COURT ORDER PERMANENTLY BARS DEFNEDANTS FROM COMMODITY INDUSTRY

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

Federal Court in New York Orders Defendants Forex Capital Trading Group, Forex Capital Trading Partners, and Highland Stone Capital Management to Pay over $1.8 Million for Fraud in Off-Exchange Foreign Currency Scheme

Court order permanently bars defendants from the commodities industry

Washington, DC - The U.S. Commodity Futures Trading Commission (CFTC) today announced that Judge Katherine B. Forrest of the U.S. District Court for the Southern District of New York entered a default judgment and permanent injunction order against defendants Forex Capital Trading Group, Inc. (Forex Group), Forex Capital Trading Partners, Inc. (Forex Partners), both of New York, N.Y., and Highland Stone Capital Management, L.L.C. (Highland Stone) of Rutherford, N.J. The order requires these defendants to pay a civil monetary penalty of $1,352,293 and to disgorge $450,764 of ill-gotten gains for the benefit of defrauded customers. The order also imposes permanent trading and registration bans against the defendants and prohibits them from violating the Commodity Exchange Act and CFTC regulations, as charged.

The order stems from a CFTC anti-fraud enforcement action filed on July 27, 2011 against these three companies and their principals (see CFTC Press Release 6083-11, July 28, 2011). The order finds that Forex Group, Forex Partners, and Highland Stone fraudulently solicited 106 customers who invested more than $2.8 million to trade retail foreign currency (forex). In soliciting customers, the defendants falsely claimed, on their websites and elsewhere, that their forex trading for customers was profitable for a period of several years, the order finds. The defendants’ claims included a falsely reported customer gain of 51.94 percent in 2010, a year, in fact, in which their customers lost more than $1.2 million. Overall, customers lost more than 93 percent of their total invested principal through the defendants’ forex trading, the order finds.

The order also finds that the defendants distributed false account statements to prospective customers showing profitable trading and acted in capacities requiring registration with the CFTC, but were not registered.

The CFTC’s litigation is continuing against the principals of Forex Partners and Forex Group, namely Susan G. Davis of Jersey City, N.J., and David E. Howard II, of New York, N.Y., and against the principal of Highland Stone, Joseph Burgos, of Rutherford, N.J.

The CFTC appreciates the assistance of the U.K. Financial Services Authority in this matter.

CFTC Division of Enforcement staff members responsible for this action are Susan B. Padove, Joy McCormack, Elizabeth Streit, Michael Geiser, Janine Gargiulo, Scott Williamson, Rosemary Hollinger, and Richard B. Wagner.

CFTC CHARGES MAN/COMPANY WITH EMBEZZLEMENT BY PONZI SCHEME

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

CFTC Charges North Carolina Resident Michael Anthony Jenkins and his Company, Harbor Light Asset Management, LLC, with Solicitation Fraud, Misappropriation, and Embezzlement in Ponzi Scheme

Defendants charged with fraudulently soliciting and accepting at least $1.79 million from approximately 377 persons

In a related criminal action, Jenkins was indicted for securities fraud and is in custody awaiting trial

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing of a federal civil enforcement action in the U.S. District Court for the Eastern District of North Carolina, charging Michael Anthony Jenkins of Raleigh, N.C., and his company, Harbor Light Asset Management, LLC (HLAM), with operating a Ponzi scheme for the purpose of trading E-mini S&P 500 futures contracts (E-mini futures). From at least January 2011 through January 2012, the defendants fraudulently solicited at least $1.79 million from approximately 377 persons, primarily located in Raleigh, N.C., in connection with the scheme, according to the complaint.

The CFTC complaint also charges Jenkins, the owner and President of HLAM, with embezzlement and failure to register with the CFTC as a futures commission merchant. Furthermore, Jenkins allegedly misappropriated $748,827 of investors’ funds to trade gold and oil futures, stock index futures, and E-mini futures in his personal accounts. Jenkins also used misappropriated funds to pay for charges at department and discount stores and gasoline stations, and for cellular phone bills and airline tickets, according to the complaint.

The CFTC complaint, filed on November 20, 2012, alleges that HLAM’s Investment Agreement falsely represented to investors that their investment was solely for investing in E-mini futures and that investors’ funds would be immediately wired to a specific trading account. However, according to the complaint, most of investors’ funds were misappropriated by HLAM and Jenkins. To conceal and continue the fraud, Jenkins allegedly sent trading spreadsheets and statements to investors that falsely reported trades and profits earned and inflated the value of investments. The defendants’ fraudulent conduct resulted in a loss of approximately $1.3 million in investor funds, consisting of $1.16 million in misappropriated and embezzled funds and $140,000 in trading losses, according to the complaint.

In its continuing litigation, the CFTC seeks restitution, return by Jenkins and HLAM of all ill-gotten gains received, civil monetary penalties, trading and registration bans, and permanent injunctions against further violations of the Commodity Exchange Act, as charged.

In a related criminal action by the Securities Division of the North Carolina, Department of the Secretary of State, Jenkins was indicted on August 20, 2012 on three counts of securities fraud in The General Court of Justice, State of North Carolina, Wake County, and is in custody awaiting trial.

The CFTC appreciates the assistance of the Securities Division of the North Carolina Department of the Secretary of State.

CFTC Division of Enforcement staff members responsible for this action are Xavier Romeu-Matta, Nathan B. Ploener, Christopher Giglio, Manal Sultan, Lenel Hickson, Stephen J. Obie, and Vincent A. McGonagle.

CFTC COMMISSIONER CHILTON SPEECH TITLED "THE OBSERVER EFFECT"

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

"The Observer Effect"

Commissioner Bart Chilton’s Speech to Risk USA 2012, New York, NY
November 14, 2012
Introduction

Good morning! It’s good to be with you today. Thank you for the kind invitation. Let’s do something a little unconventional this morning. Let’s talk about science as our guidepost for what’s going on with financial regulatory reform under Dodd-Frank—that is: the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. As part of that, we will of course want to talk risk—a reason you’re here at Risk USA.

As we get started, I’ll remember Albert Einstein’s quote: "You do not really understand something unless you can explain it to your grandmother." So, I’ll try to keep the science and the financial markets stuff pretty straightforward.

The Catalyst

Maybe a little review will help set the stage for where we are. We all know that in 2008, we began experiencing the most disastrous economic meltdown since the Great Depression—a colossal collapse. The catalyst for all that was two-fold, according to the congressionally established Financial Crisis Inquiry Commission, or FCIC: Regulators and regulation, or lack thereof; and the captains of Wall Street who took advantage of the lax rules and regulations. Those two things together caused a reaction that created the economic chaos, our Great Recession. Institutions that were thought to be too big to fail—failed. Taxpayers were stuck with a hideous bailout. Nine million people lost their jobs and millions more their homes. It was an economic force that created havoc of which we’re still trying to pull our way out.

Fundamental Forces

That fundamental economic force led to the creation of something novel: Dodd-Frank. Now scientists, I mean regulators, are in the process of implementing that financial reform. I will be the first to admit to you that it’s been a slow process. But there were 398 rules that needed to be put into test tubes and experimented with before they were deemed appropriate. Of those 398 Dodd-Frank rules to be promulgated under the Act, only about 33 percent are complete. We at CFTC have done a little better with our experiments, having completed about two-thirds of our 60 rules. One thing is for sure, all of these rules, these different experiments, are in one way or another, inter-connected, regardless of which agency is writing them. They are not done in isolation.

The Observer Effect

Now then, maybe a little physics review is in order. No need to take notes. You won’t be tested. There’s a term in physics called the "Observer Effect." Anybody heard of it? It refers to changes that the very act of observation causes when any phenomenon is being observed. It makes sense, really. Sometimes the very instruments used to observe something create the change. Think of a really simple example. If you go to check the air pressure in your tires—at least if you’re like me—it’s almost impossible not to let a little air out first when you put the gauge on the valve stem. So do you get a perfect reading? It’s probably a very close reading but the observer effect prevents it from being perfect. The same is true when you take your temperature. The mercury in the thermometer changes ever so slightly throwing off the result in a minuscule way. It’s so small that it’s not even observable to us.

Bear with me. In financial reform too, there is an observer effect. While it may not look like it, the Dodd-Frank implementation experiment is coming together a piece at a time. And what’s going on is influenced to a large extent by an observer effect. First, the rules aren’t written in a vacuum. Public comments are collected from interested observers. Other agencies and even brethren regulators in other countries are consulted. Whenever those things occur, rules and regulations are bound to change from those originally envisioned.

So, now let me go through all 60 rules and show you how the observer effect has affected them—just joking. What we can do is to summarize the types of things we are doing and put them into three categories: Transparency, Market Integrity and Accountability.

1—Transparency: Has anyone heard of the Snellen Scale? It’s the eye chart you read when you visit the optometrist. Well, for years hundreds of trillions of dollars’ worth of trading taking place in the over-the-counter (OTC) space was totally off the chart. We regulators couldn’t see it. We needed an eye chart. Fortunately, Dodd-Frank has provided us with one. After all, it was those very markets that were a major part of the problem that caused those two catalysts (that we discussed earlier) to react.

To put it in perspective, the CFTC previously regulated around $5 trillion in annualized trading on registered exchanges. That was our universe. OTC trading, however, accounts for upwards of $650 trillion! Off the chart again! That’s globally, to be fair, but a lot of it is here in the U.S.

With Dodd-Frank, that OTC trading will be conducted on regulated exchanges—many on Swaps Execution Facilitates, or SEFs. Swap Data Repositories, or SDRs, will—guess what—collect data. Those SDRs will afford the transparency in the particular markets that got us into trouble in 2008.

2—Market Integrity: Like in scientific experiments, you can’t be sure of your results until you have integrity in your testing regime. Same is true for markets. They need integrity to be worth much. Therefore, we also want to guarantee that people don’t take risks that undermine the integrity of markets or the entire financial system.

Risk is part of markets; you guys know that better than anyone. Folks should be able to take as much risk as they’re comfortable with. But, if they give themselves too much rope and hang themselves with it, the whole economy can’t be left swinging, too. Therefore, we’re instituting new capital and margin requirements and clearing.

Most of us want markets to perform the fundamental functions originally envisioned: to manage risk and discover prices. That’s good for commercial hedgers and, ultimately, it is good for consumers—heck it’s good for scientists!

One area under market integrity I’ll just mention quickly is speculative position limits. As some of you may know, this has been a particular area that has concerned me. We suffered a little setback in court last month. All I’ll say now is that we need to appeal the court’s ruling and I expect we will do so very soon. Simultaneously, we need to propose a new, revised position limits rule. There’s no reason for a long comment period. We already received more than 13,000 comment letters so we have a good idea of what people think.

I’m convinced, as are a lot of other folks, that there can be a speculative premium in markets and that skews the price discovery tenet of them and that’s not a good thing. So yes, for my part, I’ll keep fighting for position limits.

3—Accountability: The third and final Dodd-Frank grouping is accountability. Once a scientist has demonstrated something, he or she wants to put it out for peer review. It needs to be subject to the views of others. Similarly we need to listen to others as we oversee these financial markets. Here’s a question I’ve listened to many times: why is it that nobody went to prison for what took place in 2008? Unfortunately, the answer is that nobody violated the law. Well, that’s changing with Dodd-Frank. There will now be financial firm accountability, and not a moment too soon.

Most of us can’t even keep track of all the shenanigans going on in the financial sector. We saw both Goldman Sachs and Citi establish these fake-out funds where they pressed their customers to participate, then, once the fake-out funds were populated with their own customers’ money, the banks themselves took the opposite positions. There’s something wide of the scale with that. Wells Fargo entered into a $175 million settlement with the Department of Justice for charging higher fees and rates to minority customers. Barclays attempted to manipulate Libor rates. And of course, there’s MF Global where, oops, millions-and-millions of customer bucks went missing. And, there’s Peregrine Financial Group which appears to have been a $200-plus million fraud.

There are a lot of other examples of what the financial market mad scientists have done, but I bring up those few to illustrate why accountability is the needed third leg of the stool under Dodd-Frank.

Just recently, we proposed a package of accountability and customer protection rules. I’m not going to get into the technicalities of each of those proposals due to time, but suffice it to say we need them and need them now.

Insurance

There is, however, one thing that we cannot do to help futures customers. This can only be done by Congress. That is: a futures insurance fund.

How unfair is it that MF Global security customers were paid first compared to the futures customers? How unfair is it that banking and security customers both have insurance funds, yet, if you’re a futures customer, you’re outta luck.

Up until MF Global and Peregrine, I suppose people would argue there has never been a problem and that the remedy was not needed. Well, that’s a tough argument to make now. People were really harmed and I think it is irresponsible that there is not such an insurance fund for futures customers.

So that’s the big three: transparency, market integrity and accountability.

A Culture Shift

While Dodd-Frank will go a long way toward remedying the chaos created in 2008 and beyond, it won’t address all of the ills in our financial system…unfortunately. We also need a little observer effect to change the culture of Wall Street. That may mean that people should walk with their wallets if they don’t want to do business with poor corporate citizens. That’s a hefty mandate, but one that I believe is absolutely necessary. Let me explain.

I’ve been suggesting that we engage in a culture shift conversation, a shift in focus in our financial sectors. Both the government and the private sector need to be in on the discussion. This isn’t a very scientific discussion I’m suggesting. It is more about morality and good business ethics and practices. After all, government can’t regulate morality. The cultural mindset in many financial firms is something that needs to change.

What I’m suggesting is simply an effort to improve the system and move away from the Gordon Gekko "greed is good" culture in which we appear to, on many occasions, be sliding into. It will take some time and should take place in executive suites, board rooms, lunch rooms, hearing rooms, and perhaps even in court rooms.

Compensation Systems

So, what’s to be done? Well, for one, just look at the bonuses and compensation structures of these large financial firms. Of the firms I mentioned earlier, many of their CEO’s were paid extravagant amounts in 2011—from $10 to $23 million. So, they are being rewarded for how they have been operating. Way to go.

However, it surely isn’t just the people at the top. The difficulty is more deeply-rooted at firms. Lots of times, firms have been rewarding the cowboy traders. Did you read last week about the high-flying UBS trader who lost billions in London? His compensation rose dramatically, totally based upon a bonus and compensation system of rewarding high-flying trades. The problem there was he wasn’t really making money—sort of like the London Whale with JP Morgan earlier this year. There is something called a "failure to supervise" on the part of firms. Not sure what is up with the firms on these things. But the larger point is that the traders have been propelled by a compensation and bonus system which is out of whack. The firm’s short-term profit motive has been so fantastically strong—for the next quarter or next year—that they have been risking their entire firm’s reputation and existence on short-term gain.

The irony is this belief system of "profit is everything" won't generate the long-term gains the firm shareholders seek. I’m sure the boards are smarter than to only see a few months ahead. What they want is sustainable longer-term economic business growth.

Hiring and Recruitment

Here’s another thing. Rather than hiring a lot of cowboy traders, how about getting more risk professionals—those actually good at risk management. That means recruiting and hiring strategies need to change.

There needs to be a better sense of balance between profit and risk centers. The executive suite folks need to understand and create this balance as part of the corporate culture.

Government
As I said, government can’t be culture cops and mandate morality in financial firms, but we can set the stage for avoiding bad behavior. More importantly, we can incentivize good behavior through our laws, rules and regulations. The Dodd-Frank Act goes a long way in this regard. Specifically, we can help establish an environment in which these firms operate with appropriate transparency, integrity, and standards of conduct.

And finally, in order to help spur this culture shift conversation, we need to re-focus ourselves as regulators on fines and penalties that actually mean something. Fines can’t simply be a cost of doing business. Government is strapped for funding and that means we don’t have the staff to do all that we would want. We could use more investigators and attorneys. The cost of us not having adequate resources is that we often would prefer to enter into a settlement with a firm or individual that has violated the law. That saves us scarce resources. At the same time, the nogoodniks know our deal and they continually try to low-ball on settlement amounts. They have done such a good job; executives at firms are making crude calculations about fines. When the fine is minuscule compared to what can be gained through the illegal activity, that’s not a true deterrent. Merrill Lynch, for example, over-charged their own customers for debit and over-draft fees by $32.2 million. The fine (and this was not the CFTC) was only $2.8 million. That seems like an economic no-brainier. Government needs to do better and we don’t need any scientific experiments to tell us so.

The New Frontier: SEFs
Finally, let’s discuss the Swaps Execution Facility rule.

First (my attorney always makes me say this) I’m not pre-judging what the Commission will do on this rule. I’m just going to comment on about my preferences—which, of course, happen to be correct.

This challenge is really different from just about any experiment we’ve ever conducted. It’s not like drafting regulations for the securities and futures markets that were already well-established when rules governing them were put in place. In this instance, while we had a robust swaps market in the U.S., prior to Dodd-Frank, we did not have a system making the platforms registered entities. Therefore, it’s been a challenge to design the right rules, to carry out the intent of Congress and to ensure that systems intended to be covered by the law are not over- or under-regulated.

For me, ensuring that existing systems, like appropriate voice brokerage, can continue to be used in the SEF environment, is crucial. I also want to ensure that processors—those folks who were truly just facilitating trading, not actually hosting the trading—don’t fall under the SEF umbrella. Again, that’s not what Congress intended. Finally, under the law we are not only supposed to ensure pre-trade price transparency, but at the same time we are to promote the trading of swaps on SEFs. Neither goal outweighs the other. If we pass a final rule which embodies these things, we will have done a good job in my view. And this experiment will be a success not for just a short time, but SEFs will exist for a long time. So, I’m looking forward to getting this final rule out, and moving on from there.

Conclusion
It has been a pleasure to be with you and run through all of these issues. I know it is a lot, but as you may have observed, there’s a lot going on in our markets today and a lot being done in financial regulatory reform.

Maybe you can recall another Einstein quote: "The world is a dangerous place to live; not because people are evil, but because of the people who don’t do anything about it." I’m glad you guys are here and are involved in all of this. I commend you.

We’re trying to make the implementation process as transparent—as observable—as possible. We had a financial crisis caused by those catalysts – government and Wall Street. The effect was Dodd-Frank. Our work is to ensure that the new law addresses the problems in an appropriate fashion. To use another scientific rule, that there is an equal and opposite response. As I’ve tried to illustrate, the pieces of financial reform are relative to one another and relevant to all of us. I hope that in the not too distant future, we can observe this period as having been a crucial time for improving our markets and thus, the economic engine of our democracy.

Thank you.

　

THE GOLD BUG AND ALLEGED FRAUD

Photo Crdit:  U.S. Marshals Service
FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

CFTC Charges Floridian Christopher Smithers with Fraud in Connection with Commodity-Related Activities and Violations of a Federal Court’s Prior Orders

Smithers allegedly defrauded customers in trading commodity futures contracts and in the purchase of gold bullion

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that it filed a federal civil enforcement action in the U.S. District Court for the Southern District of Florida charging Christopher Smithers of Jupiter, Florida, with fraud in connection with his commodity-related activities in violation of the Commodity Exchange Act (CEA) and CFTC regulations. The CFTC complaint also charges Smithers with violating two prior U.S. District Court orders that, among other things, permanently prohibited Smithers from engaging in any commodity-related activities.

According to the complaint, filed on October 22, 2012, from at least October 2008 to March 2009, Smithers committed fraud by misrepresenting to customers that his commodity futures trading was profitable when it actually resulted in losses of $220,000. From June 22, 2011 through November 2011, Smithers allegedly falsely represented to various futures commission merchants the identity of the person who opened and controlled commodity trading accounts. Smithers made such misrepresentations to circumvent prior U.S. District Court orders that prohibited him from trading commodity futures contracts, according to the complaint.

The complaint also alleges that in 2011 Smithers misappropriated $162,980 of a customer’s funds that were provided to him for the purchase of gold bullion and that he used the funds for personal expenditures. Finally, during 2011, Smithers fraudulently solicited a customer for funds with which to trade commodity futures, according to the complaint.

The complaint alleges that Smithers’ commodity futures trading was in violation of two previous U.S. District Court for the Southern District of Florida orders of permanent injunction entered against him in CFTC v. Matrix Trading Group., Inc., David Weeden, and Christopher Smithers, Civil Action No. 00-8880-CIV-ZLOCH (S.D. Fla. Oct. 3, 2002) and CFTC v. Christopher Smithers, Prosperity Consultants, Inc., and Jack Smithers, Case No. 05-80592-CIV-Hurley (S.D. Fla. Nov. 6, 2006).

The CFTC complaint seeks civil monetary penalties and injunctive relief against Smithers.

CFTC Division of Enforcement staff responsible for this case are Harry E. Wedewer, Dmitriy Vilenskiy, Danielle E. Karst, John Einstman, Paul G. Hayeck, and Joan M. Manley.

DEFENDENTS PERMANENTLY FORBIDDEN FROM WORKING IN COMMODITIES INDUSTRY

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION,

Federal Court Orders Robert A. Christy and His Company, Crabapple Capital Group LLC, to Pay over $2.6 Million in Monetary Sanctions for Foreign Currency Fraud

Court permanently bars defendants from commodities industry

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that it obtained a federal court order requiring defendants Robert A. Christy of Milton, Ga., and his company, Crabapple Capital Group LLC (Crabapple) of Alpharetta, Ga., to pay over $2.6 million in monetary sanctions for foreign currency (forex) fraud.

Specifically, the order requires the defendants to pay a $1,541,882 civil monetary penalty and $1,099,598 in restitution to settle CFTC charges that they operated a forex commodity pool fraud, misappropriated customer funds, and made false statements to the National Futures Association (NFA). The order also imposes permanent trading and registration bans against the defendants and permanently prohibits them from violating the Commodity Exchange Act and CFTC regulations, as charged.

The order, filed on October 16, 2012, by Judge Richard W. Story of the U.S. District Court for the Northern District of Georgia, stems from a CFTC anti-fraud enforcement action filed against Christy and Crabapple on April 19, 2012 (see CFTC Press Release 6242-12, April 25, 2012).

The order finds that, from at least October 2008 through April 2012, the defendants defrauded 22 individuals who contributed $1,416,000 to an investment pool operated by Crabapple to trade forex. In the course of soliciting investors, according to the order, the defendants’ statements to pool participants regarding the defendants’ forex trading performance were completely false. Christy misrepresented Crabapple’s trading performance history and experience and advertised regular monthly trading profits when, in fact, Crabapple had experienced consistent and significant losses, the order finds.

The order also finds that the defendants misappropriated most of the pool participants’ money. Christy treated Crabapple’s checking account as his personal piggy bank, using the money in the account for a variety of personal, business, and marketing expenses, even though the defendants told pool participants that their contributions would be used to trade forex, according to the order.

The defendants concealed their fraud by preparing and distributing false monthly account statements to pool participants and by making false statements and submitting false accounting records to the NFA in the course of an NFA examination, the order finds.

The CFTC appreciates the assistance of the U.S. Attorney’s Office for the Northern District of Georgia and the NFA.

CFTC Division of Enforcement staff responsible for this case are Jo Mettenburg, Thomas Simek, Stephen Turley, Charles Marvine, Rick Glaser, and Richard Wagner.

INTRODUCING BROKER TO PAY $340,000 FOR LACK OF SUPERVISION OF OFFICERS, EMPLOYEES, AND AGENTS

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
September 21, 2012

CFTC Orders Infinity Futures LLC, an Introducing Broker, to Pay $340,000 for Supervision Violations

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued an order filing and settling charges against Infinity Futures LLC (Infinity), a Chicago-based registered Introducing Broker, for failing to supervise diligently the handling of certain trading accounts by its officers, employees, and agents.

The CFTC order finds that Infinity’s officers, employees, and agents ignored warning signs that third party customer funds were improperly being deposited in a proprietary trading account. The order also finds that an Infinity customer was holding himself out to the public as a Commodity Trading Advisor and trading individual client accounts, without being registered with the CFTC or obtaining a power of attorney, as required.

Additionally, according to the order, Infinity did not have an adequate system of supervision in place, its compliance manual was outdated, no written policies or procedures were provided to its associated persons, and Infinity did not follow or enforce its compliance procedures. Infinity also did not adequately train its employees, officers, and agents regarding detection of suspicious account activity and fraud prevention, the order finds.

The CFTC order requires Infinity to pay a $300,000 civil monetary penalty, disgorge $40,000 in ill-gotten gains, and cease and desist from violating CFTC regulation 166.3, as charged. The order also requires Infinity to comply with certain undertakings including hiring an outside compliance consulting firm to assist in training staff and reviewing and updating its current compliance procedures.

CFTC Division of Enforcement staff members responsible for this case are Robert Howell, Joseph Patrick, Susan Gradman, Brigitte Weyls, Scott Williamson, Rosemary Hollinger, and Richard Wagner.

ASSETS FROZEN IN ALLEGED COMMODITY POOL FOREX SCHEME

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

CFTC Charges Florida Resident William Jeffery Chandler with Forex Fraud and Misappropriation

Federal court enters emergency order freezing defendant’s assets and protecting books and records

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that on September 11, 2012, Judge James D. Whittemore of the U.S. District Court for the Middle District of Florida entered an emergency order freezing the assets of defendant William Jeffery Chandler of Ft Myers, Fla. The court’s order also prohibits Chandler from destroying or altering books and records. The judge set a hearing on the CFTC’s motion for a preliminary injunction for September 26, 2012.

The court’s order arises out of a civil enforcement action filed by the CFTC on September 10, 2012, charging Chandler with foreign currency (forex) fraud and misappropriation. Chandler has never been registered with the CFTC in any capacity, according to the complaint.

The CFTC complaint alleges that, since at least July 2010, and continuing to the present, Chandler has solicited at least six individuals to contribute at least $773,100 to a pooled account to trade off-exchange forex contracts in Chandler’s account at Dukascopy Bank SA, a Switzerland-domiciled bank. To entice prospective pool participants to invest, Chandler allegedly guaranteed a two percent to 12.5 percent monthly return on participants’ principal.

However, according to the complaint, Chandler’s Dukascopy Bank account was closed on or about July 15, 2011, due to changes in U.S. regulations. The Dukascopy Bank account was transferred to Alpari US LLC, a U.S.-based registered Retail Foreign Exchange Dealer, on August 8, 2011, according to the complaint. At that time, the pooled account allegedly had a balance of only $292.49, far less than the amount contributed by pool participants.

Chandler allegedly continues to solicit and receive funds from pool participants to trade in his Dukascopy Bank account, even after it had closed, and continues to represent to pool participants that their funds remain in the pool in his Dukascopy Bank account. Although Chandler has received requests from many pool participants to return their funds, he refuses to refund participant’s principal, instead asserting a litany of fabricated excuses, according to the complaint. Chandler has misappropriated the vast majority of the pool’s funds for his personal use, the complaint charges.

Furthermore, pool participants received statements from a purported accounting firm named A.R. Watkins; however, upon information and belief, A.R. Watkins is a fictitious entity controlled by Chandler, according to the complaint.

In its continuing litigation, the CFTC seeks civil monetary penalties, restitution, rescission, disgorgement of ill-gotten gains, trading and registration bans, and preliminary and permanent injunctions against further violations of the Commodity Exchange Act and CFTC regulations, as charged.

The CFTC appreciates the assistance of the Pasco County Sheriff’s Office.

CFTC Division of Enforcement staff responsible for this case are Jo Mettenburg, Jeff Le Riche, Stephen Turley, Rick Glaser, and Richard Wagner.

MAN ORDERED TO PAY OVER $17 MILLION FOR RUNING FOREX POOLED INVESTMENT FRAUD

FROM U.S. COMMODITY FUTURES TRADING COMMISSION

Federal Court in Texas Orders Christopher B. Cornett to Pay over $17 Million in Sanctions in Foreign Currency Fraud Action

Washington, DC - The U.S. Commodity Futures Trading Commission (CFTC) today announced that it obtained a federal court order of default judgment and permanent injunction requiring defendant Christopher B. Cornett of Buda, Texas, to pay $10.16 million in restitution and a $6.78 million civil monetary penalty in connection with a foreign currency (forex) pooled investment fraud. The order, entered on August 24, 2012, by Judge Lee Yeakel of the U.S. District Court for the Western District of Texas, also imposes permanent trading and registration bans against Cornett and permanently prohibits him from further violations of federal commodities law, as charged.

The court’s order stems from a CFTC complaint filed on February 2, 2012, charging Cornett with solicitation fraud, issuing false account statements, misappropriating pool participants’ funds, and failing to register with the CFTC as a commodity pool operator.

The order finds that, from at least June 2008 through at least October 2011, Cornett solicited prospective pool participants to invest in a pooled forex investment and that he acted as the manager and operator of the pool. The pool was referred to at various times as ITLDU, ICM, International Forex Management, LLC, and/or IFM, LLC, according to the order. In his solicitations, Cornett falsely told prospective pool participants that, while there were weeks when he either lost money or broke even trading forex, he had never experienced a losing month or a losing year trading forex, the order finds.

The order also finds that, from June 18, 2008 through September 2010, Cornett solicited approximately $7.07 million from pool participants, participants redeemed approximately $1.64 million, and Cornett lost approximately $4.17 million of the pool’s funds trading forex. During this period, Cornett had only one profitable month trading forex and earned little, if any, fees for acting as the pool’s operator, the order finds. Thus, during this period, Cornett misappropriated approximately $1.26 million of the pool’s funds and for most, if not all of the period, provided participants with false weekly reports/account statements, the order finds.

The court’s order further finds that, from October 2010 through October 2011, Cornett solicited an additional approximately $6.95 million from pool participants. Cornett transferred approximately $3.37 million to forex trading accounts at six foreign brokers and lost approximately $2.3 million at five of the brokers, and likely lost an additional $905,000 at the sixth broker trading forex with pool funds, the order finds. As of October 2011, Cornett had misappropriated approximately $1 million of the pool’s funds and less than $520,000 remained in bank accounts in the names of the pool, according to the order.

The CFTC appreciates the assistance of the U.S. Attorney’s Office for the Western District of Texas, Internal Revenue Service Criminal Investigation, and the Federal Bureau of Investigation.

The CFTC also appreciates the assistance of the U.K. Financial Services Authority, the British Virgin Islands Financial Services Commission, the Ontario Securities Commission, Germany’s BaFin, the Swiss Financial Market Supervisory Authority, the Eastern Caribbean Securities Regulatory Commission, and St. Vincent and the Grenadines’ International Financial Services Authority.

CFTC Division of Enforcement staff members responsible for this action are Patrick M. Pericak, Daniel Jordan, Jessica Harris, Rick Glaser, and Richard B. Wagner.

CFTC ANNOUNCES EMERGENCY ASSET FREEZE AGAINST COMMODITY TRADING ADVISOR

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
CFTC Charges California Resident Victor Yu and His Company, VFRS, LLC, with Multi-Million Dollar Forex Fraud and Failure to Register as a Commodity Trading Advisor

Federal court issues order freezing defendants’ assets and protecting books and records

Washington, DC - The U.S. Commodity Futures Trading Commission (CFTC) today announced that on July 27, 2012, The Honorable Yvonne Gonzalez Rogers of the U.S. District Court for the Northern District of California entered an emergency order freezing the assets of defendants Victor Yu (Yu) of San Jose, Calif., and his company, VFRS, LLC (VFRS), based in Alameda, Calif. The court’s order also prohibits the destruction or alteration of books and records, and grants the CFTC immediate access to such documents. The judge set a hearing on the CFTC’s motion for a preliminary injunction for August 10, 2012.

The order arises out of a civil enforcement action filed by the CFTC on July 26, 2012, charging defendants Yu and VFRS with defrauding at least 100 clients in connection with off-exchange foreign currency (forex) trading. The CFTC’s complaint also charges Yu with failure to register with the CFTC as a commodity trading advisor (CTA).

According to the CFTC complaint, since at least August 2009 to the present the defendants’ clients invested more than $5 million in forex trading accounts and lost more than $2 million, while defendants received fees of more than $270,000 from their clients.

The defendants allegedly fraudulently solicited clients to open forex accounts that allowed the defendants to place trades in their accounts using trading software that Yu claimed to have developed. Further, defendants misrepresented to clients that the trading software made forex trading "extremely safe," prevented clients from ever reaching certain loss thresholds, and guaranteed that clients will not have a losing trade, according to the complaint. In addition, defendants allegedly misrepresented to some prospective customers that their trading software had shown positive returns on every trade it had ever made and has successfully predicted activity in the currency markets back to the 1920s.

To solicit new clients, Yu and VFRS, by and through Yu, held face-to-face meetings with prospective clients in various clients’ homes, obtaining leads primarily through word-of-mouth, according to the complaint. Yu allegedly promised existing clients a referral fee or a percentage of any profits earned in the new clients’ forex accounts. When opening accounts, clients signed agreements promising to pay the defendants a service fee of 30 percent of their net profits, and the defendants provided log-in and password information so that clients could "hook up" to the defendants’ trading software. The complaint alleges that by this conduct, Yu acted as a CTA and was required to register with the CFTC.

In its continuing litigation, the CFTC seeks civil monetary penalties, restitution, trading and registration bans, and preliminary and permanent injunctions against further violations of the federal commodities laws, as charged.

IDAHO ENTREPRENEUR ORDED TO PAY $11.8 MILLION FOR OPERATING COMMODITY TRADING PONZI SCHEME

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
Federal Court in Idaho Orders Michael Justin Hoopes to Pay over $11.8 Million for Operating a Ponzi Scheme

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) obtained a federal court order requiring defendant Michael Justin Hoopes of Rexburg, Idaho, to pay more than $10.4 million in restitution and a civil monetary penalty of over $1.4 million for operating a Ponzi scheme that defrauded Idaho residents and others. The order also imposes permanent trading and registration bans against Hoopes and permanently prohibits him from further violations of the Commodity Exchange Act and CFTC regulations, as charged.

The consent order of permanent injunction, entered on July 26, 2012, by Judge Edward J. Lodge of the U.S. District Court for the District of Idaho, stems from a CFTC complaint filed on October 25, 2011, that charged Hoopes with solicitation fraud and misappropriation in connection with a commodity futures scheme (see CFTC Press Release 6128-11, October 26, 2011).

The order finds that from at least September 2007 to October 25, 2011, Hoopes fraudulently solicited and accepted $2,068,103 from 10 individuals, mostly Idaho residents, to trade stock index commodity futures in a commodity pool that he owned and operated called Aspen Trading, LLC. The order also finds that Hoopes solicited and accepted an additional $9.68 million from other mostly Idaho residents during the same period for various other investments, all of which was extensively commingled with Hoopes’ personal funds and funds accepted for futures trading in Aspen Trading. Hoopes misappropriated at least $151,694 of the commingled funds for his personal expenses, including car, credit card, and mortgage payments, according to the order.

Between October 2006 and May 31, 2011, Hoopes suffered net losses of over 90 percent of the $2,280,550 he traded in futures, according to the order. To conceal his losses, Hoopes paid pool participants $594,339 in purported profits in the manner of a Ponzi scheme and issued false account statements to at least one pool participant showing that the Aspen Trading account was earning monthly profits as high as 83.52 percent, with only one losing month, according to the order. In reality, however, Hoopes never opened a trading account in Aspen Trading’s name but simply altered his personal trading account statements to make it appear as though the Aspen Trading account was earning large profits from futures trading, the order finds.

The CFTC appreciates the assistance of the United States Attorney’s Office for the District of Idaho.

CFTC COMMISSIONER O'MALIA SPEAKS ON TECHNOLOGY

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
“I Have One Word for You: Technology”
Remarks by Commissioner Scott D. O’Malia at SIFMA Tech Leaders Forum 2012, New York City, New York
June 19, 2012
Introduction
In the 1967 film The Graduate, Mr. McGuire, a family friend of recent college grad Benjamin Braddock, played by Dustin Hoffman, gives the young, aimless and slightly disillusioned gentleman the sagest wisdom he can, "I want to say one word to you. Just one word.... Plastics.” Mr. McGuire had a vision that there would be a great future in plastics. Benjamin was worried about his future. He wanted it to be “different.” And this guy was telling him in one word that it could be. Today, that one word is "Technology."
I suppose that doesn’t come as a surprise to anyone in this room full of visionaries. Technology is a tremendous asset; it provides leverage and is a force multiplier. My two eldest daughters, Kelsey and Claire, both have quite an aptitude for math and science. Looking towards their future, I hope that they will hear me when I tell them in their own times of uncertainty, “Technology.”

As a regulator, it is an honor to be invited to speak at an event like this since most folks don’t think of the Commodity Futures Trading Commission (“CFTC”) when it comes to technology. And frankly, that makes sense since we have largely remained in the world of “plastics” when it comes to deploying and utilizing technology to support our oversight responsibilities.

Today, in addition to addressing technology in the markets and in the hands of regulators, I would also like to discuss a few other topics including the Commission's rulemaking progress and budget issues as they relate to implementation of the Dodd-Frank Act and the choices we are making. I’m also happy to answer any questions you may have at the end.

I am grateful for the kind introduction by SIFMA President and CEO Tim Ryan. I would like to give you a few more details about my background and explain why I am so focused on technology.

Prior to my nomination to the Commission, I served as the Clerk of the Senate Committee on Appropriations, Subcommittee on Energy and Water where I had responsibility for funding the Department of Energy (“DoE”). That position’s mission was focused on deploying improved energy technologies. But, what few people realize is that the DoE also funds research on everything from nuclear physics to the nuclear weapons program. Simulating, solving and understanding the most challenging physics questions require massive computer hardware and software operating at speeds that previously didn’t exist. And it was my job to fund this cutting edge technology.

After the ban on underground nuclear testing, the weapons program relied heavily on computer simulation that required bigger and faster computers than what currently existed. So, we invested millions of research dollars into advanced computing and simulation. I am especially proud of the Roadrunner supercomputer, a joint effort with Los Alamos National Laboratory and IBM to create what was then the world’s fastest computer. On May 25, 2008, Roadrunner became the first computer to break and sustain the petaFLOP barrier by processing more than 1.026 quadrillion calculations per second. As you all can imagine it is hard to just walk away from one million, billion calculations per second. And, so I didn’t.

Technology Advisory Committee 2.0
I have continued to fly the technology flag, and I have focused a great deal of my term thus far on advancing the use of technology to more effectively meet the CFTC’s surveillance, oversight and regulatory responsibilities largely through reestablishing and chairing the Technology Advisory Committee (TAC).

We are re-chartering for a second two-year term, and, like every technology upgrade, I have branded it TAC 2.0.

I have been fortunate enough to bring together a diverse membership with industry-wide expertise and shared goals of establishing technological “best practices” for oversight and surveillance while informing the Commission of the technological issues related to ongoing rulemakings under the Dodd-Frank Act. We have covered such issues as pre-trade functionality and pre-trade credit checks, data collection standards, technological surveillance and compliance, the deployment of technology solutions in the swaps market, and most recently, algorithmic and high frequency trading. To put a finer point on what we have accomplished since bringing back the TAC in June 2010 with its 24 charter members, we have:

Held seven public meetings;
Established the 19-member Subcommittee on Data Standardization charged with providing recommendations based on public/private solutions for creating well-accepted standards for describing, communicating, and storing data on complex financial products;
Established the 23-member Subcommittee on Automated and High Frequency Trading charged with advising the Commission as to a working definition of high frequency trading (“HFT”) in the context of automated trading strategies;
Issued Recommendations on Pre-Trade Practices for Trading Firms, Clearing Firms and Exchanges involved in Direct Market Access; and
Issued recommendations on data standardization through the use of legal entity and product identifiers.

To be sure, our open forums and the contributions of both members and guest presenters have informed and influenced critical policy and regulatory decisions inextricably linked to technological issues, and I believe that many of our rulemakings are better for it.
CFTC is the LEI Leader

In reviewing today’s agenda, I noticed that the Legal Entity Identifier (“LEI”) is a panel topic. Let me take a moment to update you on where the Commission currently is in its LEI implementation strategy. There is good news and not so good news depending on your time horizon. In terms of progress at the CFTC, I’ve got some good news. As to the Global LEI, the news is not as good.

By way of brief background, the CFTC’s swap reporting rules require that counterparties report their trades to a swap data repository (SDR) and be identified by a legal entity identifier. LEIs will be a crucial data aggregation tool that enables the CFTC to utilize the data in SDRs to perform the fundamental mission of monitoring both the swaps and futures markets. It will also give us insight into systemic risk exposure, one of the main goals of the Dodd-Frank Act.

CFTC Leads in Establishing the Legal Entity Identifiers
As was made abundantly clear by the TAC Subcommittee on Data Standards in its final recommendations at our March meeting, a LEI is feasible and the sooner we apply it, the better. As I noted, there is good news and not so good news. The good news is that the Commission is moving to bring LEI’s online for U.S. firms (or anybody transacting in the U.S.) to have an LEI by the time mandatory reporting is required for credit swaps and interest rate swaps, which will be 60 calendar days after the publication in the Federal Register of the Commission’s final rule providing further definition of “swap” (a/k/a “Compliance Date 1”).1

As part of its cooperation with international process, and because the use of identifiers will begin in reporting under CFTC jurisdiction before the global system is established, CFTC is referring to the identifier to be used in reporting under its rules as the CFTC Interim Compliant Identifier or the “CICI”. The Commission anticipates that when the global LEI system is established, the CICI will transition into the global system.
On March 9, 2012 the Commission requested submissions from industry participants wishing to be considered to provide the CICI. The Commission received submissions from several industry participants, and all candidates have provided written demonstrations and live, on-site demonstrations. As I mentioned earlier, the Commission anticipates determining whether a CICI meeting its requirements is available, and designating that provider as the source for CICIs to be used in swap data reporting under Commission jurisdiction, in the very near future.

Status of International LEI Process Coordinated by FSB
While, I was assured that the initial issuance of LEIs by an international body would occur by spring 2012, the international effort has been delayed until March of 2013. The delays are related to governance issues and the insistence upon greater public sector involvement, albeit they still require a private sector solution to implement the systems.

At its May 2012 meeting in Hong Kong, the Financial Standard Boards (“FSB”) approved recommendations for a global LEI system to the G-20 Leaders for consideration (this week) at their summit in Los Cabos, Mexico.2

The recommendations set out a three-tiered governance framework that includes:
A Regulatory Oversight Committee (ROC) committed to support governance in the public interest;
A Central Operating Unit (COU) for ensuring application of uniform global operational standards, and having a Board of Directors that may include both industry representatives and independent participants; and
Local Operating Units (LOUs) that provide the primary interface for entities wishing to register for an LEI, and provide local implementations of the global system.

Further delaying implementation, the recommendations provide for establishment of an LEI Implementation Group (LEI IG), comprised of LEI experts from the global regulatory community charged with launching the global LEI system by March 2013. The LEI IG will be led by representatives from different geographical regions, and will undertake legal and policy work to develop the charter for the ROC and the governing documents for the system, and technology work with the private sector to establish the COU. CFTC will be a member of the LEI IG.

Let me remind you of the good news. In the meantime, the Commission will be adopting its interim LEI, and this should cover roughly half of the overall swaps market. I hope the timely application of an LEI by the Commission will reduce the costs of applying an LEI system retroactively.

HFT Technology in the Market
I would like to spend a few minutes to share with you my thinking on high frequency trading. This topic has generated passionate views, both pro and con, and spawned headlines, economic studies and even books on the subject.

HFT currently accounts for a majority (56% in 2011) of the U.S. equity volume3 and is approaching 50% of our futures market transactions. The influx of high frequency traders are behind the massive trading volume increases. Supporters argue that HFTs are the modern pit trader market makers that narrow bids and provide essential liquidity. Detractors complain that HFT have changed the market dynamics by playing games with trade strategies that bait hedgers and have reduced trade size. The bottom line is there is no definition for, or, rather, there is a struggle to find an appropriate characterization of this practice in our markets.

In a forthcoming study to appear in The Journal of Portfolio Management, Easley, Lopez de Prado, & O'Hara4point out that automated trading systems have created two markets. One market populated by low frequency traders that focus on “macro factors” like available supply, monetary policy and financial statements, while the HFT market focuses “market microstructural factors such as “rigidities in price adjustments across markets” and “variations in matching engines.” The authors accurately point out that the “the goal [of HFT] is to exploit inefficiencies derived for the markets microstructure, such as rigidities in price adjustment within and across markets [agents], idiosyncratic behavior and asymmetric information." What we have here is a tale of two markets operating in one venue.

This is a topic I am very interested in, especially in terms of its relative impact on the markets. What I find most intriguing about the debate itself is that it is not always clear that folks on the pro side and folks on the con side are even talking about the same thing. One person’s HFT may not be another’s. In an effort to take the first step and define the practice, last November, I sent a letter to the Technology Advisory Committee members asking them for their opinion on a definition of HFT. After hearing back from them, I took the next step and formed through a public nomination process the Subcommittee on Automated and High Frequency Trading to develop an appropriate definition of HFT within the universe of automated trading. My goal is to have a working description of the attributes of HFT activities in order to better understand the impact they have on our markets. Developing a nomenclature is important if only as a means to study this trading activity on a consistent basis. Before we implement a new regulatory regime on any continent or in cyberspace, I believe we need to agree on what and who comprises this growing segment of our markets.

Within the ATS/HFT Subcommittee, we have established four working groups, each tasked with identifying specific issues associated with automated trading. The first working group is tasked with defining high frequency trading within the context of automated trading systems. The second group is examining whether or not there should be multiple categories of HFT. Specifically, this working group is examining distinctions in trading activity and how such distinctions should be identified or tagged by the exchanges in which they operate. The third working group is focusing on oversight, surveillance and economic analysis, to understand how HFTs behave as compared to other automated systems. The fourth working group is addressing market micro structure issues to identify possible disruptions that might be provoked by automated trading systems and potential solutions to mitigate such events. Under the leadership of CFTC Chief Economist Andrei Kirilenko and fellow CFTC staff these working groups have been conducting weekly conference calls and will be presenting their preliminary views at the public meeting of the TAC I am holding tomorrow at our CFTC headquarters in Washington.

My goal is to collect the facts, develop the data about the impact of HFT (and all automated trading for that matter) and establish a consistent, universally acceptable view on our new market participants. I never intended to assemble this group to develop rulemakings. This expert group was organized to define and discuss the current and potential impacts of HFT in the futures and swaps markets. It is up to the Commission to develop the policy solutions, and I hope that the Commission will benefit from the extensive debate and hard work of the Subcommittee as well as empirical market data before it considers taking action.

Technology in the Hands of Regulators
Technology in the hands of regulators is a good thing, and I will always support it in any role I have. We are now at the CFTC only beginning to leave “plastics,” but our new Office of Data and Technology headed by Chief Information Officer John Rogers is making progress. Trust me, it is all relative. What my colleagues are seeing now is that technology offers us the opportunity to see across our jurisdictional markets (futures and swaps) and the only way we can develop the appropriate level of surveillance is through the deployment of algorithms and automation. Expanding our surveillance to include order data will require additional hardware to store and sort a massive amount of data. The CFTC has a long way to go, especially when it comes to automating some of our more mission-critical goals such as monitoring systemic risk, but we have learned a thing or two during our first attempts to automate large trader reporting for swaps and I have some ideas as to how we can leverage our expertise.

High-Frequency Regulation
One thing I have been critical of is our speed of regulation—which has nothing to do with technology. In fact, it is speed that I think has caused us to err in some of our rules such as the large trader swaps reporting rules and in our cost-benefit analyses. I do have good news on both fronts though, and things are looking bright and shiny, but not like plastic.

For those of you who are unfamiliar with the typical Washington rulemaking process, it is generally long and all-consuming. Before the Dodd-Frank Act, the Commission issued three or four rules a year at best. My friend and former Commissioner Mike Dunn would always say that most of the Commission’s rules normally take anywhere from 15 to 18 months to finalize. So, trying to complete more than 50 rules in that amount of time guarantees mistakes and errors.

Remember the bumper sticker during Bill Clinton’s 1992 campaign, "It’s the economy, Stupid”. Well, that is still true today. However, in the Dodd-Frank microcosm “It’s the implementation, Stupid.” Let me give you an example of how important it is for the Commission to develop well thought out rules, informed by actual and realistic cost benefit analysis. We can’t guess or make assumptions about the swaps market and hope or expect market participants will be able to comply.

The Commission passed its final large trader reporting rule for physical commodity swaps under Part 20 in July 2011.5 There were a number of problems including:
The futures and options position reporting format under Parts 16 and 17 of the Commission regulations simply could not accommodate the new data needs for Part 20 swap reporting, and Industry standards for large trader swaps reporting (via XML) did not exist.


The Industry couldn’t comply within the two-month implementation deadline, and an extension had to be grated 6. On December 7, 2011, the Commission issued a 172-page guidebook7, which was longer than the rule itself.

The Commission’s Office of Data and Technology (ODT) has now developed rules to ensure that data is submitted accurately and has provided data submitters with an automated way to test their data at any time. As well, ODT now provides an automated feedback mechanism to submitters so they will know about data reporting issues (e.g., files not received, missing data) in real-time. And, just to be sure, DMO and ODT revised the Part 20 guidebook, and released the new 226-page version about three weeks ago.8
On November 20, 2011, the Commission started to receive records on a limited basis. Today, our CIO informs me that we are now receiving approximately 500,000 records per day from clearing members and an additional 200,000 records from clearing organizations. The no-action relief issued to reporting industry participants by the Division of Market Oversight9 will end in less than two weeks on July 2nd, so I am eager to hear the numbers.

I know ODT is eager about the upcoming final rule that will further define the term “swap”. Swap dealers will be required to submit data under Part 20 just 60 days after that final rule is published. Today, 50% of clearing members are in compliance with the FIXML or FpML reporting, and given what we have put them through, that is good news to me.

The lesson, I think, has been learned: swaps and futures markets are different. The large trader reporting project proves my point that the Commission must spend an appropriate amount of time understanding swaps markets and the ramifications of these rules, including the cost and benefits of each and every rule before they are finalized, not after.

Some of you may know that I have been very critical of the Commission’s cost-benefit analyses. The Commission previously minimized the role of performing complete cost-benefit analyses by turning the process into an administrative, check-the-box exercise. The good news is the Commission has altered course and the Chairman recently signed a Memorandum of Understanding with the Office of Information and Regulatory Affairs (“OIRA”) within the White House to provide technical expertise in order to develop a more thorough process for conducting the Commission’s cost-benefit analyses during the implementation of the Dodd-Frank Act.

In my view, there are three critical areas where the Commission can and must improve its cost-benefit analysis. First, the Commission should develop a realistic and status quo ante baseline. Second, the Commission should develop replicable quantitative analysis, which will allow it to make informed decisions about the market. Finally, the Commission should develop a range of policy alternatives for consideration. All three of these standards are best practices recommended in the Office of Management and Budget Circular A-4, Regulatory Analysis, which was issued in 2003. I can’t help but wonder that if we had committed the time and resources towards engaging in more thorough cost-benefit analyses that considered not only the differences between the futures and swaps markets, but that set appropriate baselines, considered alternatives, and truly attempted to quantify those baselines and alternatives, that we wouldn’t be challenged as an agency to put forth rules that are sure to stand the test of time—or at least a legal challenge. Plastic might last for an awful long time, but our rules need to be even stronger than that. We need to move on from that illusion and be “different.”
Budget

Before I close, I would like to a moment to highlight the budget situation.
This year, we have a unique budget situation. There are two budget deals that the Commission must manage. The first is our annual appropriation. Every year, brings uncertainty when the House and Senate produce two different funding solutions. This year is no different, and it will be resolved. The Senate and House will reconcile their differences and we are likely to have more funding in 2013 than we have in 2012. The only remaining question is, “When?”

The second budget factor is the debt summit that Congress and the Administration agreed to last August. This deal is set to implement on Jan 1, 2013, and it will automatically cut discretionary spending government-wide by 8 percent ($1.2 trillion in 2013). The impact on the Commission’s current year budget would be a $16.4 million reduction, translating to $188 million in total spending.

I am not aware of any plan of action for the Commission to hedge its budget exposure in the likely event that the mandatory cuts occur in January. I want to make sure the Commission avoids layoffs or other morale-busting action. Also, I don’t think anyone can predict what spending baseline the January cuts will be initiated. The prudent action is to avoid over-spending until our budget future is clear.

I have asked our budget officers for some information about the Commission’s spending outlook. Today, we have 692 people on board, less than the 710 FTE’s planned for under our $205.3 M budget. This amounts to $130 million in spending on employees and $45 million on IT, which is $175 million total, $13 million below the level proposed to be cut in January.

Just like the markets, we need to hedge our risk. Clearly our most pressing risk is the impact of morale-busting layoffs. We have worked our staff extraordinarily hard to develop the rules, take the meetings and respond to questions. Now we are moving toward critically important rules (e.g. margin, SEF, mandatory clearing and trading, definitions, extraterritoriality). We are also entering into the implementation phase. We need people to interpret the vague and uncertain rules we have just put into effect.
Now is the time for the Commission to lock in our hedge, freeze our spending so we don’t risk over-spending and forced layoffs. This debt summit deal has been in place for almost one year. To not prepare for the worst would be irresponsible and unfair to our current employees and the Commission as a whole.

Closing
Without a doubt the Commission has a number of very real challenges ahead. First, we are adapting sensible rules that fulfill the statutory mandates of the Dodd-Frank Act. These rules must be developed with careful cost benefit analyses to ensure both the market and the Commission have the capacity to implement the proposals in a cost-effective and timely manner. We must also pay closer attention to the rule implementation. The more we work to understand the impact of our rules, the more likely the implementation process will be successful.

Second, as we approach the end of the fiscal year, we must be very careful about our spending. The budget challenges facing this nation are real and must be addressed. As such, the Commission must pick its path carefully to navigate the fiscal challenges ahead.
Finally, the Commission must make technology a much higher priority. We have taken the right steps to begin to adopt the 21st Century market technology, and put the fax machine era in our rear-view mirror, but we still have a long way to go before we are at an acceptable position. We also need to work hard to continue to understand the role technology plays in both the fundamental trading strategies as well as the microstructure strategies that the HFTs deploy. I will continue to use the Technology Advisory Committee to engage market participants to find solutions to these challenging questions.
Thank you.

1 Swap Data Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2136, 2196 (Jan. 13, 2012) (To be codified at 17 C.F.R. pt. 45).

2 Financial Stability Board (FSB), A Global Legal Entity Identifier for Financial Markets,
June 8, 2012, available atwww.financialstabilityboard.org/publications/r_120608.pdf.

3 U.S. Securities and Exchange Commission, Organizational Study and Reform at 258, Mar. 10, 2011, available at http://www.sec.gov/news/studies/2011/967study.pdf.

4 David Easley, Marcos M. Lopez de Prado & Maureen O’Hara, The Volume Clock: Insights into the High Frequency Trading Paradigm, The Journal of Portfolio Management (forthcoming) (Fall 2012), Electronic copy available at: http://ssrn.com/abstract=2034858.
5 Large Trader Reporting for Physical Commodity Swaps, 76 Fed. Reg. 43,851 (July 22, 2011) (to be codified at 17 C.F.R. pts. 15 and 20).

6 See Temporary and Conditional Relief from the Requirements of §§ 20.3 and 20.4 of the
Commission's Regulations Regarding Large Swaps Trader Reporting for Physical Commodities (Nov. 18, 2011),available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/relief_letter_111811.pdf.

7 Large Trader Reporting for Physical Commodity Swaps: Division of Market Oversight Guidebook for Part 20 Reports, Dec. 1, 2011, available
at:http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/ltrguidebook120711.pdf.

8 Large Trader Reporting for Physical Commodity Swaps: Division of Market Oversight Guidebook for Part 20 Reports, June 1, 2012, available
at:http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/ltrguidebook053112.pdf.

9 Staff No-Action Relief: Temporary and Conditional Relief from the Requirements of §§ 20.3 and 20.4 of the Commission’s Regulations Regarding Large Swaps Trader Reporting for Physical Commodities (Mar. 20, 2012),available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/relief_letter_032012.pdf.

DERIVATIVES AND THE CROSS-BORDER APPLICATION OF DODD-FRANK SWAP MARKET REFORMS

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
Remarks on Derivatives and the Cross-Border Application of Dodd-Frank Swap Market Reforms at the Institute of International Bankers’ Membership Luncheon
Chairman Gary Gensler
June 14, 2012
Good afternoon, Rich, thank you for that kind introduction and for inviting me to speak about the Commodity Futures Trading Commission’s (CFTC) efforts to bring much-needed reform to the swaps market.

With just the click of a mouse, swap market risk can spread around the globe.
AIG’s subsidiary, AIG Financial Products, brought down the company and nearly toppled the U.S. economy. How was it organized? It was run out of London – actually as a branch of a French-registered bank – though technically organized in the United States.
It was sobering evidence of how overseas risk can come crashing back to our shores to affect middle-class taxpayers, many of whom had never heard of swaps.

Swaps – developed to help manage and lower risk for commercial companies – also concentrate and heighten risk in international financial institutions. When these entities fail, as they have and surely will again, swaps can quickly spread risk across borders.
Following the crisis, when President Obama gathered together the G-20 leaders in Pittsburgh in 2009, a new consensus formed internationally. Swaps, which were basically not regulated in the United States, Japan or Europe, should now be brought into the light of regulation.

Despite different cultures, political systems and financial systems, we've made significant progress on a coordinated and harmonized international approach to reform.
In 2010, the U.S. Congress passed the historic Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). To date, the CFTC has completed 33 swaps market reforms. We are on track to finish the nearly 20 remaining reforms this year.
Japan, Europe and the largest provinces in Canada have also made substantial legislative progress on reform.

I would like to highlight the progress we're making together on transparency, clearing and margin.

Promoting transparency to the public in the swaps market is critical to both lowering the risk of the financial system, as well as to reducing costs to end users.

The CFTC has completed key transparency rules. Starting as early as September, real-time reporting to the public and to regulators will become a reality. We are nearing consideration of the final swap execution facility rule, which will bring pre-trade transparency to the marketplace.

The G-20 leaders recognized reporting to regulators is not enough. Public market transparency is critical to promoting competition and lowering risk. The Japanese and Europeans have public transparency proposals in front of their legislative bodies that would further align international reform efforts.

Clearinghouses also significantly benefit from public market transparency, as they need to mark their positions to market daily, as well as rely on liquid markets when a clearing member defaults.

While our approaches are not identical, there is a great deal of consistency among the major market jurisdictions in lowering risk by bringing standardized swaps into central clearing. We are collaborating internationally on clearinghouse rules, as well as on determinations as to which swaps must be cleared. It is my hope that the CFTC’s first clearing determinations will be put out for public comment this summer and completed this fall.

The CFTC’s determinations are likely to begin with standard interest rate swaps in U.S. dollars, Euros, British pounds and Japanese yen, as well as a number of credit default swap indices.

The CFTC is working with the Federal Reserve, the other U.S. banking regulators, the Securities and Exchange Commission (SEC), and international regulators and policymakers to align margin requirements for uncleared swaps. I think it is essential that we align these requirements globally, particularly between the major market jurisdictions. An international release on margin requirements will be put out for public comment shortly. The approach will be consistent with the approach the CFTC laid out in its margin proposal last year. We anticipate, in addition, formally reopening the comment period on our initial proposal so that we can hear further from market participants in light of the international release.

Cross-border Application of Swaps Market Reforms
Though what I've reviewed so far may have been of interest, I guess that Rich and Sally Miller invited me here today mostly to tell you how reforms will affect those of you in the international banking community.

Section 722(d) of the Dodd-Frank Act, states that swaps reforms shall not apply to activities outside the United States unless those activities have “a direct and significant connection with activities in, or effect on, commerce of the United States.”
The CFTC plans to soon put out to public comment our interpretation and related guidance on this provision to get public feedback, including from your members.
Let me touch upon how it relates to U.S. financial institutions, and then discuss how it relates to international institutions.

Recent events at JPMorgan Chase are a stark reminder of how swaps traded overseas can quickly reverberate with losses coming back into the United States.

We've seen this movie before. Financial institutions set up hundreds, if not thousands of legal entities around the globe. During a default or crisis, risk of overseas' branches and affiliates inevitably flows back into the United States.
We saw this with AIG.

We saw this with Lehman Brothers. Among Lehman Brothers’ complex web of affiliates was Lehman Brothers International (Europe) in London. When Lehman failed, this London affiliate, with more than 130,000 outstanding swaps contracts, failed as well. Who stood behind these swaps contracts? The U.S. mother ship, Lehman Brothers Holdings, had guaranteed many of them.

We saw this with Citigroup. It set up numerous structured investment vehicles (SIVs) to move positions off its balance sheet for accounting purposes, as well as to lower its regulatory capital requirements. Yet, Citigroup had guaranteed the funding of these SIVs through a mechanism called a liquidity put. When the SIVs were about to fail, Citigroup in the United States assumed the huge debt, and taxpayers later bore the brunt with two multi-billion dollar infusions. And where were these SIVs set up? They were launched out of London and incorporated in the Cayman Islands.

We saw this with Bear Stearns. Its two sinking hedge funds it bailed out in 2007 were incorporated in the Cayman Islands. Yet again, the public assumed part of the burden when Bear Stearns itself collapsed nine months later.

And remember Long-Term Capital Management? When this hedge fund failed in 1998, its swaps book totaled in excess of $1.2 trillion notional. The vast majority were booked in its affiliated partnership… in the Cayman Islands.

There are some in the financial community who want us to ignore these hard lessons of past financial institution failures.

They might tell you that swap trades booked in London branches of U.S. entities shouldn't be brought under Dodd-Frank reform.

They might tell you that affiliates, even when guaranteed by the mother ship back here in the United States, shouldn't come under Dodd-Frank reform.

They might tell you that affiliates acting as conduits for swaps activity back here shouldn't be brought under Dodd-Frank reform.

If we follow their comments, the result would be that American jobs and markets would move offshore, but, particularly in times of crisis, risk would come back to affect our economy.

So what has the CFTC staff recommended to the Commission?
First, when a foreign entity transacts in more than a de minimis level of U.S. swap dealing activity, the entity would register under the CFTC’s swap dealer registration rules.
Second, the staff recommendation includes a tiered approach for overseas swap dealer requirements. This is largely consistent with comments received from major international swap dealers. Some requirements would be considered entity-level, such as for capital, risk management, recordkeeping and reporting to swap data repositories (SDRs). Some requirements would be considered transaction-level, such as clearing, margin, real-time public reporting, trade execution and sales practices.

Third, entity-level requirements would apply to all registered swap dealers, but in certain circumstances, overseas swap dealers could meet these requirements by complying with comparable and comprehensive foreign regulatory requirements, or what we call “substituted compliance.”

Fourth, transaction-level requirements would apply to all U.S. facing transactions. For these requirements, U.S. facing transactions would include not only transactions with persons or entities operating or incorporated in the United States, but also transactions with their overseas branches. Likewise, this would include transactions with overseas affiliates that are guaranteed by a U.S. entity, as well as the overseas affiliates operating as conduits for a U.S. entity’s swap activity.
Fifth, for certain transactions between an overseas swap dealer (including a foreign swap dealer that is an affiliate of a U.S. person) and counterparties not guaranteed by or operating as conduits for U.S. entities, Dodd-Frank transaction-level requirements may not apply. For example, this would be the case for a transaction between a foreign swap dealer and a foreign insurance company not guaranteed by a U.S. person.

What does this mean for your membership?

So it means that if a legal entity has over $8 billion in market making swaps activity with U.S. market participants, it should be preparing to register as a swap dealer. For foreign financial institutions, swaps with U.S. persons or their overseas branches would count toward the de minimis threshold. In the midst of a default or a crisis, there is no satisfactory way to really separate the risk posed to a branch from being transmitted to its parent bank.

Swap dealer registration will be required two months after we finalize with the SEC the joint rule further defining the term "swap." The further definition rule is now before Commissioners at both agencies.

It means the entity would have to comply with the various Dodd-Frank provisions applicable to swap dealers, though in certain cases, this may be done through substituted compliance.

In addition to the interpretive guidance, the CFTC also is considering a release on phased compliance for foreign swap dealers. The separate release addresses comments from international and U.S. market participants. For overseas swap dealers that register with the CFTC, the release provides for phased compliance in the following manner:
Compliance with transaction-level requirements with U.S. persons and branches of U.S. persons would be required;
Entity-level requirements (other than reporting to SDRs) that might come under substituted compliance may be delayed for up to one year. During that time, the CFTC would be moving to complete the cross-border interpretive guidance and would work with market participants and foreign regulators on plans for substituted compliance; and
For overseas swap dealers, swap transactions with U.S. persons and branches of U.S. persons would be required to be reported to a SDR (or the CFTC).
The CFTC has had a long history of recognizing comparable regulations of foreign regimes. We have entered into numerous memoranda of understanding on both information sharing and supervisory coordination with our international counterparts with regard to foreign clearinghouses, exchanges and intermediaries.
Conclusion

The 2008 crisis – caused in part by swaps – was the worst financial and economic crisis Americans have experienced since the Great Depression. Eight million Americans lost their jobs, and millions of families lost their homes.

The crisis was a failure of the financial system and of financial regulation. The high levels of debt and excessive risk that contributed to the crisis continue to reverberate in Europe and the United States.

The CFTC is well over halfway to finishing critical swaps market reforms bringing transparency to this market and lowering its risk to the public. We’ve taken into account more than 30,000 comment letters, held 1,600 meetings with the public and hosted 18 roundtables. But now it's time to finish the job.

Some in the financial community have suggested that we retreat from these critical reforms. But the ever-growing financial storm clouds hanging over Europe and the lessons from the U.S. financial crisis should guide us that now is not the time to retreat from reform. Now is the time to promote transparency and protect the public.

FUTURES COMMISSION MERCHANT ORDERED TO PAY $250,000

FROM:  COMMODITY FUTURES TRADING COMMISSION

CFTC Orders Futures Commission Merchant Open E Cry, LLC to Pay $250,000 to Settle Failure to Supervise Charges

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing and simultaneous settlement of charges against Open E Cry, LLC (OEC), a registered futures commission merchant (FCM), for failing to diligently supervise the handling of its customer accounts.  OEC has offices in Powell, Ohio, and Chicago, Ill.

The CFTC order requires OEC to pay a $250,000 civil monetary penalty and to cease and desist from further violations of CFTC regulation 166.3, which requires diligent supervision of customer accounts. 

The CFTC order finds that for a period of months prior to June 2010, OEC failed to detect and correct a flaw in software it offered its customers for trading futures contracts that miscalculated the customers’ intraday profits and losses from trading the Russian ruble futures contract.  As a result of the flaw, the order finds that the software that OEC offered its customers calculated profits and losses resulting from trades in the ruble contract at only 10 percent of actual amounts.  OEC was unaware of the flaw, according to the order.

Also, according to the order, over a period of several hours in June 2010, a Russian national, Marat Yunusov,exploited the ruble calculation error and OEC’s supervision failures.  Yunusov engaged in a fraudulent prearranged trading scheme using his OEC account in which he traded more than 20,000 ruble contracts through 372 individual trades, as well as an additional 70,000 E-micro British pound futures contracts with an account that he controlled at another FCM, the order finds.  Yunusov’s ruble trading generated an actual loss of approximately $9 million in his OEC account, which roughly matched the ruble profits in the account he controlled at the other FCM, the order finds.  As a result of the flaw, however, OEC’s systems inaccurately reflected a ruble loss of only $900,000 rather than $9 million. 

The order also finds that as part of the scheme, Yunusov engaged in prearranged trading in British pound futures, which resulted in a gain to Yunusov in his OEC account of more than $900,000.  As a result of the flaw, it appeared to OEC that Yunusov’s net ruble/pound trading at OEC was slightly profitable, when in fact Yunusov’s true net results for his ruble and pound trading that day showed a significant loss, according to the order. 

OEC also failed to implement adequate alert systems to detect suspicious trading activity, such as the trading of extremely large quantities of futures contracts, and thus failed to detect and stop Yunusov’s trading, according to the order.

The CFTC thanks the CME Group for its assistance.  

CFTC CHARGES FLORIDA FIRM AND OWNER WITH FRAUD RELATING TO COMMODITY POOL

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
CFTC Charges Jose S. Rubio and his Florida firm, Rubio Wealth Management, LLC, with Commodity Pool Fraud
Defendants also charged with misappropriation, false statements, commingling investor funds, and failure to register
Defendants allegedly fraudulently solicited over $1.8 million from at least 21 individuals
Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that it filed a civil enforcement action against Jose S. Rubio (Rubio) and Rubio Wealth Management, LLC (RWM) of Surfside and Coral Gables, Fla., respectively. The CFTC complaint charges Rubio and RWM with defrauding investors in connection with operating a commodity pool to trade commodity futures and off-exchange foreign currency (forex) contracts. The CFTC complaint also charges Rubio with making false statements to pool participants, misappropriating pool funds, commingling investor funds with those of RWM, failing to register as a commodity pool operator, and failing to produce documents to the CFTC.

The CFTC complaint, filed June 7, 2012, in the U.S. District Court for the Southern District of Florida, alleges that from at least January 2008 through the present, Rubio and RWM solicited and accepted at least $1.8 million from at least 21 individuals in connection with their commodity pool. According to the complaint, Rubio and RWM lost in excess of $900,000 through trading and misappropriated at least $820,000 of participants’ funds.

Rubio allegedly made misrepresentations when soliciting and accepting pool participants’ funds. Rubio and RWM allegedly misappropriated some of those funds and used some investor funds to repay other investors, in the manner of a Ponzi scheme. The complaint also alleges that Rubio commingled investor funds with those of RWM, failed to register with the CFTC, and failed to produce documents to the CFTC.

The complaint alleges that, to conceal and perpetuate the fraud, Rubio failed to provide annual financial statements to pool participants and provided at least one pool participant with false investment performance documents that failed to disclose trading losses and misappropriation.

In its continuing litigation, the CFTC seeks civil monetary penalties, restitution, trading and registration bans, and preliminary and permanent injunctions against further violations of the federal commodities laws, as charged.

The CFTC appreciates the assistance of the Florida Office of Financial Regulation and the Financial Industry Regulatory Authority.

CFTC Division of Enforcement staff members responsible for this case are Christopher Giglio, David Oakland, Nathan Ploener, Manal Sultan, Lenel Hickson, Steve Obie, and Vincent McGonagle.