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CFTC’s First Enforcement Action Against an Exchange (NYMEX) for CEA Violations

On August 4, 2020, the Commodity Futures Trading Commission (the “CFTC”) announced that the Honorable Vernon S. Broderick of the U.S. District Court for the Southern District of New York entered a Consent Order approving a partial settlement in a case brought by CFTC in 2013 against several defendants for violations of the Commodity Exchange Act (“CEA”).

Consent Order

General

The Consent Order resolves allegations against two high-level officials at the New York Mercantile Exchange (“NYMEX”), one of the most widely-used commodity futures and options exchanges, for using their positions to disclose nonpublic information to a broker of energy futures options. Because both employees were acting as agents and employees of NYMEX at the time of the alleged conduct, the Consent Order also holds NYMEX vicariously liable for the misconduct under Section 2(a)(1)(B) of the CEA, which allows the CFTC to bring charges against a principal for the acts of its agent – in this instance, NYMEX.

NYMEX and its Senior Employees

Disclosure of Material Nonpublic Information and other CEA Charges

The CFTC’s complaint charged William Byrnes and Christopher Curtin of willfully and knowingly disclosing material nonpublic information about NYMEX trading and customers in violation of CEA Section 9(e)(1). The complaint also charged NYMEX with a violation under CEA Section 2(a)(1), as Byrnes’ and Curtin’s disclosures had occurred within the scope of their employment. Ron Eibschutz, a commodity broker, was also charged under CEA Section 13(a) for aiding and abetting Byrnes’ and Curtin’s disclosures.

As alleged in the 2013 complaint filed by the CFTC, the two insiders, Byrnes and Curtin, used their positions as employees of NYMEX to acquire and unlawfully disclose material non-public information to the commodity broker on numerous occasions during the Great Recession. The disclosures pertained to trading activity in options on commodity futures, principally in the crude oil and natural gas markets.

According to the complaint, Curtin voluntarily resigned from his position in 2009. Byrnes’ conduct continued until his termination by NYMEX in 2010. Prior to his termination, Byrnes was awarded a promotion and was even tasked with training other employees on NYMEX’s confidentiality policies, despite NYMEX having received customer complaints that specifically accused Byrnes of disclosing confidential information.

Penalties

The Consent Order imposes a $4 million civil monetary penalty on each of the NYMEX defendants, with the two insiders’ liability capped, respectively, at $300,000 and $200,000. In addition to the civil monetary penalty, NYMEX and the employees are each forbidden from committing any future violations of CEA Section 9(e)(1), and the employees specifically are permanently barred from the commodities trading industry.

Commodity Broker

Solicitation of Nonpublic Information Disclosure

For his part, the commodity broker is alleged to have actively solicited and encouraged the disclosures by the senior NYMEX employees. In exchange for the material non-public information, the commodity broker allegedly provided one of the NYMEX employees with meals, drinks, and entertainment on multiple occasions.

Magistrate Referral

The Consent Order resolves allegations against NYMEX and its senior employees, but not the commodity broker, whose case has been referred to a Magistrate Judge for additional mediation and settlement proceedings.

Background

NYMEX

NYMEX, which was founded in 1882, is the world’s largest physical commodities exchange dealing in futures. NYMEX is part of the CME Group which, according to the CME Group, is the world’s leading and most diverse derivatives marketplace.

NYMEX handles numerous commodities including in the following areas: (i) fuels (e.g., crude oil (including benchmark WTI and Brent), natural gas, gasoline, fuel oil, jet fuel, diesel, biodiesel, ethanol, coal, and coking coal); (ii) electric load capacity; (iii) emissions (e.g., California and European Union greenhouse standards); (iv) certain precious metals (e.g., silver, platinum, palladium); (v) certain agricultural products (e.g., cocoa, cotton); and (vi) freight.

CME Group

CME Group is made up of three other exchanges – the Chicago Mercantile Exchange (“CME”), the Chicago Board of Trade (“CBOT”), and COMEX.

CME handles, among other things, interest rate, derivatives, currency, and Treasury products; CBOT is responsible for agricultural, interest rate, and equity index products; and COMEX focuses on precious, base and ferrous metals trading.

Clearing/Settlement Services

As alleged in CFTC’s complaint, NYMEX operates CME ClearPort, a platform that provides clearing and settlement services for exchange-traded contracts and over-the-counter derivatives transactions. There are more than 1,000 energy, metals, and agricultural commodities contracts available for clearing on ClearPort. By using the platform, NYMEX customers are able to clear futures and options transactions, resulting in the deposit of confidential information relating to upcoming trades. According to ClearPort’s customer user agreements, customer data regarding trades and other information can only be disclosed to third parties in order to facilitate the customer’s transactions.

Improper Activities

CFTC’s complaint alleges that as high-level employees of NYMEX – Byrnes was a supervisor on the ClearPort Facilitation Desk and Curtin was the Associate Director of the Globex Control Center – Byrnes and Curtin had access to information that the commodity broker was not privy to. For example, the senior NYMEX employees had access to confidential information, including the names of the entities and individuals trading particular contracts and the size or price of individual transactions. Additionally, the complaint also alleged that one of the senior NYMEX employees provided the commodity broker with the identities of the parties to specific trades, the identities of the brokers that entered trades into the systems, the side of each party to the trades (buy or sell), the number of contracts traded, prices and the structure of particular transactions, and trading strategies used in particular transactions, as well as information relating to futures and options positions of particular market participants.

According to the complaint, these senior employees used their access to acquire this confidential information provided by NYMEX’s customers and, subsequently, disclose it to the commodity broker in violation of federal law. In addition, these disclosures violated NYMEX’s own internal policies relating to customer confidentiality and CME’s Code of Conduct, which recognizes that trade data of the type that the employees disclosed is nonpublic information that must be kept confidential.

On more than sixty occasions, one of the senior NYMEX employees is alleged to have disclosed material non-public information from ClearPort to the commodity broker. On several of those occasions, this NYMEX employee disclosed information using a NYMEX-issued phone that he allegedly knew was monitored and recorded. In fact, this employee allegedly instructed the commodity broker not to call him on the company phone and frequently stated that he would call the commodity broker back on an unrecorded line.

Ongoing Compliance Practices

What is particularly troubling is that NYMEX is a clearinghouse that is supposedly less subject to manipulation than trades that are not cleared. According to the CME Group, its Market Regulation Department conducts trade, position, account, and market surveillance to identify and prevent potential rule violations and ensure that all four of its exchanges – NYMEX, CME, CBOT, and COMEX – fulfill these self-regulatory responsibilities.

The case demonstrates the hazards of disclosing material non-public information in the commodities trading industry, as well as the severity with which the CFTC views those acts. Participants in such transactions would be well-advised to retain experienced legal counsel to develop internal compliance systems that prevent brokers from using meals, drinks, and entertainment to obtain information they should not be given. This is an ongoing case, and the resolution that is ultimately reached as to the commodity broker’s portion of the case will provide additional guidance to participants in transactions involving commodities trades.

Further CFTC Guidance on Factors Used in Evaluating Corporate Compliance Programs

On September 10, 2020, the CFTC issued a memorandum titled “Guidance on Evaluating Compliance Programs in Connection with Enforcement Matters” (the “Guidance”). This is the first such guidance issued by the CFTC. The Guidance highlights that when the CFTC is evaluating a compliance program, it will focus on whether the program was reasonably designed and implemented to prevent misconduct, whether it was intended to and is able to detect misconduct and, lastly, what mechanisms are in place to remediate the misconduct.

According to the Guidance, at every phase of its evaluation, the CFTC will conduct a risk-based analysis and take into consideration the specific entity involved, its role in the market, and the potential market or customer impact of the underlying misconduct. In considering remediation, the CFTC will focus on whether (i) the impact of the conduct was adequately addressed, (ii) the individuals involved in the misconduct were appropriately disciplined, and (iii) compliance program deficiencies were identified and addressed.

Ultimately, however, the release teaches a more fundamental lesson – that the CFTC expects exchanges and other integral market players to uphold their mandate to act as responsible financial participants. Thus, the key takeaway of the Guidance, as well as the NYMEX Consent Order, is clear – exchanges and other significant financial institutions must ensure that their compliance programs can (and do) deter bad behavior and foster a culture of compliance to assure the integrity of worldwide financial markets.[1]

In the absence of comprehensive compliance development and continuous monitoring programs, these participants risk substantial enforcement actions.

 


[1] On October 7, the Office of the Comptroller of the Currency and the Federal Reserve Board issued orders addressing significant ongoing deficiencies in Citigroup’s risk management and internal control systems. Among other things, the orders require Citigroup to prepare a data governance action plan. This requirement may have been prompted by Citi’s deletion, due to a known design flaw, of 2.77 million audio files in 2018 that included trader recordings responsive to a CFTC subpoena issued in 2017 as part of an ongoing investigation. Citi had previously assured the CFTC that such subpoenaed recordings were being preserved. See CFTC Release No. 8257-20.

For additional guidance on how prosecutors are evaluating compliance programs, click here for an analysis of the September 29, 2020 deferred prosecution agreement that resolved criminal market manipulation charges against JP Morgan Chase & Co.

Contacts

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