2014 Energy & Commodities Conference Energy & Commodities Conference. ... Company B requests a copy of the interview transcript ... and produce its books and records and answer questions

Cadwalader, Wickersham & Taft LLPwww.cadwalader.com

October 8, 2014

2014 Energy & Commodities Conference

What You Need to Know About Investigations Conducted By Commodity Exchanges and the NFA

Cadwalader, Wickersham & Taft LLP 3

Panelists

• Michael Brosius, Director of OTC Derivatives, National Futures Association

• Erik Haas, Director, ICE Futures U.S. Inc.• Steve Schwartz, Executive Director & Global

Enforcement Counsel, CME Group, Inc.• Athena Eastwood, Cadwalader• Paul J. Pantano, Jr., Cadwalader

SRO Investigations


Are Exchange Investigations on the Rise?

• Types of conduct / transactions that are of particular concern to SROs

• CFTC Regulation 38.151(a) requires a DCM to require its members and market participants to consent to the DCM’s jurisdiction as a condition of market access


Surveillance

• CFTC Regulation 1.52(c)(1)– Each self-regulatory organization must establish and

operate a supervisory program that includes written policies and procedures concerning the application of such supervisory program in the examination of its member registrants for the purpose of assessing whether each member registrant is in compliance with applicable self-regulatory organization and Commission regulations governing minimum net capital and related financial requirements, the obligation to segregate customer funds, risk management requirements, financial reporting requirements, recordkeeping requirements, and sales practice and other compliance requirements.


Investigation Process

• CME Rulebook Chapter 4: Enforcement of Rules– Rule 402: Business Conduct Committee– Rule 407: Investigation, Assignment for Hearing and

Notice of Charges• ICE Disciplinary Rules

– Rule 21.03: Business Conduct Committee– Rule 21.04: Power to Compel Testimony and Production

of Documents• NFA Compliance Rule 3: Compliance Procedures

– Rule 3-2: Investigation


CME Group Enforcement Process


ICE Futures U.S. Disciplinary Process

Market Regulation(combined functions)

•Surveillance: Position limits, EFRPs, LTR, price monitoring

•Trade Practice: Disruptive Trading, Wash Trading,

Money Pass, Block Trading, Cross Trading, Trading Ahead

•Audits: Recordkeeping, Audit Trail

Inve

stig

atio

n R

epor

t/Sup

porte

d S

ettle

men

t

Business Conduct

Committee•Determination of IFUS Rule

violation

•Determination of penalty, in absence of settlement

•Approval of settlement

App

eal o

f BC

C D

eter

min

atio

n

Formal Hearing


Settlements

• Global settlement with SRO and CFTC• CFTC Enforcement Advisory: Cooperation Factors in

Enforcement Division Sanction Recommendations• CME Rule 408(C): Offers of Settlement• ICE Disciplinary Rule 21.11: Settlement Prior to

Commencement of Hearing• NFA Compliance Rule 3-11: Settlement


Hypothetical

• Futures Trader at Company A contacts Broker Bob (who is an AP at a registered IB) to buy a block trade for 50 lots of NG futures at $10.00 per MMBtu.

• Broker Bob calls Futures Trader at Company B to see if she wants to sell a block of 50 lots of NG at $10.00 to Company A. She tells Bob she will call him back.

• Futures Trader at Company B calls her colleague on Company B’s physical natural gas desk (“Physical Gas Trader”), and asks him if he can buy NG in the cash market for less than $10 per MMBtu. He says yes if he transacts now. Without telling Futures Trader at Company B, Physical Gas Trader enters into a forward contract to buy the equivalent of 50 lots of physical natural gas at $9.50.


Hypothetical

• Futures Trader at Company B calls Broker Bob and agrees to sell the block at $10.00 to Company A. Broker Bob tells Futures Trader at Company A that his bid has been lifted by Company B.

• Broker Bob fails to submit the block trade for clearing within time required by the Exchange.

• Company B discovers the timing error in emails from Broker Bob and self-reports the error to the Exchange.


Hypothetical

Company A contacts

Broker Bob to buy block trade

Broker Bob

contacts Company B about selling

block trade

Company B enters

into forward contract

for amount equivalent to block

trade

Company B calls Broker

Bob and agrees to sell block

trade

Broker Bob

submits the trade

for clearing after the deadline

Company B

discovers timing error

Company B self-reports timing

error to the Exchange


Hypothetical

• What would be the Exchange’s response? • What if Company B had reported this to the NFA?


Factual Development

• The Exchange has requested that Company B produce all emails and voice recordings from both Futures Trader and Physical Trader for the week leading up to and including execution of the block trade.

• Company B’s transaction documents and trade capture system appear to show that it entered into the physical trade before agreeing to sell the block trade.

• Company B has determined that it did not retain copies of the emails or voice recordings.


Factual Development

• Futures Trader at Company B calls her buddy at the Exchange to explain the circumstances surrounding the block. Futures Trader did not tell internal legal counsel or compliance that she planned to call the Exchange.

• Same issue for NFA – Broker Bob calls the NFA to explain.


Factual Development

• The Exchange conducts formal interviews of Futures Trader and Physical Gas Trader. Later, Company B requests a copy of the interview transcript from the Exchange. The Exchange declines to provide a copy.

• Same issue for the NFA – assume NFA conducts a formal interview of Broker Bob.


Factual Development

• After the quarterly enforcement call between the CFTC and the Exchange/NFA, the CFTC requests more information from the Exchange/NFA/Company B regarding the block trade and the physical trade.


Factual Development

• The Exchange approaches Company B with a settlement demand of $35,000.

• What is the process for negotiating a settlement with the Exchange?

• Company B is interested in negotiating a settlement with the Exchange, but is worried about additional fines from the NFA and the CFTC. Company B would like to negotiate a global settlement.

10/8/14

CWT Energy Conference Hypothetical – ANSWER KEY

Futures Trader at Company A contacts Broker Bob (who is an AP at a registered IB) to buy a block trade for 50 lots of NG futures at $10.00 per MMBtu.

Broker Bob calls Futures Trader at Company B to see if she wants to sell a block of 50 lots of NG at $10.00 to Company A. She tells Bob she will call him back.

Futures Trader at Company B calls her colleague on Company B’s physical natural gas desk (“Physical Gas Trader”), and asks him if he can buy NG in the cash market for less than $10 per MMBtu. He says yes if he transacts now. Without telling Futures Trader at Company B, Physical Gas Trader enters into a forward contract to buy the equivalent of 50 lots of physical natural gas at $9.50.

Futures Trader at Company B calls Broker Bob and agrees to sell the block at $10.00 to Company A. Broker Bob tells Futures Trader at Company A that his bid has been lifted by Company B.

Broker Bob fails to submit the block trade for clearing within time required by the Exchange.

Company B discovers the timing error in emails from Broker Bob and self-reports the error to the Exchange.

What would be the Exchange’s response?

-2-

What if Company B had reported this to the NFA?

Factual Development:

The Exchange has requested that Company B produce all emails and voice recordings from both Futures Trader and Physical Trader for the week leading up to and including execution of the block trade.

Company B’s transaction documents and trade capture system appear to show that it entered into the physical trade before agreeing to sell the block trade.

Company B has determined that it did not retain copies of the emails or voice recordings.


Futures Trader at Company B calls his buddy at the Exchange to explain the circumstances surrounding the block. Futures Trader did not tell internal legal counsel or compliance that she planned to call the Exchange.

Same issue for NFA – Broker Bob calls the NFA to explain.


The Exchange conducts formal interviews of Futures Trader and Physical Gas Trader. Later, Company B requests a copy of the interview transcript from the Exchange. The Exchange declines to provide a copy.

Same issue for the NFA – assume NFA conducts a formal interview of Broker Bob.


After the quarterly enforcement call between the CFTC and the Exchange/NFA, the CFTC requests more information from the Exchange/NFA/Company B regarding the block trade and the physical trade.


The Exchange approaches Company B with a settlement demand of $35,000.

What is the process for negotiating a settlement with the Exchange?

Company B is interested in negotiating a settlement with the Exchange, but is worried about additional fines from the NFA and the CFTC. Company B would like to negotiate a global settlement.

Answer Key

Generally, block trades must be reported within 15 minutes.

-3-

ICE Block Trade FAQ https://www.theice.com/publicdocs/futures_us/exchange_notices/Block_Trade_FAQ.pdf

CME & CBOT: http://www.cmegroup.com/rulebook/files/cme-cbot-ra1305-3.pdf

NYMEX & COMEX: http://www.cmegroup.com/rulebook/files/NYMEX-COMEX-RA1408-4.pdf

ICE has the power to summon any Member, any employee of any Member and any non-member market participant to appear to give testimony under oath or in any other manner or to produce documents, books, or records. Rule 21.04.

The CME has the authority to inspect books and records and to require a party to appear and produce its books and records and answer questions regarding alleged violations of Exchange Rules. Rule 401.

Each Member and Associate shall cooperate promptly and fully with NFA in any NFA investigation, inquiry, audit, examination or proceeding regarding compliance with NFA requirements or any NFA disciplinary or arbitration proceeding. Each Member and Associate shall comply with any order issued by the Executive Committee, the Membership Committee, the Business Conduct Committee, the Appeals Committee or any NFA hearing or arbitration panel. Rule 2-5.

ICE Rule 21.11 authorizes the Hearing Panel to approve a settlement prior to the commencement of the hearing. With or without admitting guilt, the respondent may agree to a variety of sanctions including fines, suspension, expulsion, and a cease and desist order. https://www.theice.com/publicdocs/rulebooks/futures_us/21_Disciplinary.pdf

CME Rule 408.C authorizes a respondent to submit a written offer of settlement by the Panel. A respondent may submit an offer with or without admitting violations. http://www.cmegroup.com/rulebook/CME/I/4/4.pdf

NFA Rule 3-11 authorizes a respondent to submit a settlement offer to the business conduct committee. https://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE%203-11&Section=4