Tower Research Capital Not Such a CFTC Bad Boy After E-Mini Fraud

[F]rom approximately March 2012 until December 2013, three traders who were members of a single trading team at Tower engaged in a scheme to defraud other participants in the markets for E-Mini S&P 500, E-Mini NASDAQ 100 and E-Mini Dow futures contracts (collectively, E Mini futures contracts). The S&P 500 and NASDAQ 100 future contracts were traded on the Chicago Mercantile Exchange, while the Dow futures contracts were traded on the Chicago Board of Trade.

On thousands of occasions throughout this period, the traders fraudulently placed orders to buy and sell the E-Mini futures contracts with the intent to cancel those orders before execution, including in an attempt to profit by deceiving other market participants. By placing these orders, the traders intended to, and did, inject false and misleading information about the genuine supply and demand for E-Mini futures contracts into the markets. This deceived other market participants into believing something untrue, namely, that the visible order book accurately reflected market-based forces of supply and demand. This false and misleading information was intended to, and at times did, trick other market participants into reacting to the apparent change and imbalance in supply and demand by buying and selling E-Mini futures contracts at quantities, prices and times they otherwise likely would not have traded.

The department and Tower have filed a joint motion, which is subject to the court's approval, to defer for the term of the DPA any prosecution and trial of the criminal information filed against Tower.

A number of significant factors contributed to the criminal resolution with Tower, including the company's cooperation with the United States and Tower's extensive remedial efforts. Tower also swiftly moved in early 2014 to terminate the three traders, made significant investments in sophisticated trade surveillance tools, increased legal and compliance resources, revised the company's corporate governance structures and changed its senior management.

[F]rom at least March 2012 through December 2013, Tower, by and through the traders, on thousands of occasions, placed orders to buy or sell futures contracts with the intent to cancel those orders prior to execution. The traders implemented their manipulative and deceptive scheme by placing one or more orders that they wanted to get filled (genuine orders) on one side of the market, typically consisting of passive orders whose quantities are only partially visible to other market participants; and, on the opposite side of the market, placing one or more orders that the traders intended to cancel before execution (spoof orders), typically consisting of fully-visible passive orders for a larger total quantity. Generally, after receiving a full or partial fill on the genuine orders, the traders then cancelled the spoof orders.  In placing the spoof orders, the traders often used an order splitter to enter several smaller, randomly-sized orders in an attempt to obscure their scheme from other market participants. The traders engaged in this scheme to induce other market participants to trade against their genuine orders-by intentionally sending a false signal to the market that they wanted to buy or sell the number of contracts specified in the spoof orders and creating a false impression of supply or demand-so that the genuine orders would fill sooner, at better prices, or in larger quantities than they otherwise would.               

The order recognizes Tower's cooperation with the Division of Enforcement's investigation and notes that its cooperation resulted in a reduced civil monetary penalty. The order also provides for offsets for any payment of restitution, disgorgement, or monetary penalty that is made pursuant to the U.S. Department of Justice's (DOJ) related criminal action.

However, I write to express my extreme reservations with the Commission's decision to issue a Consent Order which includes advice that automatic disqualification under Rule 506(d)(1) of the Securities and Exchange Commission's ("SEC") regulations should not arise as a consequence of the Consent Order. Under these unique circumstances involving such significant violations of the Commodity Exchange Act's anti-fraud and anti-manipulation provisions, I do not believe that the Commission should provide a waiver to automatic disqualification from relying on certain exemptions from registration for private offerings under Rule 506(d)(1).  Section 926 of the Dodd-Frank Act clearly states that disqualification from Regulation D offerings should result where there is a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct -- like Tower's actions here.  Section 926 further specifies which state and federal financial and/or banking regulators to which the disqualification provision applies. 

Rule 506(d)(2)(iii) of the SEC's regulations expressly provides that disqualification "shall not apply" if the relevant regulator "advises in writing" that disqualification "should not arise as a consequence of such order."  According to the preamble, this "allows the relevant authorities to determine the impact of their orders." 

Today, the CFTC chooses to provide this advice in writing.  However, given the gravity of Tower's actions, which involved unprecedented levels of spoofing, I am not comfortable advising the SEC that the automatic disqualification should not apply.  In instances of this magnitude, where fraud and abuse harmed market integrity and market participants, the SEC should be the sole authority regarding whether or not a waiver should result.  In much the same way that the SEC's rule allows relevant authorities to determine the impact of their orders, allowing the SEC to determine whether automatic disqualification should apply here would insure that the relevant authority determines the impact of Regulation D.  

I also note that, Rule 506(d)(2)(iii) of the SEC's regulations does not require that the written advice be included in a final order of the Commission; it only requires that such advice be provided "before the relevant sale." Accordingly, it is not clear to me that, at this point, the Regulation D issue is ripe, and therefore, it should not have been a matter for settlement negotiations at this time. 

Finally, and as a general matter, regardless of how major the infraction, I am concerned that the SEC's 2013 amendments to Rule 506(d)(1), which added the CFTC to the list of regulators whose "regulatory bars and other final orders will trigger disqualification", and corresponding waiver authority, has added an unintended layer of complexity to the Commission's ability, under the Commodity Exchange Act, to efficiently and effectively execute its enforcement duties.  In short, the SEC is best suited to issue waivers to its market participants from its rule; not the Commission.  In this instance, where Tower has not previously been required to register with the CFTC or the SEC, there is ample time for the SEC to consider whether the CFTC's action against Tower today should result in automatic disqualification.  

For these reasons, while I concur in the sanctions in today's matter, I do not agree with the Commission's issuance of a statement that automatic disqualification under Section 506(d)(1) should not arise as a consequence of the order. . .

Initially, following the adoption of the SEC Rule 506 disqualification provision in 2013, the CFTC included language in settlement agreements providing the requested waivers. However, in mid-2015, following SEC Commissioner Stein's criticism of the CFTC's for its decision to grant a waiver to Deutsche Bank AG in a case involving manipulation and false reporting of LIBOR, the CFTC suspended the granting of such requests and instead began referring those requests to the SEC. In 2018, the CFTC resumed granting waivers of disqualification under SEC Regulations A and D. It appears that this reversal was due to considerations of expediency-to avoid the potential delay and complication that could result from involving another federal agency in the CFTC's settlement negotiations.

I dissent from the Commission's approval of the administrative settlement with Tower Research Capital LLC ("Tower").  While I agree with the substantial remedial sanctions the CFTC is imposing on Tower, I do not support the Commission's decision to grant Tower a waiver from the "bad actor" disqualification in Securities and Exchange Commission ("SEC") Rule 506. The CFTC has neither the legal authority nor the expertise to determine the appropriate procedures and qualifications for public and private securities offerings and how best to protect investors from fraud in the securities markets.  These matters are the core responsibility of the SEC, not the CFTC.

As a legal matter, the CFTC does not have the authority to make determinations-such as by providing binding "advice" under SEC Rule 506-as to the appropriate procedures or qualifications for the offering of securities under the Securities Act of 1933 ("Securities Act").  There is nothing in the Commodity Exchange Act ("CEA"), the securities laws, or any other law that authorizes the CFTC to make these securities law determinations.   "[A]n agency literally has no power to act . . . unless and until Congress confers power upon it." Because there has been no delegation by Congress to the CFTC to administer the registration of securities, including determining which firms should be exempt from registration requirements, the CFTC's determination that Tower should not be disqualified from certain registration requirements under the Securities Act is ultra vires-it has no legal effect.

As a matter of policy, it is inappropriate for the CFTC-the federal derivatives regulator-to opine on, or determine, whether securities offerings should be exempt from registration under the securities laws.  The CFTC does not possess the expertise to determine the appropriate procedures for securities offerings, or how to best protect investors from fraud in securities offerings.  Administering the securities laws is the responsibility of the SEC.

The SEC's process for waiving automatic disqualifications does not serve the interests of the CFTC, the SEC, or the public.  The rule complicates the CFTC's ability to prosecute violations of the CEA because firms that are subject to disqualification will not resolve their actions unless the CFTC agrees to waive the disqualification.  And the rule does not advance the SEC's interests in protecting investors because decisions regarding waivers are being made by a derivatives regulator for a hodgepodge of reasons, not by the securities regulator according to the criteria it has established for those decisions. . . .

SEC Commissioner Stein Stands Alone In Her Defense Of The Investing Public And Industry (BrokeAndBroker.com Blog / May 22, 2015) http://www.brokeandbroker.com/2781/stein-waivers/

UPDATE: Bill Singer's Ennui In Response To The DOJ FOREX Press Junket (BrokeAndBroker.com Blog / May 20, 2015)
http://www.brokeandbroker.com/2779/forex-bill-singer/

JPMorgan Chase, Citigroup, Barclays, RBS, And UBS Seek SEC Reg D Waivers (BrokeAndBroker.com Blog /  May 21, 2015)http://www.brokeandbroker.com/2780/sec-reg-d/
As I somewhat inelegantly observed, in part, in my May 21, 2015 Blog:

Bill Singer's Comment: Gimme a goddamn break! Of course the manipulation of the Forex market had nothing to do with "offerings" by the parent or subsidiaries. We're talking about rigging a spot market for currency trading NOT the offering of a private placement or initial public offering in currencies. Are you truly going to split those hairs? The issue of invoking the Reg D "ineligible issuer" disqualification is that you (or, if you prefer, your "employees responsible") had engaged in horrific acts in furtherance of a conspiracy to rig the Forex markets, thus causing massive financial harm to the markets -- which, as you know, include existing and potential investors. The invocation of the disqualification is supposed to get your attention and ensure that you feel some pain for the acts set forth in the settlement. You're not supposed to be rewarded by the grace of a pretense or legal fiction.

• DOJ
• SEC
• CFTC
• E-Mini
• Spoofing
• Fraud
• Bad Boy
• Ineligible Issuer
• Rostin Behnam
• Dan Berkovitz
• Kara Stein
• Deutsche Bank
• BrokeAndBroker
• Bill Singer