Thank you for that introduction and thanks to all the folks at FIA for hosting me.  And thank you all for being with us today, if only virtually.  We at the CFTC are wishing everyone the best, and hoping all of you stay safe and healthy during this difficult time.  We look forward to being back together in person, hopefully before too long.

We’re together today to talk about penalties at the CFTC, and the penalty guidance we recently issued in the Division of Enforcement.  But before we dig into the details, I want to take a step back, and offer our view about how we got here, and what we’re hoping to accomplish with this penalty guidance.[1]

The Path Starts with Dodd-Frank

The path here, in my view, traces back to July 2010 and the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank sought, among other things, to improve transparency, mitigate systemic risk, and protect against market-related abuse in the U.S. derivatives markets.  Congress largely placed responsibility for implementing these derivatives-market reforms with the CFTC. 

This of course, had significant implications for the Commission, and for the Division of Enforcement.  Among other things, Dodd-Frank significantly expanded the Commission’s enforcement jurisdiction, and it granted the Commission new enforcement tools to wield in policing this broader jurisdiction.  Over the balance of the next decade, the Commission and its dedicated staff of career civil servants have shown themselves to be up to the task Congress laid out in Dodd-Frank.

Consider just a few data points.  Since Dodd-Frank, the Commission’s enforcement program has focused on the most pernicious forms of wrongdoing, bringing more cases involving misconduct that undermines market integrity, like manipulation and spoofing, than ever before.  To increase the deterrent effect of our enforcement actions, we’ve imposed substantial penalties, enhanced our evaluation of compliance programs, strengthened remediation requirements, and ramped up our parallel activity with the Department of Justice.  To keep pace with our rapidly evolving digital markets, we’ve revolutionized the way we collect, analyze, and use data.  And to increase transparency and fairness, we’ve taken significant steps to make public the policies, procedures, and practices that guide our actions, and to explain why we take the actions we do.  The penalty guidance we’ll talk about today flows from this final point.

The CFTC Is Committed to Transparency, Fairness, and Advancing the Rule of Law

Recently, the Commission for the first time articulated a set of core values:  Commitment, Forward-thinking, Teamwork, and Clarity.[2]  Our penalty guidance advances the core value of clarity, providing market participants with greater transparency as to Division staff’s decision-making processes in this critical area.  As Chairman Tarbert has stated, “[W]e must be transparent in how we enforce the law.  One goal of our enforcement program is to change behavior in a positive way by deterring misconduct before it happens.  Deterrence requires clarity about how our laws work.”[3]

In this vein, the Division of Enforcement has taken a number of significant steps to promote transparency and increase clarity.  We published an Enforcement Manual, laying out publicly for the first time the Division’s practices and procedures.[4]  We began issuing Annual Reports at the conclusion of the Fiscal Year, laying out the Division’s priorities, and explaining how the Division’s enforcement efforts were designed to advance them.[5]  And we explained in publicly available staff guidances how the Division would handle a variety of issues—ranging from cooperation and self-reporting, to new areas of enforcement activity, to today’s topic, penalties.[6]  This push toward ever greater transparency is something that, under Chairman Tarbert’s leadership, I know will continue.

Penalty Guidance—What We’re Hoping To Achieve

Last week, the Division of Enforcement issued penalty guidance to all staff, which we made publicly available and published in an updated version of our Enforcement Manual.[7]  This marks the first formal public statement on penalties at the CFTC in 25 years.  The memorandum to staff with the guidance is available on the CFTC website, as is the Enforcement Manual.  I encourage you to read the guidance carefully.

So why issue this penalty guidance at all, and why now?  This is where we turn back to Dodd-Frank.  In the nine Fiscal Years since Dodd-Frank, the CFTC has obtained more than $13.6 billion in monetary relief.  That’s an average of more than $1.5 billion per year.  As you might expect, given the dramatic expansion of jurisdiction and authority that came with Dodd-Frank, these numbers mark a sharp increase over the pre-Dodd-Frank averages. 

Just as the size of the penalties have grown, so too has the breadth of cases that have produced these penalties.  We’ve pursued misconduct in every corner of our markets, from cattle futures traded by feedyards to financial instruments traded by Wall Street banks.  We’ve obtained significant penalties in traditional markets like precious metals, and new-age markets like digital assets.  And we’ve kept pace as our markets transformed from analogue to digital, from order tickets trading hands in the pits to algorithms trading at high frequency on the screen.

So over the past several years, we have regularly brought cases commanding eight—and sometimes nine—figures in monetary relief, stretching across an ever-growing range of market activity, often involving new rules, new conduct, and new CFTC market participants.  Yet we had not made a clear public statement as to how we arrived at particular penalties, or what we hoped to accomplish by imposing them.  That’s where our penalty guidance comes in.

On a big picture level, this penalty guidance reflects our view that the ultimate goal of our enforcement program is to deter misconduct.  Indeed, the guidance explains that, in considering the appropriate penalty, staff will “be guided by the overarching consideration of ensuring the proposed penalty achieves the dual goals of specific and general deterrence.”[8]

But for enforcement actions to deter, the potential wrongdoer must have some sense of how certain types of misconduct will be punished.  For companies to build effective compliance programs, they must understand how enforcement authorities would view certain categories of conduct.  For business executives to cultivate a true culture of compliance, they must be able to explain to their employees how enforcement bodies would separate right from wrong, and the expected consequences for any wrongdoing.  All of this requires clear statements about how and why enforcement authorities punish.    

Moving from the big picture to the more pragmatic, we also issued the penalty guidance in the hopes it would be informative and useful on a practical level.  Consistent with the CFTC’s history as a principles-based regulator, the penalty guidance sets out the principles and factors that will guide staff action.  This has the added benefit of yielding a document that is short enough that the people affected—business leaders, compliance professionals and market participants—should be able to easily read it, understand it, and implement any lessons learned. In addition, the guidance binds Division staff, ensuring consistency across teams.  And by making clear to the outside world the factors we consider, the guidance should streamline any discussions we have with defense counsel and market participants about penalties.  To the extent you are preparing for discussions with staff about penalties, your preparations should focus on the factors laid out in the guidance. 

*         *         *

In the end, it seems to us that Justice Oliver Wendell Holmes got it right when he wrote about penalties.  We all wish, as Holmes explained, to deal only with what he called the “good men.”[9]  But at times, particularly when it comes to enforcement, we must confront the “bad man” as well.[10]  It is for them we must design systems that offer the bad man “as much reason as a good one for wishing to avoid an encounter with the public force.”[11]  For even “[a] man who cares nothing for an ethical rule which is believed and practiced by his neighbors is likely nevertheless to care a good deal to avoid being made to pay money, and will want to keep out of jail if he can.”[12] 

If we in the Division of Enforcement can use penalties to make the bad man, just as much as the good, follow the law, we will have achieved our ultimate goal:  to use the law, and the rule of law, “to make good citizens, and good men.”[13]  That is what we are hoping to achieve.

I concur with issuing the interim final rule to extend by one year the initial swap margin compliance deadline for “Phase V” financial entities that is currently set for September 1, 2020 (“IFR”).

As I have stated previously, the Commission should be reluctant to extend compliance deadlines when a long lead-in period has been provided.  The 2020 compliance date for the swap margin rule was originally set in January 2016.  However, the COVID-19 pandemic is significantly impacting business operations just as the negotiation and implementation of the initial margin agreements and processes for Phase V are in full swing leading up to the September 1, 2020 deadline.  These activities can be time consuming and require substantial human interaction given the need to negotiate terms and third party custodial agreements, and agree on margin calculation methods.  Accordingly, while many firms were undertaking this process, it appears that a substantial amount of work remained for Phase V firms just as the COVID-19 pandemic erupted.

With respect to the length of the extension, the progress of the pandemic and speed at which work operations will normalize is uncertain.  As discussed in the IFR, on April 3, 2020, the Basel Committee on Banking Supervision and Board of the International Organization of Securities Commissions (“BCBS/IOSCO”) amended its existing margin policy framework to extend the relevant comparable compliance date to September 1, 2021.[1]   While the Commission is not obligated to follow this framework, doing so when reasonable and on the same timeline as other regulators will reduce the likelihood of regulatory arbitrage.   Given that the existing September 1, 2020 compliance date is fast approaching, and recognizing the benefits of international cooperation on this issue, I will support the one-year extension as provided in the IFR.

At the same time, it is critical that we continue to emphasize the importance of requiring margin for uncleared swaps. During the 2008 financial crisis, when margin for uncleared swaps was not required, American International Group (“AIG”) would have failed as a result of its pending default on swaps that, according to AIG personnel, only months earlier presented little or no risk exposure for AIG.  The Federal Reserve System and the U.S. Department of the Treasury provided over $180 billion of support to prevent that outcome.[2]  A default by AIG would have substantially damaged its swap counterparties and left other market participants uncertain as to the knock-on effects of that default.

Requiring margin for uncleared swaps is a critical part of our regulatory framework that was put in place to help prevent another financial crisis. Uncleared swaps activity remains vigorous.  The requirement to post initial margin helps mitigate systemic risk and reduce counterparty contagion and related effects by ensuring that collateral is available to offset losses from the default of counterparties.  In response to the 2008 financial crisis, the Dodd-Frank Act required that the Commission establish minimum initial and variation margin regulations for certain swaps entered into by swap dealers.[3]  The need for margin was also recognized by the G20 nations when the G20 directed the BCBS/IOSCO to establish the swap margin policy framework for global implementation of margin requirements.[4] 

The IFR notes that Phase V is estimated to cover about eight percent of the swap trading activity for firms that may be subject to the margin requirements, and therefore that the uncollateralized swaps entered into by the entities in this phase “pose less risk to the financial markets than the risk posed by uncleared swaps entered into by entities that have already come into the scope of IM compliance.”[5]  While literally correct, this statement only relates to relative risk with respect to other swap activities and says nothing about the absolute known or unknown risk posed by the swap activity covered by the Phase V extension.  The Commission’s statement regarding this relative risk should not be misinterpreted to provide justification for any further extensions or exceptions from the margin requirements for these entities.

I will support today’s notice of proposed rulemaking and reopening of a comment period primarily aimed at amending the conditions of the current exemption under Commission regulation 3.10(c)(3) (referred to as the “3.10 Exemption”) available to certain non-U.S. commodity pool operators (CPOs) to further reflect the increasingly global nature of the CPO space and clarify the Commission’s approach with respect to its oversight of foreign intermediaries that are not engaged in commodity interest activities on behalf of U.S. customers.  I greatly appreciate the time and consideration that the staff of the Division of Swap Dealer and Intermediary Oversight (DSIO) gave to my comments and concerns.  I also wish to thank the Office of General Counsel (OGC) staff for ensuring that we consistently adhere to the letter and spirit of the Commodity Exchange Act (CEA or the “Act”) and regulations.  I am pleased that the ongoing dialog that has become a hallmark of many working relationships within the Commission is enduring better than ever through the pandemic, and that we can advance important policy and regulatory initiatives without sacrificing constructive debate and deliberation.

Today’s proposal both expands the availability of the 3.10 Exemption to non-U.S. CPOs who operate both qualifying offshore commodity pools and other commodity pools that may or may not meet an alternative regulatory registration exemption or exclusion and eases certain identifiable and unduly restrictive impediments to relying on the 3.10 Exemption.  Like several recent rulemakings undertaken with respect to Part 4 of the Commission Regulations, today’s proposal is a continuation of the Commission’s ongoing efforts in honing its regulatory footprint with respect to this dynamic segment of the derivatives market by refining our approach through calibrating decades of policy and rulemakings to the needs of the market participants, consumers, and the national public interest we are charged with protecting.

Though today’s proposal is brief in its delivery, it reflects many years of staff experience and familiarity with the Commission’s historical positions and reasoning in addressing material policy issues raised by appropriately balancing the financial interests of foreign intermediaries and their customers with our commitment to the financial integrity of U.S. markets and U.S. customer protection.  I believe today’s proposal equally reflects the Commission’s commitment to making targeted changes in step with improvements in surveillance and monitoring capabilities as well with our relationships with both the National Futures Association (NFA) and foreign regulators.

Last fall, when the Commission finalized several amendments to Part 4 of the regulations addressing various registration and compliance requirements for CPOs and commodity trading advisors, I commended its decision to not move forward at that time on proposals to exempt from registration qualifying CPOs operating commodity pools outside of the U.S. consistent with Commission Staff Advisory 18-96[1] and adding a prohibition against statutory disqualifications for certain exempt CPOs.[2]  The decision not to act reflected a thoughtful consideration of the comments received and the practicalities of both proposals as they related to ongoing concerns about cross-border issues and the Commission’s regulatory goals.

Today’s proposal results from ongoing review and discussions with market participants and the NFA to determine how best to provide relief that better aligns the Commission’s customer protection concerns with the Commission’s regulatory provisions in an increasingly international asset management space.[3]  Other aspects of today’s proposal include the addition of a safe harbor for person’s engaged in CPO activities with respect to offshore commodity pools that take certain enumerated actions aimed at preventing U.S. persons from participating in such pools, and a provision permitting certain U.S. control affiliates of a non-U.S. CPO to contribute capital to such CPO’s offshore pools as seed money without impacting the non-U.S. CPO’s eligibility for the 3.10(c) Exemption.  Taking a pause as opposed to rushing forward has afforded Commission staff additional time to tailor regulatory language so as to avoid confusion and inadvertent loss of longstanding Commission policy aimed at protecting U.S. customers.

While I have some questions and will be interested in hearing from commenters on the specific issues raised with regard to seed money and certain other aspects of the proposal that seem to permeate multiple policy-driven discussions of late, I believe today’s proposal is reasonable, will reduce regulatory burdens without sacrificing key regulatory protections, and is drafted in observance of the high standards for exercising exemptive authority under section 4(c) of the Act.  To that end, I am reassured that the exercise of such authority unequivocally preserves the Commission’s authority outlined in section 4(d) of the Act to investigate a CPO’s compliance with the requirements and conditions of the 3.10(c) Exemption, as proposed, and to bring an enforcement action for any violation of any provision of the CEA or Commission regulations caused by the failure to comply with or satisfy any of the Exemption’s conditions or requirements.[4]  This is in addition to the Commission’s retained authority to take enforcement action against any non-U.S. CPO claiming the 3.10 Exemption based on their activities within the U.S. derivatives markets consistent with our authority regarding market participants generally.

Again, I would like to thank the staffs of DSIO, OGC and the rest of the Commissioners who worked to put forth this proposal.

Introduction

I support the proposal to amend regulation 3.10(c)(3) addressing the exemption from registration for foreign persons who operate commodity pools for customers located outside of the United States (“Proposal”).  The Commission should focus its limited resources on commodity pools in which U.S. persons participate, rather than commodity pools located outside the U.S. in which only non-U.S. persons participate.  The Proposal addresses several specific scenarios in which the registration exemption would apply, and which previously created potential uncertainty for market participants.

I am concerned, however, that the provision in the Proposal that would enable controlling affiliates—U.S. entities with U.S. investors that provide capital to non-U.S. pools—to rely on the exemption could be used by CPOs who take funds directly from U.S. persons to evade the CPO registration and regulatory requirements.  I look forward to reviewing comments on whether that provision is appropriate and whether additional conditions or limitations should apply to prevent such abuse.

Non-U.S. Pools with no U.S. Customers

It is longstanding CFTC policy that an entity that meets the CPO definition and trades commodity interests in our markets is not required to register as a CPO if the entity is located offshore and only operates pools for persons located outside of the United States.[1]  In 2007, the Commission expressly codified the exemption in regulation 3.10(c)(3).  Customer protection is a primary goal of the Commission’s registration and regulatory requirements for CPOs.[2]  The rationale for the exemption for foreign pools has been that the CFTC’s customer protection regulations generally should focus on regulating activities that have an impact on U.S. customers and commerce.[3]  To the extent the commodity pools that would be exempt from registration under the Proposal trade derivatives on U.S. exchanges, those activities are subject to oversight by the exchanges and through the Commission’s exchange regulations.

Since the adoption of the regulation 3.10(c)(3) registration exemption, two developments have increased the need for greater clarity in the rule.  First, changes to CFTC regulations since the 2008 financial crisis, particularly adding swap regulation and placing needed limits on other CPO registration exemptions, have led to a significant increase in the number of pool operators that are technically subject to registration.  Second, the business of commodity investment management has become more global in nature, increasing the complexity of cross border activities by the firms that operate commodity pools.

The Proposal would exempt non-U.S. CPOs from registration and regulation with respect to individual commodity pools that do not solicit from U.S. persons or have U.S. investors.[4]  The Proposal also provides that this exemption for some pools may be used with other exemptions or exclusions permitted under our regulations.  These changes largely reflect the pre-existing policy that non-U.S. CPOs need not register their offshore pools.

The Proposal would provide a safe harbor to the non-U.S. CPOs in the event that U.S. persons become inadvertently invested in the offshore pools.  The Proposal appears to provide adequate conditions on the safe harbor to prevent abuse thereof.  I look forward to comments on whether the proposed conditions should be expanded, reduced, or otherwise modified.

Finally, the Proposal would permit a non-U.S. CPO to rely on the exemption even if a U.S. entity that controls the non-U.S. CPO contributes capital in the initial funding of the exempt offshore pools.  This provision could be beneficial for U.S. fund managers seeking to compete in foreign markets and may be acceptable with appropriate limits. 

I am concerned, however, that the controlling affiliate provision would enable persons in the U.S. to indirectly invest—either knowingly or unknowingly—in unregulated foreign commodity pools.  Under this provision, partnerships and corporations could take in investment funds from U.S. persons and invest those funds in commodity pools operated by non-U.S. pool operators that they “control.”   Neither the controlling affiliates nor the pool operators would be regulated by the CFTC.  The U.S. investors in the U.S. control affiliate would receive none of the CPO disclosures or other protections afforded by our laws and regulations.  In fact, they may never know that the entity they are investing in is placing their funds in offshore commodity pools.  There is no requirement to disclose this information to U.S. persons investing in the controlling affiliate. 

Furthermore, the Proposal permits an unregistered non-U.S. CPO to accept “initial capital contributions” from a control affiliate that is a U.S. person, but does not provide any limitations on the duration or extent of such contributions.  Arguably, under the proposed provision, the controlling affiliate could fund the entire pool investment with funds from U.S. persons and leave that amount in the pool with no time limitation, thus allowing a complete end-run around our CPO regulations.

The Proposal expressly acknowledges that evasion of our CPO rules is possible and says that such evasion would be unlawful.  I want to thank the CFTC staff who drafted the Proposal for working with my office to add some conditions to the provision.  However, I am still concerned there may be insufficient safeguards to prevent abuse.  For these reasons, I requested that several questions be added to the Proposal to address which additional conditions could appropriately be added to achieve the purpose of the provision and still provide sufficient protections to the U.S. investors in the controlling affiliate.  I look forward to the comments on this issue.

Exercising Commodity Exchange Act Section 4(c) Authority

Finally, the Proposal relies on authority provided to the Commission in CEA section 4(c) to adopt exemptions from regulatory requirements if certain public policy goals are better served and if certain conditions are satisfied.  Generally, I am not in favor of using this authority unless no other direct legal authority exists and doing so clearly falls within the intent of Congress in giving the Commission that power.  During the development of the draft Proposal, I raised a number of concerns regarding the use of section 4(c) and I want to commend the CFTC staff for their efforts to address my concerns by more fully explaining in the Proposal why the use of section 4(c) authority is appropriate in this instance.

A little over two months ago, the Commission cancelled a scheduled open public meeting due to the COVID-19 pandemic.[1]  One of the three matters on the agenda for deliberation that day was the most recent amendment to the CFTC Margin Rule, which sought to align the compliance schedule for initial margin or “IM” requirements with recent changes to the BCBS/IOSCO framework extending implementation dates through September 1, 2021.  The Commission ultimately voted to approve a final rule, the April 2020 Final Rule, extending the schedule one year by dividing the last compliance “phase”—which had been phase 5—into two phases, now phases 5 and 6.[2]  The primary stated purpose for the extension was to mitigate the potential for market disruption that could result from the large number of entities—approximately 700—coming into compliance with IM requirements at the same time.[3]  The Commission’s action reflected further efforts to coordinate and harmonize with international counterparts and U.S. Prudential Regulators, who establish the margin requirement for the uncleared swaps of swap dealers and major swaps participants for whom they are the primary regulator.[4]

Today’s interim final rule will amend the CFTC Margin Rule a second time.  The interim final rule will align part of the remaining compliance schedule—phase 5— with recent revisions to the BCBS/IOSCO framework further extending the implementation schedule for the margin requirements for non-centrally cleared derivatives by one year in response to concerns expressed by market participants in the early stages of the COVID-19 pandemic.  The interim final rule does not address the last compliance phase, phase 6, beginning on September 1, 2021.  While a similar extension would preserve both the intent of the recent amendments to the CFTC Margin Rule and consistency with the BCBS/IOSCO framework, the standards for foregoing notice and comment rulemaking procedures under the Administrative Procedure Act[5] are rightfully high and demonstrating separate exigency for the 2021 compliance deadline without notice and comment would be inappropriate given that there is adequate time for the process.  Accordingly, the Commission is focusing its resources on entities that will need relief within the next several months.

I approved the April 2020 Final Rule cautiously; noting that this seminal part of the policy response following the 2008 financial crisis was perhaps becoming even more critical as we collectively faced the uncertainty of COVID-19.[6]  As I highlighted in my statement, in times of market stress and volatility, margin not only provides confidence, but it embodies vigilance when responding to risks and real-world concerns.  While I believed—and continue to believe—that it is important to address transition risks associated with IM implementation, it is nevertheless my expectation that covered entities will work diligently in the time they are given to come into compliance.

I have and continue to be fully prepared to respond to the fallout of current market conditions as a result of the pandemic, and will not hesitate to act within my capacity to preserve market interests and protect customers and market participants, I have no appetite for an indefinite deferral of the final phases for IM implementation.  We are collectively working through the COVID-19 pandemic towards goals of continuity, resiliency, and normalcy. I do not believe that there is any circumstance where that equates to abandonment of core reforms at a time when the very relief being sought is a result of addressing market volatility and stress.

I support today’s interim final rule deferring for one year compliance for the phase 5 swap entities that would come into scope beginning on September 1^st of this year.  I base my decision on representations that the COVID-19 pandemic has severely and adversely impacted preparations for the exchange of regulatory IM.  Such disruption will undeniably make compliance with the September 1, 2020 deadline untenable if doing so diverts already strained resources from critical continuity functions.  I have some concerns that by postponing the compliance deadline, we are inviting increased counterparty risk and the risk of contagion through the additional uncleared swaps that will be entered into during the one year extension period and will not be subject to IM requirements.  Addressing claims for relief due to increased market volatility by delaying margin requirements for a subset of swaps seems counterintuitive, and I am pleased that the Commission is soliciting comments on the matter. I am hopeful that the Commission will take appropriate action if subsequent facts or comments so require.

In closing, I’d like to recognize Commissioner Stump and her leadership as Sponsor of the Global Markets Advisory Committee, which recently adopted recommendations in connection with implementation of the IM requirements for uncleared swaps for the Commission to consider.[7]  Also, I wish to thank the staff in the Division of Swap Dealer and Intermediary Oversight for their diligent and thoughtful work on this interim final rule.