Securities Regulation Daily Reference to SEC bad actor disqualification waiver overshadows $67.5M settlement of CFTC spoofing charge
Thursday, November 7, 2019

Reference to SEC bad actor disqualification waiver overshadows $67.5M settlement of CFTC spoofing charge

By Mark S. Nelson, J.D.

Tower Research Capital LLC will pay the largest total monetary relief ever imposed by federal regulators in a spoofing case, but two CFTC commissioners strongly criticized the CFTC’s advice regarding waiver of SEC bad actor disqualifications.

The CFTC’s order settling spoofing charges against proprietary trading firm Tower Research Capital LLC "advises" that the SEC’s Regulation D bad actor disqualification should not apply to Tower Research Capital. That statement drew strong criticism from Commissioner’s Rostin Behnam and Dan Berkovitz, who concurred in and dissented from, respectively, the CFTC’s order because they believed the CFTC’s bad actor waiver advice was improvidently given. The bad actor provision overshadowed what is otherwise the largest total monetary settlement of a spoofing case in which Tower Research Capital will pay nearly $67.5 million without admitting or denying the CFTC’s findings. Tower Research Capital also entered into a deferred prosecution agreement (DPA) regarding a single federal criminal charge of commodities fraud (In the Matter of Tower Research Capital LLC, November 6, 2019).

CFTC Chairman Heath Tarbert said, "I’ve been clear that the CFTC will be tough on those who break the rules. This case reflects that commitment as well as the continued importance the agency is placing on parallel efforts with our law enforcement partners." CFTC Enforcement Director James McDonald emphasized the impact of the Towers Research Capital traders on markets: "This misconduct undermines the integrity of the price discovery process and can result, as it did here, in harm to law-abiding market participants."

Federal prosecutors voiced similar themes about the Tower Research Capital case. "Free markets are not open and fair when people criminally manipulate them. Fraudsters like this will be prosecuted. This case also shows the Department’s willingness to resolve cases when industry cooperates and remediates failures of internal controls," said U.S. Attorney Ryan Patrick of the Southern District of Texas in a press release announcing the criminal information and DPA.

Spoofing penalty; cooperation credit. The CFTC’s order alleged that three traders at Tower Research Capital placed thousands of spoofed trades during a nearly two year period in the E-mini S&P 500, E-mini NASDAQ 100, and E-mini Dow ($5) contracts traded on the Chicago Mercantile Exchange and the Chicago Board of Trade (CME Group Inc. owns CME and CBOT). According to the CFTC, the traders placed trades with no intention for the trades to be executed. The traders’ spoofing activities resulted in nearly $32.6 million in market losses.

The CFTC formally charged that Tower Research Capital violated Commodity Exchange Act (CEA) Section 4c(a)(5)(C) regarding spoofing and CEA Section 6c(1) and Regulation 180.1(a)(1) and (3) regarding the prohibition on manipulative and deceptive schemes. According to the CFTC, Tower Research Capital’s traders knew that their trading activities could entice others to trade in the affected contracts by falsely creating the appearance of market depth. Tower Research Capital was held accountable for the traders’ actions under CEA Section 2(a)(1)(B), which imposes liability on principals for their agents’ acts.

The CFTC’s order requires Tower Research Capital to cease and desist from violating the CEA and related regulations. The order also imposes a civil monetary penalty of $24.4 million and orders payment of $32.6 million in restitution and $10.5 million in disgorgement, for a total of $67,493,849 in monetary relief, a record amount for a spoofing case, according to the CFTC. Amounts paid by Tower Research Capital to the CFTC will offset amounts owed to the DOJ under the DPA and vice versa.

Moreover, the CFTC credited the cooperation provided by Tower Research Capital, resulting in the imposition of a reduced civil monetary penalty. The CFTC cited efforts by the firm to provide factual presentations, organize voluminous evidence, and to take numerous remedial actions, including terminating the three traders and bolstering its ability to deter and detect spoofing and manipulation. Federal prosecutors likewise acknowledged Tower Research Capital’s cooperation and remedial efforts.

In the related criminal cases, two of the Towers Research Capital traders have already pleaded guilty to various charges, including conspiracy to engage in wire fraud, commodities fraud, and spoofing. Both traders are due to be sentenced by different judges in the Southern District of Texas in February 2020. Criminal charges are pending in the Southern District of Texas regarding the third trader, a citizen of the People’s Republic of China, who was indicted in October 2018. The DPA regarding Tower Research Capital must still be approved by a judge. Tower Research Capital also must abide by ongoing CFTC cooperation and remediation obligations.

Bad actor waiver and "extreme reservations." The most contentious aspect of the CFTC’s order against Tower Research Capital involved the CFTC’s written advice "that, under the circumstances, disqualification under Rule 506(d)(l) of Regulation D of the SEC, 17 C.F.R. § 230.506(d)(l) (2019), should not arise as a consequence of this Order." Tower Research Capital had requested such advise in a letter referenced in its offer of settlement submitted to the CFTC.

CFTC Commissioner Behnam concurred in the order penalizing Tower Research Capital because of the seriousness of the charges, but he expressed "extreme reservations" about the CFTC advising that the SEC’s Regulation D bad actor disqualification should not apply to Tower Research Capital. Behnam noted that the SEC’s applicable regulation added the CFTC to the list of agencies whose enforcement actions could trigger disqualification. Previously, Dodd-Frank Act Section 926 had omitted the CFTC from this list and instead focused on state securities, banking, credit union and insurance authorities, federal banking agencies, and the National Credit Union Administration. Behnam also observed that the CFTC’s advice may be premature and should not have been part of settlement negotiations with Tower Research Capital because the SEC’s regulation does not require such advice to be given in an agency final order (the SEC’s regulation states the timing should be "before the relevant sale").

Behnam also suggested a division of labor between the SEC and the CFTC. "However, given the gravity of Tower’s actions, which involved unprecedented levels of spoofing, I am not comfortable advising the SEC that the automatic disqualification should not apply. In instances of this magnitude, where fraud and abuse harmed market integrity and market participants, the SEC should be the sole authority regarding whether or not a waiver should result." Behnam later said the SEC’s regulation adds complexity to the CFTC’s enforcement mission: "In short, the SEC is best suited to issue waivers to its market participants from its rule; not the Commission."

CFTC Commissioner Berkovitz dissented from the order against Tower Research Capital, although he did agree with the imposition of penalties on the firm. For Berkovitz, the question is about the SEC’s legal authority to confer the bad actor waiver advice option on the CFTC. "Because there has been no delegation by Congress to the CFTC to administer the registration of securities, including determining which firms should be exempt from registration requirements, the CFTC’s determination that Tower should not be disqualified from certain registration requirements under the Securities Act is ultra vires—it has no legal effect," said Berkovitz.

With respect to the "complexity" Behnam wrote of, Berkovitz was more explicit: he said firms will not agree to settle CFTC charges unless the CFTC agrees to include its advice on SEC bad actor waivers. According to Berkovitz, this state of affairs results in delaying CFTC enforcement actions and puts the CFTC, a "derivatives regulator," in the driver’s seat on matters outside its jurisdiction.

Berkovitz also noted the recent history of the CFTC’s advice on bad actor disqualification waivers and the key role played by former SEC Commissioner Kara Stein, who dissented from an SEC order granting Deutsche Bank AG a waiver from the bad actor bar on well—known seasoned issuer or WKSI status. Stein had complained that WKSI waivers are too freely granted, especially in the case of Deutsche Bank, which had been involved in criminal conduct regarding LIBOR manipulation and was receiving its third WKSI waiver in eight years. Stein also had remarked on the "loophole" in SEC rules invoked in the CFTC’s advice that prevented the related Regulation D bad actor waiver from coming before the SEC in the Deutsche Bank matter: "It is unclear to me what, if any, analysis went into this decision and what prompted the CFTC to insert language into its final order stating that a bad actor disqualification ‘should not arise as a consequence of this Order.’"

Berkovitz added that the CFTC had provided its bad action waiver advice in settlements after the SEC adopted rules implementing its Dodd-Frank Act bad actor disqualification authorities, but that the CFTC stopped including such language in its settlements after Stein published her Deutsche Bank dissent. Berkovitz said the CFTC again started including bad actor waiver language in its settlements in 2018, in his view, likely to speed CFTC enforcement matters.

The order is No. 20-06.

Companies: Tower Research Capital LLC

MainStory: TopStory CFTCNews CommodityFutures Derivatives DoddFrankAct Enforcement FedTracker Securities FraudManipulation RiskManagement SecuritiesOfferings Swaps

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