Timothy Massad, President Obama’s nominee for Chairman of the Commodity Futures Trading Commission (CFTC), recently testified before the Senate Agriculture Committee that enforcement of the futures and swaps market supervised by the CFTC would be his “top priority” if confirmed as chairman. He went on to state that, “We must aggressively pursue wrongdoers, whatever their position or size, and we must deter and prevent unlawful practices.” Massad’s statements come as the CFTC is armed with new enforcement tools and invigorated by successful, recent, cooperation with prosecutors in the U.S. Department of Justice and investigators with the Federal Bureau of Investigation.
At the same time, Massad and others (including former commissioner Bart Chilton and former Chairman Gary Gensler) have stated that the CFTC lacks the necessary resources to completely fulfill its regulatory mandate. Going forward, will the lack of funds slow the CFTC’s “aggressive pursuit of wrongdoers?” Not likely. Massad’s stated enthusiasm for enforcement suggests that justice delayed will not be justice denied.
The CFTC is more likely to continue its trend of pursuing the cases of yesteryear than to let old cases languish (See “Did CFTC cherry pick actions to justify rule,” Futuresmag.com, Jan. 18, 2014). Furthermore, as long as there are prosecutors from the Department of Justice lining up to make cases for the CFTC, one can expect the Commission to triage its resources to pursue the most egregious of cases swiftly.
In short, under-resourced or not, count on the CFTC to use its new enforcement tools and to partner with others (including criminal authorities) to aggressively enforce its new and existing rules and regulations, including in the arena of over-the-counter derivatives.
New Tools
Over the past several years, the CFTC has gained some powerful, new, enforcement tools. Section 753 of the Dodd-Frank Act amended Section 6(c) of the Commodity Exchange Act, authorizing the adoption of Rule 180.1 to effectuate the new provisions. In doing so, Dodd-Frank provided the CFTC anti-manipulation enforcement authority similar to—and perhaps even broader than—that given to the SEC under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, which are perhaps the most famous duo of civil anti-fraud provisions in the financial world.
These laws—which former CFTC Enforcement Director David Meister has described as “powerful new tool(s)” to combat market manipulation—provide the CFTC with five, essential, new, powers (see, “New tools for regs,” below).
First, these changes expand the scope of the conduct the CFTC can regulate. Now, the CFTC can pursue not only manipulation, but attempts to manipulate markets. For example, recent LIBOR enforcement actions (discussed more fully below) include claims for attempted manipulation—whether successful or not—of various LIBOR rates.
Second, Rule 180.1 broadens the scope of the transactions that the CFTC can regulate. Previously, the CFTC was limited to enforcement related to conduct in connection with a purchase or sale. Under Rule 180.1, the CFTC can regulate deceptive devices or contrivances in connection with any swap, cash contract, or futures contract. Thus, the new rule applies to conduct or attempted conduct in connection with activities well beyond the purchase or sale of a covered instrument (e.g., all of the payment and other obligations under a swap).
Third, the new rule gives the CFTC flexibility in proving its enforcement cases. Previously, the CFTC was limited to bringing fraud claims based on intentional conduct. In other words, the CFTC had to prove that an alleged violator had specific, fraudulent, intent in taking a certain action. Proof of fraudulent intent typically includes specific evidence, like an e-mail or a recorded conversation, or compelling circumstantial evidence, such as a profit-taking motive. Direct evidence of fraudulent intent is, obviously, difficult to come by.
And, circumstantial evidence can be rebutted by competing circumstantial or direct evidence of a plausible, non-fraudulent, purpose for taking certain actions. Under the new rule, the CFTC will be able to bring actions based simply on objective proof, such as an industry standard of care, that a defendant recklessly committed an action that had the effect of manipulating the market. This is a significantly lower bar for the regualtor to meet in order to prove a case or to simply launch an investigation.
Fourth, Rule 180.1 further eases the CFTC’s burden of proof by allowing the CFTC to bring a market manipulation claim without having to prove actual changes in the price of a commodity. The CFTC stated that, while a market or price effect “may well be indicia” of manipulation, “a violation of final Rule 180.1 may exist in the absence of any market or price effect.” This dovetails with the CFTC’s new authority to pursue attempted, albeit unsuccessful, market manipulation.
Fifth, the new authority granted by Dodd Frank allows the CFTC to bring claims for false statements or material omissions in any statement to a regulator. CEA Section 6(c)(2), 7 U.S.C. § 9(2). In other words, the CFTC need not point to a formal filing to bring a fraud claim. Now, it can even bring fraud claims based on information that a market participant voluntarily or cooperatively provides to the CFTC.
Government Pile-On
In addition to these new enforcement tools, the CFTC has now entered into the era of joint investigations that had already become standard in the world of securities. The CFTC reports that, over the past year, 93% of its “major fraud cases” have a parallel criminal case. In such actions, the civil and criminal authorities can act together to accomplish coordinated aims that either might find more difficult to accomplish alone.
For example, an asset freeze is more simply accomplished prior to a complaint being filed in a civil case than in a criminal case, in which the standards are much higher. “Asset Freezes and Forfeiture Procedures in Criminal and Civil Cases,” examines the Government’s authority to freeze assets held by private citizens—and provides some strategies and tactics for defense attorneys who find their clients left without funds for living expenses or to pay attorneys fees. In a combined investigation, the CFTC can obtain a court order freezing assets and appointing a receiver on an ex parte basis (in other words, before anyone appears in court for the defendants), before a complaint is even publicly available.
In a coordinated proceeding, the Federal Bureau of Investigations (FBI) often will even arrest the defendants on the morning the complaint and indictment against those defendants are made public. Lacking freedom and funds, such defendants are often quicker to settle the cases against them than are defendants with liberty and lucre to spend on their defenses.
Expect more of these coordinated proceedings going forward—particularly as the CFTC looks to extend its scant resources. In such coordinated proceedings, the CFTC can rely on criminal authorities to stop ongoing wrongdoing and the receiver (who is paid from the dwindling proceeds of the frozen estate) to marshal assets and even ferret out evidence of past wrongdoing. The CFTC ultimately brings the necessary action to obtain monetary penalties, restitution, and revocation of all applicable trading licenses. Then, the CFTC gets to issue a victorious press release with a minimal outlay of assets.
New tools + new partnerships = tough action
Recent enforcement actions—both the high-profile and the not-so-visible—demonstrate just what the CFTC can accomplish with its new tools and partnerships. In fact, the CFTC’s recent spate of LIBOR-related settlements stemmed from investigations that the CFTC conducted together with the Department of Justice, the FBI, as well as Dutch, Japanese and UK agencies. In these actions, the CFTC collected more than $1.8 billion in monetary penalties, while the Department of Justice has brought criminal charges against at least eight defendants. Of course, as some commentators have noted, the bulk of the manipulation or attempted manipulation underlying the CFTC’s actions appears to have taken place years ago—raising the question of whether or not these actions were shelved until resources were available.
Other, smaller, cases amplify these trends. On March 10, 2014, the CFTC issued a press release announcing a six-year criminal sentence for commodity pool operator Dimitry Vishnevetsky that had been obtained by the United States Attorney’s Office for the Northern District of Illinois. At the same time, the CFTC announced that it had obtained civil judgments, including a nearly $2 million monetary penalty and $1.6 million in restitution, against Vishnevetsky and his firm, Oxford Capital LLC. The sentence and judgments stem from a parallel indictment and civil complaint that were unveiled on May 1, 2012. In the underlying civil action, the CFTC had used its powers to obtain a pre-suit civil asset freeze and to preserve critical data needed for both the civil and criminal actions. The Vishnevetsky case is just one of many that follow the same basic playbook.
The CFTC is flexing its new tools, too. Amended Section 6(c) factored into the action brought last summer by the CFTC against MF Global, Inc., MF Global Holdings Ltd., Jon Corzine, and Edith O’Brien. The CFTC’s complaint, which focuses on the days leading up to MF Global’s collapse, identifies, among other ills, MF Global’s misreporting of its customer segregated funds. Under Section 6(c)(2), such false statements are actionable—based on a “knew or should have known” level of intent. In January 2014, the United States District Court for the Southern District of New York ruled that the CFTC’s complaint was sufficient and could go forward against the entities, Corzine and O’Brien.
What does the future hold?
Before retiring, former CFTC Chairman Gensler commented that the CFTC was “shelving” cases because of its lack of resources. Regardless of the budgetary constraints, it seems highly unlikely the CFTC will “shelve” enforcement of activity that can be characterized as criminal. Instead, it is more likely that the Commission will pursue such cases in tandem with the Department of Justice and a court-appointed receiver to triage its dwindling resources.
In addition, the CFTC’s new enforcement tools make it easier to bring cases by going after reckless but unsuccessful attempts to manipulate markets, for example. These tools increase the likelihood that CFTC enforcement staff is building a pipeline of new cases even if it cannot pursue them at the moment. As resources come available, this anticipated pipeline likely will result in a rash of new enforcement cases.
“Enforcement scorecard,” (below) shows the increase in both the cases filed by the Division of Enforcement over the past several years and, more importantly, the number of investigations opened each year (based on available statistics).
In short, the CFTC has a massive pipeline of cases. It can be expected to continue to file new matters and to open new investigations at an ever increasing pace — this year more than others, as the CFTC’s swap authority is now well-established and ready to be tested.
The CFTC itself has predicted that 2014 will see “continued growth in enforcement cases filed under the new jurisdiction and enforcement powers provided under Dodd-Frank including fraud based manipulation, manipulation authority over OTC trading, and enforcement of new false reporting prohibitions.”
In addition, the pipeline of old cases (hundreds of new investigations opened annually have to go somewhere) suggests that the trendline of new enforcement cases filed will continue to go up—and will include scores of old cases. The CFTC filed numerous dated enforcement actions in 2013 related to technical violations of broker segregation rules. Some industry particpants argued that this was done to help justify the reinterpreation of its residual interest rule. Regardless of your opinion, it shows that the Commission is willing to look back several years even for relative minor violations.
What does this mean for the industry? Certainly greater expenses, as compliance costs and legal fees continue to go up. Will the world be safer for investors? Perhaps, although enforcement based on yesterday’s frauds (and rule violations) only means that yesterday’s frauds are not likely to be repeated. In an ever-changing financial landscape, it could be that the CFTC’s budget would be better spent figuring out where tomorrow’s frauds are coming from—and preventing them before commodity investors are harmed.
Trace Schmeltz is a partner in the Chicago and Washington, D.C., offices of Barnes & Thornburg LLP, where he is the co-chair of the firm’s Financial, Corporate Governance, and M&A Litigation Group and a member of the White Collar Crime Defense Practice Group.