CFTC ACTING CHAIRMAN'S TESTIMONY BEFORE SENATE SUBCOMMITTEE

FROM:  COMMODITY FUTURES TRADING COMMISSION 

Testimony of Mark P. Wetjen Acting Chairman, Commodity Futures Trading Commission Before the U.S. Senate Appropriations Subcommittee on Financial Services And General Government

May 14, 2014

Good morning, Chairman Udall, Ranking Member Johanns and members of the Subcommittee. Thank you for inviting me to today’s hearing on the President's Fiscal Year 2015 funding request and budget justification for the Commodity Futures Trading Commission (Commission or CFTC).

During the last two years, despite significant budgetary constraints, the CFTC has made important progress in fulfilling its mission. As you know, under the Commodity Exchange Act, the Commission has oversight responsibilities for the derivatives markets, which include futures, options, cash, and swaps. Each of these markets is significant. Collectively, they have taken on particular importance to the U.S. economy in recent decades and, as a consequence, have grown substantially in size, measuring hundreds of trillions of dollars in notional value. Their operation and integrity are critical to the effective functioning of the U.S. and global economies.

At their core, the derivatives markets exist to help farmers, producers, small businesses, manufacturers and lenders focus on what they do best: providing goods and services and allocating capital to reduce risk and meet Main Street demand. Well-regulated derivatives markets facilitate job creation and the growth of the economy by providing a means for managing and assuming prices risks and broadly disseminating, and discovering, pricing information.

Stated more simply, through the derivatives marketplace, a farmer can lock in a price for his crop; a small business can lock in an interest rate that would otherwise fluctuate, perhaps raising its costs; a global manufacturer can lock in a currency value, allowing it to better plan and grow its global business; and a lender can manage its assets and balance sheet to ensure it can continue lending, fueling the economy in the process.

Essentially, these complex markets facilitate the assumption and distribution of risk throughout the financial system. Well-working derivatives markets are key to supporting a strong, growing economy by enabling the efficient transfer of risk, and therefore the efficient production of goods and services. Accordingly, it is critical that these markets are subject to appropriate governmental oversight.

Mr. Chairman, Ranking Member, and Committee members, I do not intend the testimony that follows to sound alarmist, or to overstate the case for additional resources, but I do want to be sure that Congress, and this committee in particular, have a clear picture of the potential risks posed by the continued state of funding for the agency. When not overseen properly, the derivatives markets may experience irregularities or failures of firms intermediating in them – events that can severely and negatively impact the economy as a whole and cause dramatic losses for individual participants. The stakes, therefore, are high.

The CFT C’s Responsibilities Have Grown Substantially in Recent Years

The unfortunate reality is that, at current funding levels, the Commission is unable to adequately fulfill the mission given to it by Congress: to prevent disruptions to market integrity, protect customer assets, monitor and reduce the build-up of systemic risk, and ensure to the greatest extent possible that the derivatives markets are free of fraud and manipulation.

Recent increases in the agency’s funding have been essential and appreciated. They have not, however, kept pace with the growth of the Commission’s responsibilities, including those given to it under Dodd-Frank.

Various statistics have been used to measure this increase in responsibilities. One often-cited measure is the increase in the gross notional size of the marketplace now under the Commission’s oversight. Other measures, though, are equally and perhaps more illustrative.

Trading Volume Has Increased

For instance, the trading volume of CFTC-regulated futures and options contracts was 3,060 million contracts in 2010 and rose to 3,477 million in 2013. Similarly, the volume of interest rate swap trading activity by the 15 largest dealers averaged 249,564 swap events each in 2010, and by 2012, averaged 332,484 each (according to the International Swaps and Derivatives Association (“ISDA”) data). Those transactions, moreover, can be executed in significantly more trading venues, and types of trading venues, both here and abroad. In addition, the complexity of the markets – its products and sophistication of the market tools, such as automated-trading techniques – has increased greatly over the years.

Clearing Houses Manage More Risk

The notional value of derivatives centrally cleared by clearing houses was $124 trillion in 2010 (according to ISDA data), and is now approximately $223 trillion (according to CFTC data from swap data repositories (“SDRs”)). That is nearly a 100 percent increase. The expanded use of clearinghouses is significant in this context because, among other things, it means that the Commission must ensure through appropriate oversight that these entities continue to properly manage the various types of risks that are incident to a market structure dependent on central clearing. A clearinghouse’s failure to adhere to rigorous risk management practices established by the Commission’s regulations, now more than ever, could have significant economic consequences. The Commission directly oversees fifteen registered clearinghouses and two of them, Chicago Mercantile Exchange, Inc., and ICE Clear Credit LLC, have been designated as systemically important by the Financial Stability Oversight Council.

Clearing Houses and Intermediaries Manage More Customer Funds

The amount of customer funds held by clearinghouses and futures commission merchants (FCMs) was $177 billion in 2010 and is now over $218 billion, another substantial increase. These are customer funds in the form of cash and securities deposited at firms to be used for margin payments made by the end-users of the markets, like farmers, to support their trading activities. Again, Commission rules are designed to ensure customer funds are safely kept by these market intermediaries, and a failure to provide the proper level of oversight increases the risk of certain practices by firms, including operational risks or fraud. In fact, recent events in the FCM community led to the temporary or permanent loss of more than a billion dollars of customer funds.

Substantially Larger Number of Firms Now Registered with the CFTC

The total number of registrants and registered entities overseen directly or indirectly by the Commission, depending on the measure, has increased by at least 40 percent in the last four years. This includes 102 swap dealers and two major swap participants (MSPs).

In addition, the CFTC oversees more than 4,000 advisers and operators of managed funds, some of which have significant outward exposures in and across multiple markets. It is conceivable that the failure of some of these funds could have spill-over effects on the financial system. In all cases, investors in these funds are entitled to know their money is being appropriately held and invested.

Additionally, the Commission directly or indirectly supervises another approximately 64,000 registrants, mostly associated persons that solicit or accept customer orders or participate in certain managed funds, or that invest customer funds through discretionary accounts. Although it leverages the resources of the self-regulatory organizations (“SROs”), the Commission itself must oversee these registrants in certain areas and provide guidance and interpretations to the SROs. The Commission does so with a total staff of only 648 employees currently onboard – about 1 percent of the number of registrants under its purview. Separately, the Commission must oversee more than three dozen registered entities, including clearinghouses and trading venues, each of which is subject to a complex set of regulatory requirements newly established or modified by the Dodd-Frank Act and designed to mitigate systemic risk.

By almost any measure, in fact, the portfolio of entities that the Commission is charged with overseeing has expanded dramatically in size and risk over the last half decade. The intermediaries in the derivatives markets are by and large well-run firms that perform important services in the markets and for their customers. Nevertheless, collectively, these firms can potentially pose risks – in some cases significant risks – to the financial system and the broader economy. Accordingly, those relying upon these firms and the public deserve assurance that such firms are supervised by an agency capable of meaningful oversight.

The CFTC Has Made Important Progress But Has Been Significantly Constrained

For much of FY 2013, the CFTC operated under continuing resolutions, which extended the FY 2012 appropriation of $205 million. These appropriations, however, were subject to sequestration. Effectively, our operating budget for FY 2013 was $195 million. Thus, the FY 2014 appropriation of $215 million was a modest budgetary increase for the Commission, lifting the agency’s appropriations above the sequestration level of $195 million that has posed significant challenges for the agency’s orderly operation. As directed by Congress, the agency has submitted a FY 2014 Spend Plan outlining its allocation of current resources, which reflects an increased emphasis on examinations and technology-related staff.

Even with these significant budget constraints, the dedicated staff of the Commission were able to complete the majority of new rulemakings required by the Dodd-Frank Act – about 50 rulemakings in all. This was in addition to the Commission’s ongoing work overseeing the futures exchange and options markets. These regulatory efforts resulted in greater transparency, which is critical to reducing systemic risk and lowering costs to end-users, while improving efficiency and supporting competition.

With regard to technology, we made progress in a variety of areas. We improved the quality of data reported to swap data repositories and have laid groundwork to receive, analyze and promulgate new datasets from SROs related to new authorities. We upgraded data analytics platforms to keep up with market growth. Financial risk surveillance tools were enhanced to support monitoring and stress testing related to new authorities. The Commission has prototyped a high-performance computing platform that dramatically reduces data analytics computation times and an on-line portal for regulatory business transactions to improve staff and industry productivity. The Commission has implemented enhanced position limit monitoring and is ready to implement pre-trade and heightened account ownership and control surveillance. Finally, the Commission has ensured that foundational server, storage, networking, and workstation technology are refreshed on a cost-effective cycle and that technology investments have cybersecurity and business continuity built-in.

In its role as a law enforcement agency, the Commission’s enforcement arm protects market participants and other members of the public from fraud, manipulation and other abusive practices in the futures, options, cash, and swaps markets, and prosecutes those who engage in such conduct. As of May 1, 2014, the Commission filed 31 enforcement actions in FY 2014 and also obtained orders imposing more than $2.2 billion in sanctions. By way of comparison, in FY 2013, the Commission filed 82 enforcement actions, and obtained orders imposing more than $1.7 billion in sanctions.

With the bulk of rulemaking behind us, the necessary focus must be examinations, market supervision and enforcement. Simply stated, this requires appropriate staffing and technological resources sufficiently robust to oversee what are highly advanced, complex global markets, and be able to take effective and timely enforcement action.

The FY 2015 Request Prioritizes Examinations, Technology, Market Integrity, and Enforcement

The President’s FY 2015 budget request reflects these priorities and highlights both the importance of the Commission’s mission and the potential effects of continuing to operate under difficult budgetary constraints.

The request is a significant step towards the longer-term funding level that is necessary to fully and responsibly fulfill the agency’s core mission: protecting the safety and integrity of the derivatives markets. It recognizes the immediate need for an appropriation of $280 million and approximately 920 staff years (FTEs) for the agency, an increase of $65 million and 253 FTEs over the FY 2014 levels, heavily weighted towards examinations, surveillance, and technology functions.

In this regard, the request balances the need for more technological tools to monitor the markets, detect fraud and manipulation, and identify risk and compliance issues, with the need for staff with the requisite expertise to analyze the data collected through technology and determine how to use the results of that analysis to fulfill the Commission’s mission as the regulator of the derivatives markets. Both are essential to carrying out the agency’s mandate. Technology, after all, is an important means for the agency to effectively carry out critical oversight work; it is not an end in itself.

In light of technological developments in the markets today, the agency has committed to an increased focus on technology. The FY 2015 budget request includes a $15 million increase in technology funding above the FY 2014 appropriation, or about a 42 percent increase, solely for IT investments.

In my remaining testimony, I will review three of the primary mission priorities for FY 2015.

Examinations

The President’s request would provide $38 million and 158 FTEs for examinations, which also covers the compliance activities of the Commission. As compared to FY 2014, this request is an increase of $15 million and 63 FTEs.

I noted earlier that the Commission has seen substantial growth in, among other things, trading volumes, customer funds held by intermediaries in the derivatives markets, and margin and risk held by clearinghouses. Examinations and regulatory compliance oversight are perhaps the best deterrents to fraud and improper or insufficient risk management and, as such, remain essential to compliance with the Commission’s customer protection and risk management rules.

The Commission has a direct examinations program for clearinghouses and designated contract markets, and it will soon directly examine swap execution facilities and SDRs. However, the agency does not at this time have the resources to place full-time staff on site at these registered entities, even systemically-important clearing organizations, unlike a number of other financial regulators that have on-the-ground staff at the significant firms they oversee. The Divisions of Market Oversight and Clearing and Risk collectively have a total of 47 examinations positions in FY 2014 to monitor, review, and report on some of the most complex financial market operations in the world.

The Commission today performs only high-level, limited-scope reviews of the nearly 100 FCMs holding over $218 billion in customer funds and 102 swap dealers. In fact, the Commission currently has a staff of only 38 to examine these firms, and to review and analyze, among other things, over 1,200 financial filings and over 2,400 regulatory notices each year. This staff level is less than the number the Commission had in 2010, yet the number of firms requiring its attention has almost doubled, and there has been a noted increase in the complexity and risk profile of the firms. Additionally, although it has begun legal compliance oversight of swap dealers and MSPs, the Commission has been able to allocate only 13 FTEs for this purpose. This number is insufficient to perform the necessary level of oversight of the newly registered swap dealer entities.

In FY 2014, the Commission overall will have a mere 95 staff positions dedicated to examinations of the thousands of different registrants that should be subject to thorough oversight and examinations. The reality is that the agency has fallen far short of performance goals for its examinations activities, and it will continue to do so in the absence of additional funding from Congress. For example, as detailed in the Annual Performance Review for FY 2013, the Commission failed to meet performance targets for system safeguard examinations and for conducting direct examinations of FCM and non-FCM intermediaries. The President’s budget request appropriately calls on Congress to bolster the examinations function at the agency, and it would protect the public, and money deposited by customers, by enhancing the examinations program staff by more than 66 percent in FY 2015.

Moreover, if Congress fully funds the President’s request, the Commission can move toward annual reviews of all significant clearinghouses and trading platforms and perform more effective monitoring of market participants and intermediaries. Partially funding the request will mean accepting potentially avoidable risk in the derivatives markets as the Commission is forced to forego more in-depth financial, operational and risk reviews of the firms within its jurisdiction. Thus, the Commission would be reactive, rather than proactive in regard to firm or industry risk issues.

Technology and Market Integrity

The FY 2015 request also supports a substantial increase in technology investments relative to FY 2014, roughly a 42 percent increase. The $50 million investment in technology will provide millions of dollars for new and sophisticated analytical systems that will, in part, assist the Commission in its efforts to ensure market integrity. As global markets have moved almost entirely to electronic systems, the Commission must invest in technology required to collect and analyze market data, and to handle the unprecedented volumes of transaction-level data provided by financial markets.

The President’s FY 2015 budget request supports, in addition, 103 data-analytics and surveillance-related positions in the Division of Market Oversight alone, an increase of more than 98 percent over the FY 2014 staffing levels. Market surveillance is a core Commission mission, and it is an area that depends heavily on technology. As trading across the world has moved almost entirely to electronic systems, the Commission must make the technology investments required to collect and make sense of market data and handle the unprecedented volumes of transaction-level data provided by financial markets.

Effective market surveillance, though, equally depends on the Commission’s ability to hire and retain experienced market professionals who can analyze extremely complex and voluminous data from multiple trading markets and develop sophisticated analytics and models to respond to and identify trading activity that warrants investigation. The FY 2015 investment in high-performance hardware and software therefore must be paired with investments in personnel that can employ technology investments effectively.

Accordingly, to make use of existing and new IT investments, the FY 2015 request would provide funding for 193 FTEs, an increase of 74 FTEs over FY 2014. These new staff positions are necessary for the Commission to receive, analyze, and effectively surveil the markets it oversees. These new positions, together with the technology investments included in the FY 2015 request, will enable the Commission to make market surveillance a core component of our mission.

The CFTC has invested appropriated funds in FY 2013 and FY 2014 in technology to make important progress. We have the groundwork in place to receive and effectively analyze swaps transaction data submitted to repositories and SROs related to new authorities. The FY 2015 request would provide funding to continue and increase the pace of progress in the areas noted above and also support the additional examination, enforcement, and economic and legal staff. Effective use of technology is essential to our mission to ensure market integrity, promote transparency, and effectively surveil market participants.

Enforcement

The President’s FY 2015 request would provide $62 million and 200 FTEs for enforcement, an increase of $16 million and 51 FTEs over FY 2014. The simple fact is that, without a robust, effective enforcement program, the Commission cannot fulfill its mandate to ensure a fair playing field. From FY 2011 to date, the Commission has filed 314 enforcement actions and also obtained orders imposing more than $5.4 billion in sanctions.

The cases the agency pursues range from sophisticated manipulative and disruptive trading schemes in markets the Commission regulates, including financial instruments, oil, gas, precious metals and agricultural products, to quick strike actions against Ponzi schemes that victimize investors. The agency also is engaged in complex litigations related to issues of financial market integrity and customer protection. By way of example, in FY 2013, the CFTC filed and settled charges against three financial institutions for engaging in manipulation, attempted manipulation and false reporting of LIBOR and other benchmark interest rates.

Such investigations continue to be a significant and important part of the Division of Enforcement’s docket. Preventing manipulation is critical to the Commission’s mission to help protect taxpayers and the markets, but manipulation investigations, in particular, strain resources and time. And once a case is filed, the priority must shift to the litigation. In addition to requiring significant time and resources at the Commission, litigation requires additional resources, such as the retention of costly expert witnesses.

In 2002, when the Commission was responsible for the futures and options markets alone, the Division of Enforcement had approximately 154 people. Today, the agency’s responsibilities have substantially increased. The CFTC now also has anti-fraud and anti-manipulation authority over the vast swaps market and the host of new market participants the agency now oversees. In addition, the agency is now responsible for pursuing cases under our enhanced Dodd-Frank authority that prohibits the reckless use of manipulative or deceptive schemes. Notwithstanding these additional responsibilities, however, total enforcement staff has shrunk – there are currently only 147 members of the enforcement staff. The President’s budget request would bring this number to 200. More cops on the beat means the public is better assured that the rules of the road are being followed.

In addition to the need for additional enforcement staff and resources, the CFTC also believes technology investments will make our enforcement staff more efficient. For instance, the FY 2015 request would support developing and enhancing forensic analysis and case management capabilities to assist in the development of analytical evidence for enforcement cases. In FY 2013 and FY 2014, appropriated funds invested in information technology have enabled the Commission to continue enhancing enforcement and litigation automation services, including a major upgrade to the document and digital evidence review platform that will enable staff to keep pace with the exploding volume of data required to successfully conduct enforcement actions.

A full increase for enforcement means that the agency can pursue more investigations and better protect the public and the markets. A less than full increase means that the CFTC will continue to face difficult choices about how to use its limited enforcement resources. At this point, it is not clear that the agency could maintain the current volume and types of cases, as well as ensure timely responses to market events.

Other FY 2015 Priorities: International Policy Coordination & Economic and Legal Analysis

The global nature of the derivatives markets makes it imperative that the United States consult and coordinate with international authorities. For example, the Commission recently announced significant progress towards harmonizing a regulatory framework for CFTC-regulated SEFs and EU-regulated multilateral trading facilities (MTFs). The Commission is working internationally to promote robust and consistent standards, to avoid or minimize potentially conflicting or duplicative requirements, and to engage in cooperative supervision, wherever possible.

Over the past two years, the CFTC, SEC, European Commission, European Securities and Markets Authority, and other market regulators from around the globe have been meeting regularly to discuss and resolve issues with the goal of harmonizing financial reform. The Commission also participates in numerous international working groups regarding derivatives. The Commission’s international efforts directly support global consistency in the oversight of the derivatives markets. In addition, the Commission anticipates a significant need for ongoing international policy coordination related to both market participants and infrastructure in the swaps markets. The Commission also anticipates a need for ongoing international work and coordination in the development of data and reporting standards under Dodd-Frank rules. Dodd- Frank further provided a framework for foreign trading platforms to seek registration as foreign boards of trade, and 24 applications have been submitted so far.

Full funding for international policy means the Commission will be able to maintain our coordination efforts with financial regulators and market participants from around the globe. If available funding is decreased, we will be less able to engage in cooperative work with our international counterparts, respond to requests, and provide staffing for various standard-setting projects. The President’s FY 2015 request would enable the Commission to sustain its efforts, providing $4.2 million and 15 FTEs that would be dedicated to international policy.

In addition, for FY 2015, the President’s budget would support $24 million and 92 FTEs to invest in robust economic analysis teams and Commission-wide legal analysis. Compared to the FY 2014 Spending Plan, this request is an increase of $4 million and 18 FTEs. Both of these teams support all of the Commission’s divisions.

The CFTC’s economists analyze innovations in trading technology, developments in trading instruments and market structure, and interactions among various market participants in the futures and swaps markets. Economics staff with particular expertise and experience provides leverage to dedicated staff in other divisions to anticipate and address significant regulatory, surveillance, clearing, and enforcement challenges. Economic analysis plays an integral role in the development, implementation, and review of financial regulations to ensure that the regulations are economically sound and subjected to a careful consideration of potential costs and benefits. Economic analysis also is critical to the public transparency initiatives of the Commission, such as the Weekly Swaps Report. Moving into FY 2015, the CFTC’s economists will be working to integrate large quantities of swaps market data with data from designated contract markets and swap execution facilities, and large swaps and futures position data to provide a more comprehensive view of the derivatives markets.

The legal analysis team provides interpretations of Commission statutory and regulatory authority and, where appropriate, provides exemptive, interpretive, and no-action letters to CFTC registrants and market participants. In FY 2013, the Commission experienced a significant increase in the number and complexity of requests from market participants for written interpretations and no-action letters, and this trend is expected to increase into FY 2015.

A full increase for the economics and legal analysis mission means the Commission will be able to support each of the CFTC’s divisions with economic and legal analysis. Funding short of this full increase or flat funding means an increasingly strained ability to integrate and analyze vast amounts of data the Commission is receiving on the derivatives markets, thus impacting our ability to study and detect problems that could be detrimental to the economy. Flat funding also means the Commission’s legal analysis team will continue to be constrained in supporting front- line examinations, adding to the delays in responding to market participants and processing applications, and hampering the team’s ability to support enforcement efforts.

Conclusion

Effective oversight of the futures and swaps markets requires additional resources for the Commission. This means investing in both personnel and information technology. We need staff to analyze the vast amounts of data we are receiving on the swaps and futures markets. We need staff to regularly examine firms, clearinghouses, trade repositories, and trading platforms. We need staff to bring enforcement actions against perpetrators of fraud and manipulation. The agency’s ability to appropriately oversee the marketplace hinges on securing additional resources.

Thank you again for inviting me today, and I look forward to your questions.

CFTC OFFICIAL'S TESTIMONY BEFORE SENATE COMMITTEE REGARDING AUTOMATED TRADING ENVIRONMENTS

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

Testimony of Vincent McGonagle, Director of the Division of Market Oversight, Commodity Futures Trading Commission Before the U.S. Senate Committee on Agriculture, Nutrition and Forestry

May 13, 2014

Chairwoman Stabenow, Ranking Member Cochran and Members of the Committee, thank you for the opportunity to appear before you today. My name is Vincent McGonagle and I am the Director of the Division of Market Oversight at the Commodity Futures Trading Commission (CFTC or Commission). I am pleased to appear before the Committee to provide an overview of the CFTC’s Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (Concept Release). The Concept Release reflects the Commission’s ongoing commitment to the safety and soundness of U.S. derivatives markets in times of technological change, including automated and high-frequency trading (HFT).

My written testimony today will describe the Concept Release and provide an overview of public comments received in response to the risk controls and market enhancements discussed therein. It will also describe the regulatory context in which automated and high-frequency trading currently operate, and numerous measures already taken by the Commission to safeguard trading in modern, technology-driven markets.

Background on Commodity Exchange Act and the CFTC’s Mission

The purpose of the Commodity Exchange Act (Act) is to serve the public interest by providing a means for managing and assuming price risks, discovering prices, or disseminating pricing information. Consistent with its mission statement and statutory charge, the CFTC is tasked with protecting market participants and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives – both futures and swaps – and to foster transparent, open, competitive and financially sound markets. In carrying out its mission and statutory charge, and to promote market integrity, the CFTC polices derivatives markets for various abuses and works to ensure the protection of customer funds.

To fulfill these roles, the Commission oversees designated contract markets (DCMs), swap execution facilities (SEFs), derivatives clearing organizations, swap data repositories, swap dealers (SDs), futures commission merchants (FCMs) and other intermediaries. The Act generally requires that all futures transactions be conducted on or subject to the rules of a board of trade that the CFTC designates as a DCM. Sections 5 and 6 of the Act and Part 38 of the Commission’s regulations provide the legal framework for the Commission to designate DCMs, along with each DCM’s self-regulatory compliance requirements with respect to the trading of commodity futures contracts. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), DCMs were also permitted to list swap contracts. Dodd-Frank also adopted a new regulatory category for exchanges that provide exclusively for the trading of swaps (i.e., SEFs).

Exchanges’ Self-Regulatory Responsibilities and CFTC Oversight

DCMs and SEFs play an important role in the regulatory structure established for derivatives markets by the Act. As self-regulatory organizations (SROs) they are responsible for front-line oversight of all exchange-traded derivatives subject to the Commission’s jurisdiction. DCMs must comply with 23 core principles, including core principles requiring them to establish, monitor and enforce compliance with their rules and to have the capacity to detect, investigate and sanction violative conduct1 and to prevent manipulation and price distortion.2 SEFs are subject to 15 core principles and must comply with similar requirements to establish and enforce trading and participation rules that will deter abuses, and have the capacity to detect and investigate rule violations.3 SEFs are also required to monitor trading in swaps to prevent manipulation and price distortion.4 Commission regulations require DCMs and SEFs to prohibit abusive trading practices by exchange members and market participants, including abuses against customers. Prohibited practices include, but are not limited to, trading ahead of customer orders, accommodation trading, improper cross trading, front-running, wash-trading, pre-arranged trades unless otherwise permitted, fraudulent trading and money passes. DCMs and SEFs must prohibit any other manipulative or disruptive trading practice prohibited by the Act or Commission regulations, and any trading practice that the DCM or SEF believes to be abusive.5

To fulfill these responsibilities, DCMs and SEFs are required to and do maintain in-house compliance departments with appropriate human and technology resources, or to contract with third-party regulatory service providers recognized under the Act. DCMs and SEFs must also maintain complete audit trails. For example, DCMs have extensive electronic records of activity on their electronic trade matching platforms. A subset of such records—trade and related order data—is provided to the CFTC daily by DCMs for the Commission’s own surveillance activities.6

The Division of Market Oversight conducts rule enforcement reviews of DCMs’ self-regulatory programs and evaluates their compliance with the Act and Commission regulations. Such reviews aim to promote DCMs’ effective performance as SROs by examining core principles most closely-related to their self-regulatory programs. These include core principles governing DCMs’ trade practice surveillance, market surveillance, audit trail, and disciplinary programs. The Division will conduct similar reviews of SEFs in the future. In addition, the Division also conducts direct surveillance of its regulated markets, and continues to improve the regulatory data available for this purpose. For example, in November 2013 the Commission published final rules to improve its identification of participants in futures and swaps markets (OCR Final Rules).7 While enhancing the Commission’s already robust position-based reporting regime, the OCR Final Rules also create new volume-based reporting requirements that significantly expand the Commission’s view into its regulated markets, including with respect to high-frequency traders.

Expansion of CFTC Enforcement Authority under Dodd-Frank and New Regulations Relevant to Automated Markets

The Commission’s responsibilities under the Act include mandates to prevent and deter fraud, manipulation, and disruptive trading. Dodd-Frank broadened the Commission’s enforcement authority to include swaps markets. Under the new law and rules implementing it, the Commission’s anti-manipulation reach is extended to prohibit the reckless use of manipulative schemes. Specifically, Section 6(c)(3) of the Act now makes it unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity. In addition, new Section 4c(a) of the Act now explicitly prohibits disruptive trading practices, such as the violation of bids or offers, intentional or reckless disregard for the orderly execution of transactions during the closing period, or the placement of bids or offers with the intent to cancel such bids or offers before execution (commonly known as “spoofing”).8

A number of Commission rulemakings to implement Dodd-Frank have focused specifically on safeguards for automated trading. These new rules address both market participants, such as FCMs, SDs and others, and exchanges, including both DCMs and SEFs. In April 2012, the Commission adopted Regulations 1.73 and 23.609 requiring FCMs, SDs and major swap participants (“MSPs”) that are clearing members to establish risk-based limits based on “position size, order size, margin requirements, or similar factors” for all proprietary accounts and customer accounts.9 The rules also require FCMs, SDs and MSPs to “use automated means to screen orders for compliance with the [risk] limits” when such orders are subject to automated execution.10 The Commission also adopted rules in April 2012 requiring SDs and MSPs to ensure that their “use of trading programs is subject to policies and procedures governing the use, supervision, maintenance, testing, and inspection of the program.”11

In June 2012, the Commission adopted rules to implement the 23 core principles for DCMs.12 Regulation 38.255 requires DCMs to “establish and maintain risk control mechanisms to prevent and reduce the potential risk of price distortions and market disruptions, including, but not limited to, market restrictions that pause or halt trading in market conditions prescribed by the designated contract market.”13 Regulation 37.405 imposes similar requirements on SEFs.14 In addition, the Acceptable Practices for DCM Core Principle 4 (Prevention of Market Disruption) and Guidance to SEF Core Principle 4 (Monitoring of Trading and Trade Processing) identify pre-trade limits on order size, price collars or bands, message throttles and daily price limits as responsive measures that a DCM or SEF may implement to demonstrate compliance with elements of Core Principle 4.15

The DCM rules also set forth risk control requirements for exchanges that provide direct market access (“DMA”) to clients. Regulation 38.607 requires DCMs that permit DMA to have effective systems and controls reasonably designed to facilitate an FCM’s management of financial risk. These systems and controls include automated pre-trade controls through which member FCMs can implement financial risk limits.16 Regulation 38.607 also requires DCMs to implement and enforce rules requiring member FCMs to use these systems and controls.17 Finally, the DCM rules implement new requirements in the Act related to exchanges’ cyber security and system safeguard programs. As with its rule enforcement reviews, the Division also conducts periodic systems safeguards examinations to review DCMs’ compliance with the systems safeguards and cyber security requirements of the Act and Commission regulations. The Act and Commission regulations also address cyber security and system safeguards within SEFs.

The CFTC’s Concept Release on Risk Controls and System Safeguards for Automated Trading Environments

The Commission’s Concept Release on Risk Controls and System Safeguards for Automated Trading Environments was published in the Federal Register on September 12, 2013.18 The initial 90-day comment period closed on December 11, 2013, but was reopened from January 21 through February 14, 2014, in conjunction with a meeting of the CFTC’s Technology Advisory Committee (TAC). As discussed in further detail below, the Concept Release considers a series of potential pre-trade risk controls; post-trade reports; the design, testing, and supervision standards for automated trading systems (ATS) which generate orders for entry into automated markets; market structure initiatives; and other measures designed to reduce risk or improve the functioning of automated markets. The Concept Release also requests public comment on 124 separate questions regarding the necessity and operation of such measures in today’s markets. In this regard, the Concept Release serves as a vehicle to catalogue existing industry practices, determining their efficacy and implementation to date, and evaluating the need for additional measures. The Concept Release is not a proposed rule, but rather a prior step designed to engage a public dialogue and educate the Commission so that it may make an informed determination as to whether rulemaking is necessary and, if so, the substantive requirements of such a rulemaking.

The Commission received a total of 43 public comments on the Concept Release, including comments from DCMs; an array of trading firms; trade associations; public interest groups; members of academia; a U.S. federal reserve bank; and consulting, technology and information service providers in the financial industry. All comments are available on cftc.gov. Many of the comments received are detailed and thorough, including some comment letters that addressed all 124 questions presented in the Concept Release. One commenter conducted a survey of its member firms to gauge existing risk-management practices. Other commenters provided academic papers in support of their points of view, and some focused on elements of the Concept Release that are of particular interest to them. CFTC Staff is studying all comments received and will make initial recommendations once its review is complete.

Fundamentally, the Concept Release asks whether existing risk controls in automated trading environments are sufficient to match the technologies and risks of modern markets. In this regard, the Concept Release focuses on the totality of the automated trading environment, including the progression of orders from the ATSs that generate them, through the clearing firms that guarantee customer orders, and on to execution by registered trading platforms. The Concept Release also addresses ATSs themselves, including their design, testing and supervision. It also raises a number of related issues, ranging from the underlying data streams used by ATSs to inform their trading decisions, to the special considerations involved in trading via direct market access. It also asks whether terms such as “high-frequency trading” should be defined in regulations, and whether HFT firms should be registered with the Commission.

The Concept Release was informed by a number of factors, including: (1) controls or best practices already in use or developed within industry; (2) existing CFTC regulatory standards that address automated trading; and (3) best practices developed by expert groups and outside organizations, including international standard setting bodies, foreign jurisdictions, and the CFTC’s TAC.

The Concept Release begins with an overview of the automated trading environment, including the development of automated order-generating and trade-matching systems; advances in high-speed communication networks; the growth of interconnected automated markets; and the changed role of humans in markets. It also highlights the importance of ATSs as tools for the generation and routing of orders.

These developments are addressed in the Concept Release through a series of 23 potential risk controls and other measures broadly grouped into four categories. The first includes “pre-trade risk controls,” such as controls designed to prevent potential errors or disruptions from reaching trading platforms, or to minimize their impact once they have. Specific pre-trade risk controls include maximum message rates, execution throttles, and maximum order sizes. Depending on the measure, pre-trade risk controls could be applicable to all trading firms; to trading firms operating ATSs; to clearing firms; or to trading platforms. The Concept Release includes a total of eight pre-trade risk controls and sub-controls.

A second category of safeguards includes “post-trade reports” and “other post-trade measures.” Examples in this category include reports that promote the flow of order, trade and position information; uniform trade adjustment or cancellation policies; and standardized error trade reporting obligations. These measures could be applicable to all trading firms; to trading platforms; or to clearing houses. There are a total of five post-trade reports and other measures or sub-measures in this category, including post-order, post-trade, and post-clearing drop copies.

The third category of risk controls discussed in the Concept Release is termed “system safeguards,” including safeguards for the design, testing and supervision of ATSs, as well as measures such as “kill switches” that facilitate emergency intervention in the case of malfunctioning ATSs. Such safeguards would generally be applicable to trading firms operating ATSs, and depending on the control, might also apply to trading platforms and others. The Concept Release presents a total of seven system safeguards, some with subparts.

Finally, the Concept Release presents a fourth category of measures focusing on various options for potentially improving market functioning or structure. These includes measures such as mandatory publication by exchanges of various market quality indicators to help inform market participants (e.g., order to fill ratios; execution speeds for different types of orders and order sizes; price impacts associated with different trade sizes; and average order duration). They also include a number potential measures requiring exchanges to amend their trade matching systems by, for example: (1) providing batch auctions instead of continuous trade matching; (2) prioritizing orders resting in the order book for some minimum period of time; or (3) aggregating multiple small orders from the same legal entity entered contemporaneously at the same price level and assigning them the lowest priority time-stamp of all orders so aggregated.

As a threshold matter, the Concept Release recognizes that orders and trades in automated environments pass through multiple stages in their lifecycle, from order generation, to execution, to clearing, and steps in between. Accordingly, it solicited comment regarding the appropriate stage or stages at which risk controls should be placed. Focal points for the implementation of risk controls described in the Concept Release include: (i) ATSs prior to order submission; (ii) clearing firms; (iii) trading platforms prior to exposing orders to the market; (iv) clearing houses; and (v) other risk control options, such as third-party “hubs” through which orders or order information could flow to uniformly mitigate risks across various platforms. The Concept Release recognizes that the appropriate location of a risk control also may depend on the type of control or its intended purpose. Therefore, it specifically seeks comment on this question, and on the desirability of a “layered” or “defense in depth” approach that places the same or similar risk controls at more than one stage of the order and trade lifecycle.

Given the variety and complexity of matters raised in the Concept Release, commenters understandably held a range of opinions. Many commenters expressed satisfaction that the Commission has undertaken this review of risk controls and system safeguards in automated trading environments. Based on comments received and other indications, a number of parties support certain Commission actions. Some have expressed “race to the bottom” concerns in the absence of minimum regulatory standards. In this regard, any risk controls that introduce latency (i.e., reduce speed) in the generation or transmission of orders could create competitive disadvantage for firms that adopt them unilaterally.

Most commenters also supported a multi-layered approach to risk controls. One commenter stated, for example, that a “holistic approach, with overlapping supervisory obligations, offers the most robust protection by engaging all levels of the supply chain…and eliminating the possibility that a single point of failure will cause significant harm to the market.” Another entity commented with respect to ATS testing and change management that “the same levels of responsibility for testing and change management should apply to all market participants that deploy their own technology, as well as providers of technology that allows access to the markets.”

At the same time, other measures contemplated in the Concept Release drew opposition by a majority of commenters. For example, a majority of parties who commented on the idea of a credit risk control implemented through a centralized hub were opposed to the idea, citing costs, complexity and an undesirable concentration of risk.

Certain key questions in the Concept Release drew very divergent opinions. Commenters disagreed on the need for a regulatory definition of high-frequency trading. Just over half of the parties who commented on this point were opposed to a definition, while the remainder were in favor. The question of defining high-frequency trading is closely related to the question of whether HFT firms not already registered with the Commission in some capacity should be required to register. Those opposed to defining high-frequency trading suggested that no clear distinction can be drawn between automated trading and high-frequency automated trading, or pointed to the difficulty in defining HFT and to the concern that any definition of HFT would become obsolete over time.

A commenter’s opinion as to whether HFT should be defined typically ran in parallel with its opinion as to whether risk controls should apply equally to all automated systems, or whether high-frequency trading or HFT firms deserve special regulatory attention. Those requesting HFT-specific measures logically saw a need to define high-frequency trading. More fundamentally, however, some academic commenters discussed concerns around the speed of trading, including within exchange order books, and suggested steps to slow trading or to reduce any potential advantages that come with speed.

One recurring theme across comments is whether pre-trade risk controls and other measures should focus on high-level principles or be more granular instead. Many industry commenters stated their preference for a principles-based approach to any rules that the Commission may adopt. These commenters argued that prescriptive requirements will become obsolete as technologies advance; may not account for the unique characteristics of market participants; and could result in participants designing around such measures. Similarly, one commenter noted that the best way to achieve standardization of risk controls is through implementing “best practices” developed through working groups of DCMs, FCMs, and other market participants.

Other commenters, however, expressed a need for more prescriptive rules. One argued, for example, that prescriptive rules are necessary unless the Commission receives documentation that the risk controls implemented by firms and exchanges are consistent and effective. Another commenter questioned whether the incentives facing industry participants would permit them to, quote, “sacrifice speed for prudent risk controls.”

Finally, as with the high-level questions discussed above, many of the specific pre-trade risk controls and other safeguards discussed in the Concept Release drew divergent opinions, either around whether the control should be a regulatory requirement or, if a requirement, how granular it should be. Commenters also addressed the appropriate design and use of particular risk controls. For example, one commenter stated that “kill switches, if implemented and used properly, can serve as an effective last-resort means of risk control,” but “are not a panacea and should only be used during extreme events when all other courses of action have been exhausted.” Another commenter specified that kill switches should exist at the trading firm, clearing firm and trading platform level, and that the Commission should assess the methodology used to set kill switch limits.

As noted previously, staff continues to review all comments received and to refine its thoughts. Next steps could include potential recommendations to the Commission for notice and comment rulemaking in one or more areas addressed by the Concept Release.

This concludes my written testimony.

1 See 17 CFR 38.150 (Core Principle 2—Compliance with Rules).

2 See 17 CFR 38.250 (Core Principle 4—Prevention of Market Disruption).

3 See 17 CFR 37.200 (Core Principle 2—Compliance with Rules).

4 See 17 CFR 37.400 (Core Principle 4—Monitoring of Trading and Trade Processing).

5 See 17 CFR 38.152 and 17 CFR 37.203(a).

6 DCMs provide information to the Commission on a “T + 1” basis, i.e., on trade date plus 1.

7 Commission, Final Rule: Ownership and Control Reports, Forms 102/102S, 40/40S, and 71, 77 FR 69177 (Nov. 18, 2013).

8 The Commission further clarified the scope of these prohibited disruptive trading practices in its Interpretive Guidance and Policy Statement on Disruptive Practices. 78 FR 31890 (May 28, 2013).

9 17 CFR 1.73(a)(1) and 23.609(a)(1).

10 17 CFR 1.73(a)(2)(i) and 17 CFR 23.609(a)(2)(i).

11 17 CFR 23.600(d)(9).

12 Commission, Final Rule: Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612 (Jun. 19, 2012) (the “DCM Final Rules”).

13 17 CFR 38.255.

14 17 CFR 37.405.

15 DCM Final Rules, 77 FR at 36718; Commission, Final Rule: Core Principles and Other Requirements for Swap Execution Facilities, 78 FR 33476, 33601 (June 4, 2013).

16 17 CFR 38.607.

17 Id.

18 Commission, Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, 78 FR 56542 (Sept. 12, 2013).

Last Updated: May 13, 2014

SOFTWARE COMPANY FOUNDERS SETTLE SEC CHARGES OF INSIDER TRADING AHEAD OF SALE

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Three Software Company Founders to Pay $5.8 Million to Settle Charges of Insider Trading Ahead of Sale

The Securities and Exchange Commission filed insider trading charges against three software company founders for taking unfair advantage of incorrect media speculation and analyst reports about the company’s acquisition.

They agreed to pay nearly $5.8 million to settle the SEC’s charges.

The SEC alleges that Lawson Software’s co-chairman Herbert Richard Lawson tipped his brother William Lawson and family friend John Cerullo with nonpublic information about the status of the company’s 2011 merger discussions with Infor Global Solutions, a privately-held software provider. Lawson Software’s stock price had begun to climb following media and analyst reports that the company was considering a sale and multiple bidders were possible. However, Richard Lawson knew reports about possible multiple bidders were incorrect, and the merger share price offered by the lone bidder was significantly lower than what journalists and analysts were speculating. While in possession of the accurate, inside information from his brother, William Lawson sold more than one million shares of his family’s Lawson Software stock holdings. He also suggested that another trader sell shares. Cerullo sold approximately 175,000 of his company shares on the basis of the nonpublic information. When Lawson Software later announced the merger agreement at the lower-than-anticipated share price, the company’s stock value dropped 8.7 percent. By selling their shares at the inflated stock prices prior to the merger announcement, the traders collectively profited by more than $2 million.

According to the SEC’s complaint filed in federal court in San Francisco, Lawson Software was founded by the Lawsons and Cerullo in 1975 and based in St. Paul, Minn. William Lawson and Cerullo each retired in 2001, but Richard Lawson was still serving as co-chairman of the board of directors when the company began considering a possible sale. After Lawson Software and Infor Global Solutions entered into a non-disclosure agreement and met about a possible merger, Richard Lawson and other members of the board were regularly informed about the ongoing merger discussions. While Infor conducted its due diligence in late February 2011, Lawson Software began a “market check” in which its financial adviser reached out to five competitors to gauge their interest in acquiring the company. The market check elicited little-to-no interest, and Richard Lawson and the board were kept informed throughout the process.

Meanwhile, according to the SEC’s complaint, a March 8 article reported that Lawson Software had retained a financial adviser to explore a possible sale. The article identified other companies as potential acquirers of Lawson Software and led to a 13-percent jump in Lawson Software’s stock price that day. The article also fueled widespread - and incorrect - media speculation about potential acquirers of Lawson Software and possible merger prices. Soon thereafter, Lawson Software publicly confirmed an acquisition offer from Infor for $11.25 per share. Nevertheless, ensuing media and analyst reports still incorrectly suggested that other potential purchasers would likely enter the bidding and submit competing higher offers for Lawson Software. Some reports suggested a merger price of up to $15-16 per share. In reality, the same companies being speculated as potential purchasers already had informed Lawson Software that they weren’t interested in an acquisition. But fueled in part by the reports, Lawson Software’s stock price closed at $12.24 per share on March 14 - nearly $1 higher than Infor’s offer of $11.25. The stock price had increased approximately 23 percent since the March 8 article.

The SEC alleges that Richard Lawson knew that these media and analyst reports were inaccurate and the very entities mentioned as possible acquirers had in fact told the company they were not interested. He knew that Infor was the lone bidder and would not increase its offer. Richard Lawson also knew that Lawson Software’s financial adviser and board of directors viewed Infor’s bid as reasonable. After Richard Lawson tipped his brother and Cerullo with nonpublic information about the planned deal, they proceeded to sell their shares at approximately $1 per share higher than the eventual merger price of $11.25. Following the merger announcement on April 26, Lawson Software’s stock price dipped to $11.06 per share at market close. The merger became effective in July 2011.

Richard Lawson agreed to settle the SEC’s charges by paying a penalty of $1,557,384.57 for tipping his brother and Cerullo. The penalty amount is equivalent to the ill-gotten gains received by William Lawson and Cerullo. Richard Lawson also agreed to be barred from serving as an officer or director of a public company. William Lawson agreed to pay disgorgement of $1,853,671.28, prejudgment interest of $162,442.60, and a penalty of $1,853,671.28 for a total of $3,869,785.16. William Lawson’s disgorgement amount includes the ill-gotten gains of the other trader who he suggested sell shares. Cerullo agreed to pay disgorgement of $178,481.29, prejudgment interest of $15,640.81, and a penalty of $178,481.29 for a total of $372,603.39. Without admitting or denying the SEC’s allegations, the Lawsons and Cerullo agreed to the entry of final judgments enjoining them from future violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The settlement is subject to court approval.

The SEC’s investigation was conducted by Michael Fuchs and Wendy Kong, and supervised by Josh Felker. The SEC appreciates the assistance of the Options Regulatory Surveillance Authority and the Financial Industry Regulatory Authority.

SEC COMMISSIONER GALLAGHER'S REMARKS ON EVOLVING ROLE OF COMPLIANCE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Introductory Remarks at The Evolving Role of Compliance in the Securities Industry Presentation

Commissioner Daniel M. Gallagher

Washington, D.C.

May 12, 2014

Thank you, David [Blass].  I’m very pleased to be here this morning to kick off today’s discussion of a timely and critical topic: the evolving role of compliance professionals.  I’d be remiss if I didn’t begin by expressing my thanks to the team responsible for today’s event: Mike Stone, who suggested the event in the first place, our panelists Howard Plotkin and Jerry Baker, and David Blass [and Steve Benham] from the Division of Trading and Markets, who worked with our panelists to put together today’s event.  It’s very heartening to me that there are people like Mike, Howard, and Jerry who are willing to so generously volunteer their time to help the Commission better understand the myriad and complicated challenges facing today’s compliance professionals.  I often speak of the scoundrels and miscreants in the securities industry; it’s a genuine pleasure to be here today with folks from the other end of the spectrum.

In recent years, a variety of factors have combined to significantly expand the scope and complexity of the issues facing compliance officers at securities firms.  Today’s compliance personnel have to address an ever-broadening array of complex and novel financial products, new trading and communication technologies, and multiple, diverse market venues.  They must do so in the face of an unprecedented torrent of new laws and regulations promulgated in response to the financial crisis, most particularly the Compliance Officer and Securities Attorney Full Employment in Perpetuity Act of 2010, or as it’s more commonly known, Dodd-Frank.  

And although securities firms have been generally increasing the amount of resources they devote to compliance matters, compliance budgets have increased in a linear manner while the demands faced by compliance officers have increased exponentially.  A member of the House Financial Services Committee, citing a study issued by the Committee,[1] stated, “It will take over 24 million man hours to comply with Dodd-Frank rules per year.  It took only 20 million to build the Panama Canal.”[2]  On the plus side, at least Dodd-Frank has caused fewer deaths by malaria or yellow fever.

Our system of oversight for regulated entities such as broker-dealers and investment advisers is predicated upon the active participation of compliance personnel.  It is a system of shared responsibility, in which the Commission oversees the firms that, in turn, oversee their associated persons, with SROs providing an additional level of oversight for broker-dealers.  Broker-dealer and investment adviser firms in essence serve as the first line of defense in this system, and the system does not work if firm legal and compliance officers are too timid to jump into the difficult regulatory issues firms face on a regular basis.

All the more important, then, that the Commission does everything in its power to encourage a robust, effective compliance function at the entities we regulate.  This includes, crucially, providing additional certainty on the topic of “failure to supervise” liability.  The Exchange Act vests the Commission with the authority to impose sanctions on a person associated with a broker-dealer if that person “has failed reasonably to supervise, with a view to preventing violations of the provisions of [the securities] statutes, rules, and regulations, another person who commits such a violation, if such other person is subject to his supervision.”[3]  Nearly identical language in the Investment Advisers Act grants the Commission the same authority with respect to associated persons of investment advisers.[4]

The Commission’s ability to impose sanctions for failures to supervise is a valuable part of our regulatory toolkit, encouraging a broker-dealer or investment adviser’s managers and executives to proactively monitor subordinate employees’ compliance with laws and regulations.  We must make sure, however, that our rules establishing failure to supervise liability do not act as a deterrent to in-house legal and compliance officers, discouraging them from departing from their clearly delineated roles.

After all, we don’t want compliance officers or in-house attorneys spending their days drafting policies and sending out memoranda while avoiding interaction with the individuals governed by those policies or the recipients of those memos out of fear of being deemed a supervisor and subjecting themselves to liability.  Indeed, we want to encourage such personnel to bring their expertise to bear in addressing important, real-world compliance issues and in providing real-time advice for concrete problems the firms and their employees face.

To do so, we need to provide guidance that is as clear as possible on our position on supervisory liability for legal and compliance personnel.  In this vein, I was especially pleased when last September, the Division of Trading and Markets, in an effort led by David Blass, issued a set of FAQs on the topic of failure to supervise liability.[5]  The feedback on these FAQs has been very positive, and I hope and expect that we will continue to address new or unsettled issues in this manner.

Events like today's training complement outward-facing initiatives such as the FAQs by providing our own staff with informed and current guidance on compliance issues, and I'm glad to be able to add my enthusiastic support.  Once again, thank you to our panelists, and thanks as well to the SEC staff here today for taking advantage of this wonderful opportunity to learn from our distinguished guests. I wish you all a productive and educational training.


[1] Dodd-Frank Burden Tracker (spreadsheet), House of Representatives Committee on Financial Services, available at http://financialservices.house.gov/uploadedfiles/dodd-frank_pra_spreadsheet_7-9-2012.pdf.

[2] Rep. Randy  Randy Neugebauer, quoted at Dodd-Frank Burden Tracker, House of Representatives Committee on Financial Services, available at http://financialservices.house.gov/burdentracker/default.aspx.

[3] 15 U.S.C. 78o(b)(4)(E)

[4] 15 U.S.C. 80b-3(e)(6).

[5] Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections 15(b)(4) and 15(b)(6) of the Exchange Act, U.S. Securities and Exchange Commission, Division of Trading and Markets, available at http://www.sec.gov/divisions/marketreg/faq-cco-supervision-093013.htm.

Statement on Jury’s Verdict in Case Against the Wylys:

Statement on Jury’s Verdict in Case Against the Wylys:

SEC CHARGES FRIENDS AND BUSINESS ASSOCIATES OF HOME DIAGNOSTICS, INC., CHAIRMAN IN INSIDER TRADING SCHEME

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

SEC Charges Three Friends and Business Associates of Former Chairman of Home Diagnostics, Inc., in Insider Trading Scheme

The Securities and Exchange Commission today announced charges against three friends and business associates of the former Chairman of the Board at Home Diagnostics Inc., George H. Holley, for trading on the basis of inside information about an impending acquisition of the company that was illegally tipped to them by Holley.

In Complaints filed in the U.S. District Court in Trenton, New Jersey, the SEC alleges that, in 2010, Holley, who co-founded Home Diagnostics, provided his friends John Campani and John Mullin, and employee Alan Posner, with confidential information about the impending acquisition of Home Diagnostics by Nipro Corporation. Campani, Mullin, and Posner each purchased Home Diagnostics stock on the basis of Holley’s tips for combined profits of more than $105,000. The SEC previously had charged Holley and other tippees with insider trading based on the same material nonpublic information (SEC v. George H. Holley, et al., No. 3:11-cv-00205-MLC-DEA (D.N.J.)).

The SEC’s complaints charge Campani, Mullin, and Posner with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the general antifraud provisions of the federal securities laws, and Section 14(e) of the Exchange Act and Rule 14e-3 thereunder, the tender offer fraud provisions. Without admitting or denying the allegations in the SEC’s Complaint against him, Campani, Mullin, and Posner each has consented to the entry of a final judgment that permanently enjoins him from future violations of Sections 10(b) and 14(e) of the Securities Exchange Act and Rules 10b-5 and 14e-3 thereunder. In addition, the judgment against Campani will require him to pay $26,700 in disgorgement plus prejudgment interest in the amount of $2,387, and a civil penalty of $13,350; the judgment against Mullin will require him to pay disgorgement of $10,450 plus prejudgment interest in the amount of $896, and a civil penalty of $5,225; and the judgment against Posner will require him to pay disgorgement of $67,910 plus prejudgment interest in the amount of $5,820, and a civil penalty of $33,955. The settlements are subject to approval by the Court.

Campani, Mullin, and Posner cooperated with the U.S. Attorney’s Office for the District of New Jersey in its criminal prosecution of Holley. Holley ultimately pleaded guilty to insider trading. The SEC’s civil action against Holley is continuing.

The SEC thanks the U.S. Attorney’s Office for the District of New Jersey, the Federal Bureau of Investigation, and FINRA, for their cooperation and assistance in this matter.