CFTC COMMISSIONER O'MALIA'S DISSENTING STATEMENT ON NON-U.S. SWAP DEALERS

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Dissenting Statement by Commissioner Scott D. O’Malia

Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States

January 2, 2014

If you thought that the Commission’s approach last year regarding cross-border issues resulted in an unsound rulemaking process, the start of 2014 is no better.

Today’s announcement of the request for comment on a staff Advisory abrogates the Commission’s fundamental legal obligations under the Administrative Procedure Act (“APA”) and provides another example of the Commission’s unsound rule implementation process.

Making matters worse, today’s request for comment is completely outside the scope of the cross-border Guidance and the Exemptive Order as the Commission did not address the issue relating to swaps negotiated between non-U.S. swap dealers (“SDs”) and non-U.S. counterparties acting through agents of the non-U.S. SDs located in the United States. This is simply a strategic move by the Commission to try to duck blame for consistently circumventing the fundamental tenets of the APA and failing to adhere faithfully to the express congressional directive to limit the extraterritorial application of the Dodd-Frank Act to foreign transactions that “have a direct and significant connection with activities in, or effect on, commerce of the United States.”1

Moreover, I question why the Commission has decided to request comment on a narrow issue of the extraterritorial application of Dodd-Frank, while essentially ignoring the dozens of comments already filed as part of the Commission’s cross-border Exemptive Order.2 Simply requesting comment on a staff Advisory does not endorse the validity of the cross-border Guidance or the staff Advisory issued based on the Guidance.

Additionally, I have serious concerns with the evolving jurisdictional application of the Commission’s authority over cross-border trades. It appears based on the staff Advisory, that the Commission is applying a “territorial” jurisdiction test to elements of a trade between non-U.S. entities. To better understand the legal underpinnings of this position, I have included several additional questions to be considered as part of the overall comment file. It is my hope that public comments will provide greater clarity regarding our cross-border authority and identify areas where we must harmonize global rules with our international regulatory partners in the near future. It makes no sense to apply guidance or staff advisories that do not enjoy the full support and authority provided through rulemakings based on the Commodity Exchange Act (“CEA”).

Looking forward into this year, the CFTC needs to do away with the reflexive rule implementation process via staff no-action and advisories that are not voted on by the Commission. It should be the goal of the Commission to develop rules that adhere to the APA and ensure proper regulatory oversight, transparency and promote competition in the derivatives space.

In this regard, I would like to seek additional comment on the following points:

1. Please provide your views on whether Covered Transactions with non-U.S. persons who are not guaranteed or conduit affiliates of U.S. persons meet the direct and significant test under CEA section 2(i).3  Please provide a detailed analysis of any such view and its effect on other aspects of the Commission’s cross-border policy, if any. Would your view change depending on whether a non-U.S. SD is a guaranteed affiliate or a conduit affiliate of a U.S. person?

2. CEA section 2(a)(1)4 provides for the general jurisidiction of the Commission. Please provide your views on whether Covered Transactions with non-U.S. persons who are not guaranteed or conduit affiliates of U.S. persons fall within the Commission’s jurisdiction under CEA section 2(a)(1) or any other provision of the CEA providing for Commission jurisdiction. Please provide a detailed analysis of any such view and its effect on other aspects of the Commission’s cross-border policy, if any. Would your view change depending on the nature of the non-U.S. SD (i.e., whether it is a guaranteed affiliate or a conduit affiliate of a U.S. person)?

3. To the extent that Covered Transactions fall within the Commission’s jurisdiction, should a non-U.S. SD be required to comply with all, or only certain, Transaction-Level Requirements? Please provide a detailed analysis of any such view and its effect on other aspects of the Commission’s cross-border policy, if any. Would your view change depending on the nature of the non-U.S. SD (i.e., whether it is a guaranteed affiliate or a conduit affiliate of a U.S. person)?

4. In the open meeting to consider the cross-border final guidance and cross-border phase-in exemptive order, I asked about the Commission’s enforcement and legal authority under the cross-border guidance. The Commission’s General Counsel replied, “[T]he guidance itself is not binding strictly. We couldn’t go into court and, in a count of the complaint, list a violation of the guidance as an actionable claim.”5 If the Commission adopts the staff Advisory as Commission policy (and not through the rulemaking process), please provide your views on the Commission’s ability to enforce such policy.

CFTC MOVES ON COMMENT REQUEST REGARDING NON-U.S. SWAP DEALERS

FROM:  COMMODITY FUTURES TRADING COMMISSION 
CFTC Approves Request for Comment on Application of Commission Regulations to U.S. Activities of Non-U.S. Swap Dealers

Washington, DC — The Commodity Futures Trading Commission (Commission) today approved the issuance of a notice of request for public comment on a staff advisory regarding the applicability of certain Commission regulations to the activity in the United States of registered, non-U.S. swap dealers when entering into swaps with non-U.S. persons.

The Commission seeks comment on all aspects of the November 14, 2013 staff advisory 13-69 in view of the complex legal and policy issues involved. Comments must be received within 60 days after publication of the notice in the Federal Register.

CFTC & FERC SIGN MEMORANDUM OF UNDERSTANDING REGARDING INVESTIGATIONS AND SURVEILLANCE

FROM:  COMMODITY FUTURES TRADING COMMISSION 

January 2, 2014

FERC, CFTC Sign MOUs on Jurisdiction and Information Sharing

Washington, DC — The Federal Energy Regulatory Commission (FERC) and the Commodity Futures Trading Commission (CFTC) have signed two Memoranda of Understanding (MOU) to address circumstances of overlapping jurisdiction and to share information in connection with market surveillance and investigations into potential market manipulation, fraud or abuse. The MOUs allow the agencies to promote effective and efficient regulation to protect energy market competitors and consumers.

The jurisdiction MOU sets out a process under which the agencies will notify each other of activities that may involve overlapping jurisdiction and coordinate to address the agencies’ regulatory concerns. The new information sharing MOU establishes procedures through which the agencies will share information of mutual interest related to their respective market surveillance and investigative responsibilities, while maintaining confidentiality and data protection. In support of the new information sharing MOU, CFTC Chairman Gary Gensler and FERC Acting Chairman Cheryl LaFleur also agreed that the agencies will work together to share appropriate data relating to financial markets for gas and electricity on an ongoing basis.

“These memoranda will further strengthen FERC’s ability to perform its market oversight and enforcement responsibilities,” said Acting Chairman LaFleur. “As FERC’s role in overseeing the competitive energy markets has grown since the passage of the Energy Policy Act of 2005, our need to coordinate with the CFTC is increasingly important. I appreciate Chairman Gensler’s work on these agreements and look forward to continued cooperation between our agencies.”

“I’m so pleased that with Acting Chairman LaFleur, our two agencies have been able to enter into these Memoranda of Understanding,” said CFTC Chairman Gensler. “These memoranda will help lead to better protection of the nation’s energy markets and increase cooperation between the agencies.”

Congress directed the CFTC and FERC to develop the MOUs as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The agencies have been operating under a 2005 MOU that allowed information exchange related to oversight or investigations.

INVESTMENT ADVISER AND OWNER RECEIVE PERMANENT INJUNCTIONS FOR ROLES IN ALLEGED FRAUD

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 
SEC Obtains Order of Permanent Injunctions Against Chicago-Area Investment Adviser and Its Owners for Fraud

The Securities and Exchange Commission (Commission) announced that on December 19, 2013, Judge Charles P. Kocoras of the U.S. District Court for the Northern District of Illinois entered an order of permanent injunctions against Oakbrook, Illinois resident Patrick G. Rooney (Rooney) and his company Solaris Management, LLC (Solaris).

According to the SEC's complaint filed on November 16, 2011, Rooney and Solaris radically changed the investment strategy of the Solaris Opportunity Fund LP (the Fund), contrary to the Fund's offering documents and marketing materials, by becoming wholly invested in Positron Corp. (Positron), a financially troubled microcap company. The SEC alleges that Rooney, who has been Chairman of Positron since 2004 and received salary and stock options from Positron since September 2005, misused the Fund's money by investing more than $3.6 million in Positron through both private transactions and market purchases. Many of the private transactions were undocumented while other investments were interest-free loans to Positron. Rooney and Solaris hid the Positron investments and Rooney's relationship with the company from the Fund's investors for over four years. Although Rooney finally told investors about the Positron investments in a March 2009 newsletter, the SEC's complaint alleges he falsely told them he became Chairman to safeguard the Fund's investments. These investments benefited Positron and Rooney while providing the Fund with a concentrated, undiversified, and illiquid position in a cash-poor company with a lengthy track record of losses.

Without admitting or denying the Commission's allegations, Rooney and Solaris consented to the entry of permanent injunctions which enjoin them from violating Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-8(a)(1) and (a)(2) thereunder; Section 17(a) of the Securities Act of 1933; and Sections 10(b) and 13(d)(1) of the Securities Exchange Act of 1934 and Rules 10b-5 and 13d-1 thereunder. Rooney and Solaris Management further agreed that the court would determine whether to impose penalties and disgorgement against them and whether Rooney should be prohibited from acting as an officer or director of a public company.

MICROSOFT SENIOR MANAGER CHARGED BY SEC WITH INSIDER TRADING

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 
SEC Charges Microsoft Senior Manager and Friend with Insider Trading in Advance of Company News

The Securities and Exchange Commission announced that, on December 19, 2013, it charged a senior portfolio manager at Microsoft Corporation and his friend and business partner with insider trading ahead of company announcements.

The SEC alleges that Brian D. Jorgenson, who lives in Lynwood, Wash., obtained confidential information about upcoming company news through his work in Microsoft's corporate finance and investments division. Jorgenson tipped Sean T. Stokke of Seattle in advance of the Microsoft announcements, the most recent occurring in October. After Stokke traded on the inside information that Jorgenson provided, the two equally split the illicit profits in their shared brokerage accounts. They made joint trading decisions with the goal of generating enough profits to create their own hedge fund.

In a parallel action, the U.S. Attorney's Office for the Western District of Washington announced criminal charges against Jorgenson and Stokke.

According to the SEC's complaint filed in U.S. District Court for the Western District of Washington, Jorgenson and Stokke made a combined $393,125 in illicit profits in their scheme, which began in April 2012.

The SEC alleges that Stokke first traded in advance of a public announcement that Microsoft intended to invest $300 million in Barnes & Noble's e-reader business. Jorgenson learned of the impending transaction after his department became involved in the financing aspects of the deal. Jorgenson tipped Stokke so he could purchase approximately $14,000 worth of call options on Barnes & Noble common stock. Following a joint public announcement on April 30, 2012, Barnes & Noble's stock price closed at $20.75 per share, a 51.68 percent increase from the previous day. Jorgenson and Stokke made nearly $185,000 in ill-gotten trading profits.

The SEC alleges that Stokke later traded in advance of Microsoft's fourth-quarter earnings announcement in July 2013. As part of his duties at Microsoft, Jorgenson prepared a written analysis of how the market would react to the negative news that Microsoft's fourth quarter earnings were more than 11 percent below consensus estimates. He estimated that Microsoft's stock price would decline by at least six percent. Jorgenson tipped this confidential information to Stokke, who purchased almost $50,000 worth of Microsoft options. After Microsoft's announcement on July 18, its stock price declined more than 11 percent the next day from $35.44 to $31.40 per share. Jorgenson and Stokke realized more than $195,000 in illicit profits.

According to the SEC's complaint, Stokke traded in advance of another Microsoft announcement on Oct. 24, 2013. Jorgenson was aware that the company would be announcing first quarter 2014 earnings that were more than 14 percent higher than consensus estimates. Rather than purchase Microsoft securities directly, Jorgenson and Stokke purchased more than $45,000 worth of call options on an exchange-traded fund in which Microsoft comprised more than eight percent of the fund's holdings. Following the announcement, Microsoft's share price increased nearly six percent and the price of the ETF increased 0.51 percent. Jorgenson and Stokke made approximately $13,000 in illegal trading profits.

Jorgenson and Stokke are charged with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, both directly and pursuant to Section 20(d) of the Exchange Act. The SEC seeks permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, and financial penalties against Jorgenson and Stokke as well as an officer-and-director bar against Jorgenson.

The SEC's investigation was conducted by Brendan P. McGlynn, Patricia A. Paw, John S. Rymas, and Daniel L. Koster of the Philadelphia Regional Office. The SEC's litigation will be led by John V. Donnelly and G. Jeffery Boujoukos.

The SEC appreciates the assistance of the U.S. Attorney's Office for the Western District of Washington, Federal Bureau of Investigation, Options Regulatory Surveillance Authority, and Financial Industry Regulatory Authority.

SEC ISSUES ANNUAL REPORT ON CREDIT RATING AGENCIES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission issued its annual staff report on the findings of examinations of credit rating agencies registered as nationally recognized statistical rating organizations (NRSROs).  The agency also submitted an annual staff report on NRSROs to Congress.

“The two reports reflect an evolving industry,” said Thomas J. Butler, director of the SEC’s Office of Credit Ratings.  “The examination report shows that the SEC’s vigilant oversight is improving compliance at NRSROs, while the annual report to Congress depicts an industry that is growing more competitive and transparent.”

The 2010 Dodd-Frank Act requires the SEC to examine each NRSRO at least annually and issue a report summarizing key findings of the examinations.  The report discusses the staff’s findings and recommendations for each of the 10 NRSROs.  Among the areas examined are whether each NRSRO conducts business in accordance with its policies, procedures, and methodologies as well as how an NRSRO manages conflicts of interest and whether it maintains effective internal controls.

The report noted, for instance, that the staff found one or more NRSROs lacked comprehensive procedures governing ratings placed under review.  The staff also found that oversight of the process for developing new rating methodologies and criteria was not sufficient at one or more NRSROs to ensure independence from business and market share considerations.

The 2013 examination report highlights certain improvements among NRSROs, such as increased investment in compliance systems and infrastructure along with enhancements in compliance training for both analytical and non-analytical employees.  These improvements address recommendations that the staff made to NRSROs on prior examinations.

The annual report to Congress, which is required by the 2006 Credit Rating Agency Reform Act, identifies the applicants for NRSRO registration, actions taken on the applications, and the SEC’s views on the state of competition, transparency, and conflicts of interest among NRSROs.

Observations from the 2013 annual report include the following:

The number of NRSROs rose to 10 with HR Ratings de México, S.A. de C.V., registering in November 2012.
Some smaller NRSROs have gained significant market share in ratings for certain types of asset-backed securities.
Transparency is increasing due to the NRSROs issuing unsolicited commentary on ratings issued by other NRSROs.

The following SEC staff made significant contributions to the examinations and reports: Abe Losice, Michele Wilham, Kenneth Godwin, Natalia Kaden, Harriet Orol, Jacob Prudhomme, Diane Audino, Kristin Costello, Scott Davey, Shawn Davis, Michael Gerity, Julia Kiel, Joanne Legomsky, Russell Long, Carlos Maymi, David Nicolardi, Sam Nikoomanesh, Joseph Opron, Abraham Putney, Mary Ryan, Warren Tong, Evelyn Tuntono, and Kevin Vasel.