CFTC APPROVED FOR PUBLICATION RISK CONTROLS AND SYSTEM SAFEGUARDS FOR AUTOMATED TRADING

FROM:  COMMODITY FUTURES TRADING COMMISSION 
CFTC Publishes Concept Release on Risk Controls and System Safeguards for Automated Trading Environments

Washington, DC—The U.S. Commodity Futures Trading Commission (Commission) today approved for publication in the Federal Register a Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (Concept Release).

The Concept Release reflects the Commission’s ongoing commitment to the safety and soundness of U.S. derivatives markets in a time of rapid technological change, and provides a platform for discussion and analysis of the appropriate responses to such changes. The Concept Release provides an overview of the automated trading environment, including its principal actors, potential risks, and responsive measures taken to date by the Commission or industry participants. The Concept Release also discusses a series of (1) pre-trade risk controls; (2) post trade reports and other measures; (3) system safeguards related to the design, testing and supervision of automated trading systems (ATSs); and (4) additional protections designed to promote safe and orderly markets. In each case, the Commission seeks extensive public comment regarding these measures.

The Commission’s Concept Release is driven by U.S. derivatives markets’ fundamental transition from human-centered trading venues to highly automated and interconnected trading environments. The operational centers of modern markets now reside in a combination of ATSs and electronic trading platforms that can execute repetitive tasks at speeds orders of magnitude greater than any human equivalent. Traditional risk controls and safeguards that relied on human judgment and speeds must be reevaluated in light of new market structures. Further, the Commission and market participants must ensure that regulatory standards and internal controls are calibrated to match both current and foreseeable market technologies and risks.

The Commission has already taken steps to address the transition to automated trading and require appropriate risk controls, including within designated contract markets (DCMs), swap execution facilities (SEFs), futures commission merchants (FCMs), swap dealers (SDs) and major swap participants (MSPs). Relevant measures to date include rules requiring FCMs, SDs and MSPs that are clearing member firms to establish risk-based limits for all proprietary and customer accounts, and to use automated means to screen orders for compliance with risk limits when such orders are subject to automated execution. The Commission has also adopted requirements for DCMs that provide direct market access, and trading pause and halt requirements for DCMs and SEFs designed to prevent and reduce the potential risk of market disruptions. Additional measures taken by the Commission, as well as practices already in place within industry participants, are discussed in the Concept Release.

CFTC ORDERS FCSTONE LLC TO PAY $1.5 MILLION PENALTY FOR LACKING DILIGENT SUPERVISON

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

CFTC Orders FCStone LLC to Pay a $1.5 Million Civil Monetary Penalty for Failing to Have Risk Controls, in Violation of Supervision Obligations

Washington, DC - The Commodity Futures Trading Commission (CFTC) today issued an Order filing and simultaneously settling charges against FCStone LLC, a Futures Commission Merchant (FCM) headquartered in New York, New York, for failing to diligently supervise its officers and employees relating to its business as an FCM in violation of Commission Regulation 166.3, 17 C.F.R. § 166.3 (2008). FCStone failed to implement adequate customer credit and concentration risk policies and controls in 2008 and part of 2009, allowing one account (Account) to acquire a massive options position that it could not afford to maintain. Ultimately, FCStone was forced to take over the Account, and lost approximately $127 million. The CFTC Order requires FCStone to pay a civil monetary penalty of $1.5 million, retain an independent consultant to review its internal controls and procedures, and cease and desist from violating its supervisory obligations.

The Order finds that from January 1, 2008 through March 1, 2009, FCStone failed to diligently supervise its officers’ and employees’ activities relating to risks associated with its customers’ accounts, and with the Account, which was primarily controlled by two individuals who traded natural gas futures, swaps, and option contracts. Because FCStone did not have adequate credit and concentration risk policies and controls, the two Account owners accumulated a massive position -- more than 2.5 million relatively illiquid commodity option contracts, which the Account owners could not afford to maintain. After the value of the positions deteriorated over the course of 2008, the Account owners were unable to meet their financial obligations with respect to the Account. As FCMs are required to do in that situation, FCStone assumed the financial obligations to the clearing house that carried the positions. Unable to successfully manage the positions, FCStone ended up suffering $127 million in losses. The Commission found that FCStone violated Regulation 166.3 by failing to diligently supervise in a manner designed to mitigate risks associated with customer accounts, such as the risks arising from unsatisfied margin obligations, negative account balances, and the handling of large relatively illiquid positions.

David Meister, the CFTC’s Director of Enforcement stated, "The Commission’s supervision regulation helps ensure the financial integrity of the markets and safeguard customer funds. When an FCM’s financial risk controls are so lacking that they do virtually nothing to prevent an unchecked customer from taking grossly excessive trading risks as happened here, a harmful domino effect of financially dangerous consequences can follow, affecting not only the FCM but also potentially other customers and the market at large. This case should serve to remind FCMs to make sure that their risk controls are in order."

The CFTC thanks and acknowledges the Securities and Exchange Commission for its assistance in this matter and the CME Group for its cooperation.

The CFTC Division of Enforcement staff responsible for this matter are Joan Manley, Allison Baker Shealy, Traci Rodriguez, George Malas and Paul Hayeck. CFTC staff from the Division of Clearing and Risk and the Division of Swap Dealer and Intermediary Oversight, including Thomas Bloom, Ryan Goodman, Kevin Piccoli and Jan Ripplinger, also provided assistance in this matter.