The US Commodity Futures Trading Commission's Division of Enforcement is having a busy year – again.
In fiscal 2022, the agency imposed over $2.5 billion in penalties on registered entities. And as it looks to close out its fiscal 2023 at the end of September, the CFTC is on track to meet or exceed that figure.
"I have always believed, and continue to believe, that regulation should not be enforcement driven," said CFTC Chairman Rostin Behnam at a US House of Representatives oversight hearing in March. "However, where preservation of market integrity and protecting the public relies on deterrence, we must ensure that every matter we file, and public action we take, brings about greater compliance and makes the next violation less likely to occur."
Each enforcement case is different, and unexpected challenges are sure to emerge in the fast-paced world of derivatives markets. However, a look back at recent agency actions can provide an indicator as to which areas of activity are top-of-mind for the Division of Enforcement at present.
Ahead of FIA's commodities forum in Houston on 13 and 14 September, FIA spoke with Ellen Wheeler, a partner and litigation attorney with Foley & Lardner, about enforcement trends that should be top of mind for firms that are active in physical and commodity derivatives markets.
As a member of the law firm’s Securities Enforcement & Litigation practice as well as its Securities, Commodities & Exchange Regulation practice, she has personally worked with market participants on issues relating to CFTC compliance and enforcement matters. Wheeler will moderate the CFTC enforcement panel at the Houston forum on 13 September, where attendees can expect to hear in-depth on these and other enforcement trends impacting commodity trading operations.
Recent enforcement actions from the CFTC show a continued focus on "unapproved" communications such as text messages sent by mobile phones. Most recently, an 8 August action against four futures commission merchants and swap dealers resulted in $260 million in fines for "failing to maintain, preserve, or produce records that were required to be kept under CFTC recordkeeping requirements, and failing to diligently supervise matters related to their businesses as CFTC registrants."
All four firms failed to stop their employees, including those at senior levels, from communicating both internally and externally using unapproved communication methods, the CFTC said.
According to an agency tally, that brought the agency's total penalties to more than $1 billion through actions against 18 financial institutions for this type of violation.
"Capturing and maintaining all required communications will continue to be a huge issue for registrants, particularly as the CFTC seems to have expanded its focus beyond the large swap dealers and FCMs to include small and midsize firms," said Wheeler.
This trend is especially challenging for small firms, she notes, which may not have the same resources or tools to effectively capture every relevant communication from every member of its staff. There are a host of messaging tools that the CFTC has focused its enforcement on recently, including messages sent via personal text or WhatsApp, as well as telephone calls that should have been recorded but were overlooked or inadvertently deleted.
"Firms need to recognize that it is no longer sufficient just to have policies prohibiting their employees from using their personal devices or unapproved messaging services," Wheeler said. "They need to monitor and ensure that behavior is not happening or, better yet, implement a system that captures and preserves those communications."
She added that firms also need to aggressively vet and test the vendors they use to capture and store these communications. as the CFTC has shown "little sympathy" for firms that have claimed vendor errors resulted in recordkeeping shortfalls.
Another increasingly common enforcement area at the CFTC is the pursuit of firms that the agency believes do not have the appropriate registrations.
Wheeler noted that the CFTC has "an expansive view" of the definition of a swap execution facility, and a "fuzzy line" that many firms may be unaware that they are crossing. These include commodity trading advisors and introducing brokers that provide advice to clients about swaps, which may be characterized as a SEF by the agency and thus subject to related oversight.
In a similar way, commodity firms that are not registered with the CFTC need to be very mindful of the definition of a CTA and have a clear understanding of whether they fall within one of the registration exemptions.
Beyond those agency actions, there also have been several instances lately where the CFTC has filed charges against entities that were not registered properly and fraudulently claimed to be so. Most notably, in April the agency charged 14 separate entities for fraudulently claiming to be registered with the CFTC as FCMs and Retail Foreign Exchange Dealers (RFED).
In June, the CFTC announced the creation of an Environmental Fraud Task Force to focus on related issues in derivatives markets. The Division of Enforcement also issued an alert to the public on how to identify and report potential violations connected to fraud or manipulation in the carbon markets via its whistleblower program.
“As carbon credit markets continue to grow, we will act to foster the integrity of these markets by fighting fraud and manipulation,” said Ian McGinley, director of the Division of Enforcement, said in a public statement at the time.
Additionally, in a July roundtable hosted by the CFTC on carbon markets, Behnam said the agency has a critical role in helping these market mature and vowed to begin work on guidance addressing standards for voluntary carbon markets.
This public campaign comes with a few question marks, however.
"Whereas the CFTC has express statutory authority to pursue fraud, manipulation and other forms of disruptive trading in carbon and related derivatives markets, its regulatory authority is less clear," Wheeler said.
That means it may be wise for market participants to continue to monitor CFTC action in this space as an indicator of where the agency may focus its attention in the months and years to come, she said.
- Market Conduct