over the Internet.
a.Two administrative cases resulting from Internet surveillance were filed in September. The cases were against individuals providing advisory services to Internet subscribers. In each, the CFTC simultaneously issued orders pursuant to which the respondents agreed to stop providing advisory services to Internet subscribers until they register with the CFTC as CTAs and comply with applicable regulatory requirements.
The action against J. Spencer Brown d/b/a ProTrade is significant because the CFTC's Internet surveillance brought Brown's unregistered activities to light soon after he launched his venture, so that, at the time this action was filed, Brown had not yet successfully solicited any customers.
The second action was brought against Steven J. Marks. This case is important because it arose in response to Marks posting messages on the Internet to financial-related bulletin boards that are geared towards individual investors. In addition to the above- noted relief, the CFTC's order directs that Marks refund all funds he received from subscribers to his service and transmit an electronic mail message over the Internet to all former subscribers notifying them of the action and of the CFTC's Internet Homepage.
b.Division of Enforcement posts an interactive Internet Webpage
In August, 1996, the Division of Enforcement set up an interactive Internet Enforcement Webpage enabling the public to contact the Enforcement Division's electronic mailbox to report suspected commodities-related wrongdoings to the CFTC. To this end, the webpage incorporates a pull-down, fill-in form to enable customers to provide information to the Enforcement Division directly on the webpage screen. The newly established Enforcement webpage also provides a brief summary of the types of abuses commonly investigated and prosecuted by the CFTC. Electronic addresses: The CFTC's Homepage is located at http://www.cftc.gov and Enforcement's email address is firstname.lastname@example.org.
c.Use of internet to post "Wanted" notice and information
The CFTC established special Internet Webpages on its World Wide Website seeking the whereabouts of a defendant who fled with customer funds. The webpages were set up on October 15, 1996, to help locate Donald B. Chancey, a defendant in a CFTC civil injunctive action filed in July, who disappeared after allegedly embezzling $3 million from at least 19 investors in an unregistered commodity pool. The webpages depict a photograph of defendant Chancey, seek information on Chancey's current whereabouts from members of the public, and provide information on an upcoming court-authorized auction of Chancey's real and personal property.
Three Enforcement Actions were filed in November.
On November 13, 1996, the CFTC filed three separate administrative complaints related to particular grain contracts marketed and sold by cooperative grain elevators and others: In re Southern Thumb Co-op, Inc., In re Grain Land Cooperative of Blue Earth, Minnesota, and In re Roger Wright, et al. Each action includes charges that the respondents are violating the prohibition against the offer of illegal, off-exchange agricultural options and/or futures contracts. Two complaints also include charges of fraud in connection with the marketing of these illegal instruments. The complaint against Roger Wright also charges a registered FCM and one of its employees with aiding and abetting Wright's unregistered activities and with trading without proper authorization. The actions are pending before an administrative law judge.
CFTC and Exchanges engaged in significant surveillance activities throughout the spring and summer this year. The three enforcement actions were filed following significant surveillance activity throughout the spring and summer by the CFTC and the exchanges. Unprecedented market conditions in certain commodities had caused the CFTC and exchanges to closely monitor the trading and expiration of particular agricultural futures contracts and to survey traders and carrying firms to ensure that market participants would be able to meet their commitments in the futures markets.
CFTC staff issued a "Statement of Policy in Connection With the Unwinding of Certain Existing Contracts for the Delivery of Grain and Statement of Guidance Regarding Certain Contracting Practices" on May 15, 1996, to assist members of the agricultural community in unwinding existing HTA contracts and writing agreements in the future. These Statements were issued to provide guidance as to what would be prudent risk-reduction practices for the future and to facilitate attempted settlement negotiations between producers and elevators that would be beneficial to both parties. An explanatory section accompanying the Statements made clear that staff was not taking a position on the validity or legality of any individual contract; rather, the staff stated that, "such determinations must be based on the specific contracts to be analyzed, and made within their specific factual context."