Tag: CFTC

The Race to Report: DOJ Announces Pilot Whistleblower Program

In recent years, the Department of Justice (DOJ) has rolled out a significant and increasing number of carrots and sticks aimed at deterring and punishing white collar crime. Speaking at the American Bar Association White Collar Conference in San Francisco on March 7, Deputy Attorney General Lisa Monaco announced the latest: a pilot program to provide financial incentives for whistleblowers.

While the program is not yet fully developed, the premise is simple: if an individual helps DOJ discover significant corporate or financial misconduct, she could qualify to receive a portion of the resulting forfeiture, consistent with the following predicates:

  • The information must be truthful and not already known to the government.
  • The whistleblower must not have been involved in the criminal activity itself.
  • Payments are available only in cases where there is not an existing financial disclosure incentive.
  • Payments will be made only after all victims have been properly compensated.

Money Motivates 

Harkening back to the “Wanted” posters of the Old West, Monaco observed that law enforcement has long offered rewards to incentivize tipsters. Since the passage of Dodd Frank almost 15 years ago, the SEC and CFTC have relied on whistleblower programs that have been incredibly successful. In 2023, the SEC received more than 18,000 whistleblower tips (almost 50 percent more than the previous record set in FY2022), and awarded nearly $600 million — the highest annual total by dollar value in the program’s history. Over the course of 2022 and 2023, the CFTC received more than 3,000 whistleblower tips and paid nearly $350 million in awards — including a record-breaking $200 million award to a single whistleblower. Programs at IRS and FinCEN have been similarly fruitful, as are qui tam actions for fraud against the government. But, Monaco acknowledged, those programs are by their very nature limited. Accordingly, DOJ’s program will fill in the gaps and address the full range of corporate and financial misconduct that the Department prosecutes. And though only time will tell, it seems likely that this program will generate a similarly large number of tips.

The Attorney General already has authority to pay awards for “information or assistance leading to civil or criminal forfeitures,” but it has never used that power in any systematic way. Now, DOJ plans to leverage that authority to offer financial incentives to those who (1) disclose truthful and new information regarding misconduct (2) in which they were not involved (3) where there is no existing financial disclosure incentive and (4) after all victims have been compensated. The Department has begun a 90-day policy sprint to develop and implement the program, with a formal start date later this year. Acting Assistant Attorney General Nicole Argentieri explained that, because the statutory authority is tied to the department’s forfeiture program, the Department’s Money Laundering and Asset Recovery Section will play a leading role in designing the program’s nuts and bolts, in close coordination with US Attorneys, the FBI and other DOJ offices.

Monaco spoke directly to potential whistleblowers, saying that while the Department will accept information about violations of any federal law, it is especially interested in information regarding

  • Criminal abuses of the US financial system;
  • Foreign corruption cases outside the jurisdiction of the SEC, including FCPA violations by non-issuers and violations of the recently enacted Foreign Extortion Prevention Act; and
  • Domestic corruption cases, especially involving illegal corporate payments to government officials.

Like the SEC and CFTC whistleblower programs, DOJ’s program will allow whistleblower awards only in cases involving penalties above a certain monetary threshold, but that threshold has yet to be determined.

Prior to Monaco’s announcement, the United States Attorney’s Office for the Southern District of New York launched its own pilot “whistleblower” program, which became effective February 13, 2024. Both the Department-wide pilot and the SDNY policy require that the government have been previously unaware of the misconduct, but they are different in a critical way: the Department-wide policy under development will explicitly apply only to reports by individuals who did not participate in the misconduct, while SDNY’s program offers incentives to “individual participants in certain non-violent offenses.” Thus, it appears that SDNY’s program is actually more akin to a VSD program, while DOJ’s Department-wide pilot program will target a new audience of potential whistleblowers.

Companies with an international footprint should also pay attention to non-US prosecutors. The new Director of the UK Serious Fraud Office recently announced that he would like to set up a similar program, no doubt noticing the effectiveness of current US programs.

Corporate Considerations

Though directed at whistleblowers, the pilot program is equally about incentivizing companies to voluntarily self-disclose misconduct in a timely manner. Absent aggravating factors, a qualifying VSD will result in a much more favorable resolution, including possibly avoiding a guilty plea and receiving a reduced financial penalty. But because the benefits under both programs only go to those who provide DOJ with new information, every day that a company sits on knowledge about misconduct is another day that a whistleblower might beat them to reporting that misconduct, and reaping the reward for doing so.

“When everyone needs to be first in the door, no one wants to be second,” Monaco said. “With these announcements, our message to whistleblowers is clear: the Department of Justice wants to hear from you. And to those considering a voluntary self-disclosure, our message is equally clear: knock on our door before we knock on yours.”

By providing a cash reward for whistleblowing to DOJ, this program may present challenges for companies’ efforts to operate and maintain and effective compliance program. Such rewards may encourage employees to report misconduct to DOJ instead of via internal channels, such as a compliance hotline, which can lead to compliance issues going undiagnosed or untreated — such as in circumstances where the DOJ is the only entity to receive the report but does not take any further action. Companies must therefore ensure that internal compliance and whistleblower systems are clear, easy to use, and effective — actually addressing the employee’s concerns and, to the extent possible, following up with the whistleblower to make sure they understand the company’s response.

If an employee does elect to provide information to DOJ, companies must ensure that they do not take any action that could be construed as interfering with the disclosure. Companies already face potential regulatory sanctions for restricting employees from reporting misconduct to the SEC. Though it is too early to know, it seems likely that DOJ will adopt a similar position, and a company’s interference with a whistleblower’s communications potentially could be deemed obstruction of justice.

© 2024 Bracewell LLP
For more on Whistleblowers, visit the NLR Criminal Law / Business Crimes section.

Third Time’s a Charm? SEC & CFTC Finalize Amendments to Form PF

On February 8, the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) jointly adopted amendments to Form PF, the confidential reporting form for certain registered investment advisers to private funds. Form PF’s dual purpose is to assist the SEC’s and CFTC’s regulatory oversight of private fund advisers (who may be both SEC-registered investment advisers and also registered with the CFTC as commodity pool operators or commodity trading advisers) and investor protection efforts, as well as help the Financial Stability Oversight Council monitor systemic risk. In addition, the SEC entered into a memorandum of understanding with the CFTC to facilitate data sharing between the two agencies regarding information submitted on Form PF.

Continued Spotlight on Private Funds

The continued focus on private funds and private fund advisers is a recurring theme. The SEC recently adopted controversial and sweeping new rules governing many activities of private funds and private fund advisers. The SEC’s Division of Examinations also continues to highlight private funds in its annual examination priorities. Form PF is similarly no stranger to recent revisions and expansions in its scope. First, in May 2023, the SEC adopted requirements for certain advisers to hedge funds and private equity funds to provide current reporting of key events (within 72 hours). Second, in July 2023, the SEC finalized amendments to Form PF for large liquidity fund advisers to align their reporting requirements with those of money market funds. And last week, this third set of amendments to Form PF, briefly discussed below.

SEC Commissioner Peirce, in dissent:

“Boundless curiosity is wonderful in a small child; it is a less attractive trait in regulatory agencies…. Systemic risk involves the forest — trying to monitor the state of every individual tree at every given moment in time is a distraction and trades off the mistaken belief that we have the capacity to draw meaning from limitless amounts of discrete and often disparate information. Unbridled curiosity seems to be driving this decision rather than demonstrated need.”

Additional Reporting by Large Hedge Fund Advisers on Qualifying Hedge Funds

These amendments will, among other things, expand the reporting requirements for large hedge fund advisers with regard to “qualifying hedge funds” (i.e., hedge funds with a net asset value of at least $500 million). The amendments will require additional disclosures in the following categories:

  • Investment exposures, borrowing and counterparty exposures, currency exposures, country and industry exposures;
  • Market factor effects;
  • Central clearing counterparty reporting;
  • Risk metrics;
  • Investment performance by strategy;
  • Portfolio, financing, and investor liquidity; and
  • Turnover.

While the final amendments increase the amount of fund-level information the Commission will receive with regard to individual qualifying hedge funds, at the same time, the Commission has eliminated the aggregate reporting requirements in Section 2a of Form PF (noting, in its view, that such aggregate information can be misleading).

Enhanced Reporting by All Hedge Funds

The amendments will require more detailed reporting on Form PF regarding:

  • Hedge fund investment strategies (while digital assets are now an available strategy to select from, the SEC opted not to adopt its proposed definition of digital assets, instead noting that if a strategy can be classified as both a digital asset strategy and another strategy, the adviser should report the strategy as the non-digital asset strategy);
  • Counterparty exposures (including borrowing and financing arrangements); and
  • Trading and clearing mechanisms.

Other Amendments That Apply to All Form PF Filers

  • General Instructions. Form PF filers will be required to report separately each component fund of a master-feeder arrangement and parallel fund structure (rather than in the aggregate as permitted under the existing Form PF), other than a disregarded feeder fund (e.g., where a feeder fund invests all its assets in a single master fund, US treasury bills, and/or “cash and cash equivalents”). In addition, the amendments revise how filers will report private fund investments in other private funds, “trading vehicles” (a newly defined term), and other funds that are not private funds. For example, Form PF will now require an adviser to include the value of a reporting fund’s investments in other private funds when responding to questions on Form PF, including determining filing obligations and reporting thresholds (unless otherwise directed by the Form).
  • All Private Funds. Form PF filers reporting information about their private funds will report additional and/or new information regarding, for example: type of private fund; identifying information about master-feeder arrangements, internal and external private funds, and parallel fund structures; withdrawal/redemption rights; reporting of gross and net asset values; inflows/outflows; base currency; borrowings and types of creditors; fair value hierarchy; beneficial ownership; and fund performance.

Final Thoughts

With the recent and significant regulatory spotlight on investment advisers to private funds and private funds themselves, we encourage advisers to consider the interrelationships between new data reporting requirements on Form PF and the myriad of new regulations and disclosure obligations being imposed on investment advisers more generally (including private fund advisers).

The effective date and compliance date for new final amendments to Form PF is 12 months following the date of publication in the Federal Register.

Robert Bourret also contributed to this article.

©2024 Katten Muchin Rosenman LLP

by: Adam Bolter of Katten 

For more SEC and CFTC news, visit the NLR Securities & SEC section.

Crypto Fraud Remains Focus of CFTC Whistleblower Program

For the second straight year, the majority of whistleblower tips received by the Commodity Futures Trading Commission (CFTC) Whistleblower Program were related to cryptocurrency fraud.

On October 31, the CFTC released its Annual Report on the Whistleblower Program for the 2023 Fiscal Year. The report revealed that during the fiscal year, the CFTC received a record 1,530 whistleblower tips.

According to the report, “the majority of tips received during the Period involved allegations of fraudulent solicitation and subsequent misappropriation of crypto/digital assets.” The report further explains that examples of these crypto frauds include “pump-and-dump schemes, fraudulent representations of moneymaking opportunities, or refusals to honor withdrawal requests.”

“The majority of the tips received this year involved crypto—an area that continues to have pervasive fraud and other illegality,” said CFTC Commissioner Christy Goldsmith Romero in a statement supporting the Whistleblower Program. “With the rise of crypto, more retail customers have come under the CFTC’s jurisdiction, making even more critical the efforts of the CFTC’s Whistleblower Program and the Office of Customer Education and Outreach.”

Through the CFTC Whistleblower Program, qualified whistleblowers are entitled to monetary awards of 10-30% of the sanctions collected by the CFTC in the enforcement action related to their disclosure. To qualify for an award, a whistleblower must voluntarily provide original information that leads to a successful enforcement action of at least $1 million.

Back in 2019, the CFTC Whistleblower Program issued a Whistleblower Alert drawing attention to how individuals can blow the whistle on cryptocurrency fraud. The Alert explains that “when a virtual currency is used in a derivatives contract, or if there is fraud or manipulation involving a virtual currency traded in interstate commerce, CFTC enforcement of the [Commodity Exchange Act] comes into play.”

Since then, the CFTC has filed a number of high-profile charges against entities for crypto fraud. For example, in 2021, BitMEX was ordered to pay $100 million for illegally operating a cryptocurrency trading platform and Coinbase was ordered to pay $6.5 million for false, misleading, or inaccurate reporting and wash trading. Earlier this year, the CFTC charged Binance and its founder, Changpeng Zhao, with operating an illegal digital asset derivatives exchange.

In December 2022, CFTC Chair Rostin Behnam testified before the U.S. Senate about the CFTC’s regulation of digital assets and cryptocurrency. Behnam highlighted the essential role the agency’s whistleblower program plays in its enforcement efforts in these areas. “In the absence of direct regulatory and surveillance authority in an underlying cash market, CFTC enforcement activity begins with a referral or whistleblower tip from an external source,” Behnam stated.

Over the past decade-plus, the CFTC Whistleblower Program has become an integral part of the CFTC’s enforcement efforts. Given that in recent years the agency has increasingly focused on cryptocurrency fraud, it is no surprise that the whistleblower program is playing a central role in the CFTC’s efforts on that front.

“Whistleblowers play a vital role in supporting CFTC investigations related to fraud and other illegality,” Commissioner Romero further stated. “The CFTC could not fully protect customers and markets without whistleblowers. Whistleblowers help identify fraud and other illegality, interpret key evidence, and save considerable Commission resources and time. The faster we can stop fraud, the more we can protect customers from harm.”

This article was authored by Geoff Schweller.

Copyright Kohn, Kohn & Colapinto, LLP 2023. All Rights Reserved.
For more news on Crypto Fraud and the CFTC Whistleblower Program, visit the NLR Communications, Media & Internet section.

CFTC Whistleblower Program’s FY23 Report to Congress Reveals Continued Success of the Program in Protecting Markets and Customers

CFTC Whistleblower Office Receives the Highest Number of Whistleblower Tips and Award Applications Since the Inception of the Program

Today the CFTC’s Whistleblower Program issued its annual report to Congress for FY23.  The report reveals that the program continues to be a key enforcement tool for the CFTC.  Since the inception of the program, the CFTC has awarded approximately $350 million to whistleblowers, and whistleblower disclosures have led to more than $3 billion in enforcement sanctions.  In a statement accompanying the report, Commissioner Christy Goldsmith Romero underscored the vital role of whistleblowers in helping the CFTC to protect customers and markets:

Whistleblowers play a vital role in supporting CFTC investigations related to fraud and other illegality.  The CFTC could not fully protect customers and markets without whistleblowers.  Whistleblowers help identify fraud and other illegality, interpret key evidence, and save considerable Commission resources and time.  The faster we can stop fraud, the more we can protect customers from harm.

Given the great benefit that whistleblowers provide to the CFTC’s enforcement efforts, it is critical for the CFTC to provide both incentives for whistleblowers to come forward, and protections for working with a federal whistleblower program.  The CFTC’s Whistleblower Program recognizes that whistleblowers put themselves at considerable professional and reputational risk in order to help the government.  The Program provides confidential protection to whistleblowers.  The Program also recognizes that incentives in the forms of monetary awards increase the number of whistleblower tips.  This Report confirms that fact, with 1,530 tips this year, the highest of any year.

Highlights of the report include:

  • During FY23, the CFTC granted seven applications for whistleblower awards, totaling approximately $16 million, to individuals who voluntarily provided original information that led to successful enforcement actions. Some of the whistleblowers provided information leading the CFTC to open the relevant investigations, while others provided substantial ongoing assistance and cooperation with the CFTC as the matter progressed.
  • The CFTC’s Whistleblower Office (“WBO”) received 1,530 whistleblower tips, which represents an increase of roughly 50 percent over the number of tips the WBO received in FY 2021 and FY 2020.
  • The WBO received tips regarding a wide range of alleged violations, including market manipulation, spoofing, insider trading, corruption, illegal swap dealer business conduct, recordkeeping or registration violations, and fraud or manipulation related to digital assets, precious metals, and forex trading.
  • The WBO received 301 whistleblower award applications, a new record for the CFTC Whistleblower Program – roughly doubling the previous record established in FY22.
  • The whistleblowers that received awards during FY23 conserved substantial CFTC resources and contributed in various ways, including: (1) providing a high degree of ongoing support to Enforcement Staff, including, among other things, interpreting key evidence, facilitating the appearance of another witness; (2) helping the CFTC expand its analysis of the misconduct and further analyze the harm suffered by customers as a result of the violations; and (3) providing information that was sufficiently specific, credible, and timely to cause Enforcement Staff to open an investigation leading to a successful covered action. In one of the orders granting an award, the CFTC noted that “[w]ithout the whistleblower’s information, DOE staff might not have learned of the violations at issue until much later and more customers could have been harmed.”

CFTC Whistleblower Reward Program

Under the CFTC Whistleblower Reward Program, the CFTC will issue rewards to whistleblowers who provide original information that leads to covered judicial or administrative actions with total civil penalties in excess of $1 million (see how the CFTC calculates monetary sanctions). A whistleblower may receive an award of between 10% and 30% of the total monetary sanctions collected.

Original information “leads to” a successful enforcement action if either:

  1. The original information caused the staff to open an investigation, reopen an investigation, or inquire into different conduct as part of a current investigation, and the Commission brought a successful action based in whole or in part on conduct that was the subject of the original information; or
  2. The conduct was already under examination or investigation, and the original information significantly contributed to the success of the action.

A covered “judicial or administrative action” is “any judicial or administrative action brought by the Commission under [the CEA] that results in monetary sanctions exceeding $1,000,000.”  7 U.S.C. § 26(a)(1).   In determining a reward percentage, the CFTC considers the particular facts and circumstances of each case. For example, positive factors may include the significance of the information, the level of assistance provided by the whistleblower and the whistleblower’s attorney, and the law enforcement interests at stake.

© 2023 Zuckerman Law
For more articles on whistleblowers, visit the NLR Criminal Law / Business Crimes section.

Rise in VCM Business May Trigger CFTC Oversight on Sales of Carbon Offset Credits

Many major companies have announced a blueprint to minimize their carbon footprint. Some companies have gone so far as to proclaim that they will achieve “net zero” emissions in the near future. To accomplish their climate goals, many have turned to purchasing products called “carbon offset credits.”

Offset credits are defined as tradable “rights” or certificates linked to activities that lower the amount of carbon dioxide (CO2) in the atmosphere. These offsets are purchased and sold on what is commonly referred to as “voluntary carbon markets” (VCMs), where owners of carbon-reducing projects can sell or trade their carbon offsets to emitters who wish to offset the negative effects of their emissions.[1] The VCMs, however, have been subject to criticism and concern due to lack of effective regulation to combat potential fraud. In response, the US Commodity Futures Trading Commission (CFTC) has announced its intent to increase enforcement resources and expertise to police the carbon markets.

How It Works

The owner of the carbon-reducing project applies to an independent (and largely unregulated) registry for carbon offsets. The registry then evaluates the project, often relying on complex information submitted by the project owner, to determine whether and how much atmospheric carbon the project will reduce. If the registry determines the project will reduce atmospheric carbon, it will issue a carbon offset credit to the project owner.

Typically, one offset credit represents one metric ton of carbon dioxide removed or kept out of the atmosphere. The price of offset credits will vary depending on different project types, different levels of benefits, and the markets in which they are traded. Once the registry issues the offset credit, the project owner can sell it to whomever it wants on a VCM. It is not uncommon for profit-seeking entities such as brokers or investors to purchase the offset credit and then sell it to the “end user,” which is the entity that wants to take credit for the carbon reduction. Once the “end user” purchases the offset credit, the credit is “retired” to ensure that it cannot be sold again.

Although voluntary carbon markets have been around for decades, they have taken off in recent years amid a deluge of corporate climate commitments. From 2018 to 2021, the VCM’s value grew from $300 million to $2 billion. Global management consultancy company McKinsey estimates that the value of VCMs may reach as high as $180 billion by 2030, while Research and Markets has projected a global value of $2.68 trillion by 2028.

Yet, the voluntary carbon market is fragmented and largely unregulated, suffers from varying accounting standards, and has been described as “the Wild West” for fraud. An investigation by The Guardian found that 90% of offsets issued by one of the largest registries for rainforest preservation projects were worthless because they did not represent legitimate carbon reductions. The voluntary carbon market is largely unregulated in the United States, and carbon offsets are almost exclusively issued by nongovernmental entities. Perhaps not surprisingly, regulators have started to look at the voluntary carbon markets more closely. In particular, the CFTC has shown an increasing interest in carbon in recent years.

Road Ahead

In September 2020, the CFTC’s Climate-Related Market Risk Subcommittee issued a report, “Managing Climate Risk in the U.S. Financial System,” that concluded climate change poses a major risk to the stability and integrity of the US economy and presented several dozen recommendations to mitigate climate risks. Less than a year later, CFTC Chairperson Rostin Behnam created the Climate Risk Unit to focus on the role of derivatives “in climate-related risk and transitioning to a low carbon economy.”

In June 2022, the CFTC held the first ever Voluntary Carbon Markets Convening to discuss issues related to a potential carbon offset market and to solicit input from industry participants in the CFTC’s potential role. After the Convening, the CFTC issued an RFI asking whether and how the CFTC should be involved in creating and regulating a voluntary carbon market. The responses to the RFI reflected that, while most industry participants agreed on the need for additional transparency and standardization in the voluntary carbon markets, they disagreed on the role the CFTC should play in such a market. A group of seven United States senators, including Sens. Cory Booker (D-NJ) and Elizabeth Warren (D-MA), argued that the CFTC should establish a robust regime governing the carbon market. Others argued that it is too soon for the CFTC to create rules and a registration mechanism, expressing concern that those actions might stifle industry innovation and progress.

At a keynote speech in January 2023, Chair Behnam stated that the CFTC “can play a role in voluntary [carbon] markets.” CFTC Commissioner Goldsmith Romero echoed the sentiment a month later in another speech and gave proposals for the CFTC to “promote resilience to climate risk.” Among those was a proposal that the “Commission should promote market integrity by increasing enforcement resources and expertise to combat greenwashing and other forms of fraud.”

The voluntary carbon market, Goldsmith Romero noted, “carr[ies] particular concerns of greenwashing, fraud, and manipulation” which “can lead to serious harm, distort market pricing, seriously damage a company’s reputation, and undermine the integrity of the markets.” This is particularly true with an esoteric commodity such as carbon offsets. For tangible commodities such as soybeans or oil, verifying delivery of the goods is relatively easy. But for carbon offsets, the offset purchaser often cannot verify that the promised greenhouse gas reduction is actually occurring; instead, the purchaser must rely on the promises made by the project owner or independent registry.

At present, the CFTC has limited enforcement jurisdiction over carbon offsets because only a limited number of carbon derivatives are traded on regulated futures markets. Carbon, as well as carbon and other environmental offsets or credits, are generally considered “commodities” as defined by § 1a(9) of the Commodity Exchange Act of 1936 (CEA). As a regulated commodity, transactions involving carbon credits or offsets are subject to the CFTC’s anti-fraud and anti-manipulation enforcement jurisdiction.

As VCMs continue to grow, it is likely that offerings of carbon derivatives such as futures, options, and swaps will grow with them, which may provide the jurisdictional catalyst for the CFTC to get more involved. The CFTC has exclusive jurisdiction over the regulation of futures markets, including oversight of the listing of new contracts on futures exchanges. Currently, a limited number of carbon futures are available to trade, and most trade on already regulated exchanges such as the Global Emissions Offset (GEO) futures contracts traded at the Chicago Mercantile Exchange (CME). The price of CME’s GEO futures contract is based on CORSIA-eligible (Carbon Offsetting and Reduction Scheme for International Aviation) offset credits issued through specific independent registries.

But given the varying standards and methodologies for these registries, combined with an increasing number of investigations that have found significant issues with offset credits, it is reasonable to expect that the CFTC may eventually seek to engage in more oversight of the registries to ensure that futures contracts are not being manipulated and the offset credits are actually delivering the carbon reductions promised. Given that offsets are widely traded as commodities, that demand for offset-based derivatives products is growing, and that fraud may be a widespread problem throughout the marketplace, it seems like a matter of when, not if, the CFTC begins to regulate VCMs more heavily.

FOOTNOTES

[1] Although often used interchangeably, voluntary carbon markets are different from compliance carbon markets. Compliance carbon markets are regulated markets set by “cap-and-trade” regulations at the state, national, or international governmental organizations. Governmental organizations set a cap on carbon emissions and then provide members with credits that act as a “permission slip” for a company to emit up to the cap. Voluntary carbon markets, on the other hand, involve trading of carbon credits between companies to reduce their own carbon footprint.

© 2023 ArentFox Schiff LLP
For more Environmental Law news, click here to visit the National Law Review.

Government Brings First Cryptocurrency Insider Trading Charges

In a series of parallel actions announced on July 21, 2022, the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) initiated criminal and civil charges against three defendants in the first cryptocurrency insider trading case.

According to the criminal indictment, DOJ alleges that a former employee of a prominent cryptocurrency exchange used his position at the exchange to obtain confidential information about at least 25 future cryptocurrency listings, then tipped his brother and a friend who traded the digital assets in advance of the listing announcements, realizing gains of approximately $1.5 million. The indictment further alleges that the trio used various means to conceal their trading, and that one defendant attempted to flee the United States when their trading was discovered. The Government charged the three with wire fraud and wire fraud conspiracy. Notably, and like the Government’s recently announced case involving insider trading in nonfungible tokens, criminal prosecutors did not charge the defendants with securities or commodities fraud.

In its press release announcing the charges, US Attorney for the Southern District of New York Damian Williams said: “Today’s charges are a further reminder that Web3 is not a law-free zone. Just last month, I announced the first ever insider trading case involving NFTs, and today I announce the first ever insider trading case involving cryptocurrency markets. Our message with these charges is clear: fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street. And the Southern District of New York will continue to be relentless in bringing fraudsters to justice, wherever we may find them.”

Based on these facts, the SEC also announced charges against the three men in a civil complaint alleging securities fraud. In order to assert jurisdiction over the matter, the SEC alleges that at least nine of the cryptocurrencies involved in the alleged insider trading were securities, and the compliant traces through the Howey analysis for each. The SEC has not announced charges against the exchange itself, though in the past it has charged at least one cryptocurrency exchange that listed securities tokens for failure to register as a securities exchange. Perhaps coincidentally, on July 21 the exchange involved in the latest DOJ and SEC cases filed a rulemaking petition with the SEC urging it to “propose and adopt rules to govern the regulation of securities that are offered and traded via digitally native methods, including potential rules to identify which digital assets are securities.”

In an unusual move, Commissioner Caroline Pham of the Commodity Futures Trading Commission (CFTC) released a public statement criticizing the charges. Citing the Federalist Papers, Commissioner Pham described the cases as “a striking example of ‘regulation by enforcement.’” She noted that “the SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together.” Commissioner Pham continued, “Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input—through notice-and-comment rulemaking pursuant to the Administrative Procedure Act.” She concluded by stating that, “Regulatory clarity comes from being out in the open, not in the dark.” The CFTC is not directly involved in either case, and it is atypical for a regulator to chide a sister agency on an enforcement matter in this fashion. On the same day, another CFTC Commissioner, Kristin Johnson, issued her own carefully-worded statement that seemed to support the Government’s actions.

Article By Scott H. Kimpel of Hunton Andrews Kurth

For more criminal law and business crimes legal news, click here to visit the National Law Review.

Copyright © 2022, Hunton Andrews Kurth LLP. All Rights Reserved.

CFTC Wades Into Climate Regulation

On June 2, 2022, the Commodities Futures Trading Commission (CFTC) issued a Request for Information (“RFI”) for “public comment on climate-related financial risk to better inform its understanding and oversight of climate-related financial risk as pertinent to the derivatives markets and underlying commodities markets.”  According to the RFI, the CFTC is contemplating “potential future actions including, but not limited to, issuing new or amended guidance, interpretations, policy statements, regulations, or other potential Commission action within its authority under the Commodity Exchange Act as well as its participation in any domestic or international fora.”

Specifically, the RFI issued by the CFTC is quite wide-ranging, and engages with numerous aspects of the CFTC’s authority, focusing on both systemic and narrow issues.  For example, the CFTC has, among other things, issued a broad request for comment on how “its existing regulatory framework and market oversight . . . may be affected by climate-related financial risk” and “how climate-related financial risk may affect any of its registered entities, registrants, or other market participants, and the soundness of the derivatives markets.”  It is hard to imagine a broader request by the CFTC–it is effectively asking for input on how “climate-related financial risk” may impact any portion of its regulatory purview.  Conversely, the CFTC has also posed very specific questions, including as to how the CFTC “could enhance the integrity of voluntary carbon markets and foster transparency, fairness, and liquidity in those markets,” and how it could “adapt its oversight of the derivatives markets, including any new or amended derivative products created to hedge-climate-related financial risk.”  In short, based upon the RFI, the CFTC could conceivably adopt a narrow or broad view of how it should adjust its regulations to account for climate-related financial risk.  Notably, however, the CFTC also asked if there were “ways in which updated disclosure requirements could aid market participants in better assessing climate-related risks,” which suggests that the CFTC may echo the SEC’s recent proposed rule for mandatory climate disclosures.

Most significantly, the fact that yet another financial regulatory agency is focused on “climate-related financial risk” suggests that the Biden Administration is willing to expend significant resources and energy in engaging in this type of regulation to advance its climate agenda.  When considered in tandem with the SEC’s recent proposed rules for mandatory climate disclosures and to combat greenwashing, it is apparent that there is a significant regulatory focus on climate issues and the financial markets.  This move by the CFTC also suggests that the Biden Administration will fully support the SEC’s proposed rules against the inevitable legal challenge.  (And, based upon the concurrences of the Republican CFTC commissioners to this RFI, it is likely that any climate-related regulation proposed by the CFTC will also be subject to legal challenge, likely on the grounds that such a regulation exceeded the CFTC’s authority.)  Most importantly, this move by the CFTC–that seeks to “understand how market participants use the derivative markets to hedge and speculate on various aspects of physical and transition [climate] risk”–demonstrates that the regulatory focus on climate and the financial markets will remain a top priority for the foreseeable future.

The Commodity Futures Trading Commission today unanimously voted to release a Request for Information (RFI) to seek public comment on climate-related financial risk to better inform its understanding and oversight of climate-related financial risk as pertinent to the derivatives markets and underlying commodities markets.

Article By Jacob H. Hupart of Mintz

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CFTC Issues Interpretive Letter Regarding Cleared Swaps Customer Collateral

The National Law Review recently published an article by Kevin M. Foley and James M. Brady of Katten Muchin Rosenman LLP, CFTC Issues Interpretive Letter Regarding Cleared Swaps Customer Collateral:

Katten Muchin Rosenman LLP

The Division of Clearing and Risk (DCR) of the Commodity Futures Trading Commission issued an interpretive letter regarding cleared swaps customer collateral requirements under Part 22 of the CFTC’s rules. The DCR interpretation addresses a number of issues with respect to which derivatives clearing organizations (DCOs) and clearing member futures commission merchants (FCMs) requested clarification, including: (1) limitations on the use of cleared swaps customer collateral; (2) the use of variation margin, in particular if a DCO elects to net variation margin across an FCM’s cleared swaps customers; (3) comingling of cleared swaps customer collateral; (4) the processes by which an FCM may report to a DCO its customers’ portfolio of rights and obligations; (5) the circumstances in which a DCO may accept cleared swaps customer collateral in excess of the DCO’s initial margin requirements; and (vi) the determination of the value of cleared swaps customer collateral in the event of an FCM default.

The DCR interpretive letter is available here.

©2012 Katten Muchin Rosenman LLP

Part I: Update on CFTC Rules 4.5 and 4.13 for Registered Investment Companies and Hedge Funds

The National Law Review recently published an article regarding CFTC rules for Registered Investment Companies and Hedge Funds written by Michael A. Piracci, F. Mindy Lo, and Laura E. Flores of Morgan, Lewis & Bockius LLP:

Investment advisers operating registered investment companies and private funds that conduct more than a de minimis amount of speculative trading in futures, commodity options, and other commodity interests will no longer be exempt from registering with the CFTC as CPOs.

The Commodity Futures Trading Commission (CFTC) announced on February 9the adoption of final rules that significantly curtail the ability of registered investment companies to claim relief under CFTC Rule 4.5 as well as the rescission of the exemption from commodity pool operator (CPO) registrationcontained in Rule 4.13(a)(4), which is relied on by a substantial portion of the hedge fund industry. The CFTC did not, as it had proposed, rescind the exemption from CPO registration under Rule 4.13(a)(3) for hedge funds that conduct a de minimis amount of trading in futures, commodity options, swaps, and other commodity interests.[1]

The Final Rules will require full CPO registration by investment advisers operating registered investment companies and private funds that conduct more than a de minimis amount of speculative trading in futures, commodity options, and other commodity interests. Those investment advisers required to register as CPOs as a result of changes in Rule 4.5 must become registered by the later of December 31, 2012 or 60 days after the effective date of the final rulemaking by the CFTC defining the term “swap.” Once an investment adviser is registered as a CPO for a registered investment company, it will not be required to comply with the CFTC’s recordkeeping, reporting, and disclosure requirements until 60 days after the adoption of final rules implementing certain proposed exemptions from these requirements for registered investment companies.[2] Investment advisers operating private funds that are currently relying on the Rule 4.13(a)(4) exemption will be required to register as CPOs by December 31, 2012, unless they are able to avail themselves of another exemption.

CFTC Rule 4.5 Exemption

CFTC Rule 4.5 currently provides an exclusion from the definition of CPO for advisers operating entities regulated as registered investment companies, banks, benefit plans, and insurance companies. Prior to August 2003, any of the regulated persons claiming eligibility for the exclusion under Rule 4.5 were required to represent that commodity futures or options contracts entered into by the qualified entity were for bona fide hedging purposes[3] and that the aggregate initial margin and/or premiums for positions that did not meet the bona fide hedging criteria did not exceed 5% of the liquidating value of the qualifying entity’s portfolio, after taking into account unrealized profits and losses. The rule further required that participation in the qualifying entity not be marketed as participation in a commodity pool or otherwise as a vehicle for trading commodity futures or options. In August 2003, as part of a larger overhaul of its regulation of CPOs and commodity trading advisors (CTAs), the CFTC eliminated the Rule 4.5 eligibility conditions requiring that the qualified entity limit speculative trading to 5% of the liquidating value of its portfolio and not market itself as a vehicle for exposure to commodity futures or options.[4]

The Final Rules return Rule 4.5 to its pre-2003 requirements for registered investment companies (but not for the other types of regulated entities), with the addition of an alternative definition of de minimis. Banks, benefit plans, and insurance companies currently relying on the exemption are unaffected by the changes and may continue to conduct their commodity pool businesses without registration. In a comment letter, however, National Futures Association (NFA) suggested broadening the scope of the coverage to apply the same types of limits on banks and trust companies as the revised rule does on registered investment companies.[5]

In the case of registered investment companies, the CFTC noted in the Final Rules release, as it had in the proposed rules, that it was concerned that funds were “offering de facto commodity pools” and should be subject to CFTC oversight to “ensure consistent treatment of CPOs regardless of their status with respect to other regulators.”[6] As a result of the adopted changes, a registered investment company will no longer be able to rely on Rule 4.5 to avoid registering the investment adviser as a CPO if the registered investment company invests more than an immaterial amount of its assets in commodity futures, commodity options, and swaps, other than for hedging, or markets itself as providing commodity exposure. In response to requests from commenters, the CFTC confirmed “that the investment adviser for the registered investment company is the entity required to register as the CPO,” if registration is required. Prior to the adoption of the Final Rules, there was a lack of clarity around which entity or persons might be considered to be the CPO of a registered investment company that was deemed to be a commodity pool. Many in the industry were concerned that a registered investment company’s board of trustees or directors would be required to register. The CFTC recognized that requiring trustees or directors to register as CPOs “would raise operational concerns for the registered investment company as it would result in piercing the limitation on liability for actions undertaken in the capacity as director.”[7]

In order to rely on amended Rule 4.5, a registered investment company will have to limit the aggregate initial margin it posts for its speculative commodities-related trading to 5% of the liquidating value of its portfolio, after taking into account unrealized profits and losses. Alternatively, a registered investment company may limit the aggregate net notional value[8] of its speculative commodities-related trading positions to 100% of the liquidation value of its portfolio, after taking into account unrealized profits and losses (excluding the in-the-money amount of an option at the time of purchase). The new exclusion added by the rule allows a registered investment company to enter into derivatives having a net notional value equal to up to 100% of the fund’s net asset value (NAV). Although this exclusion does provide additional flexibility over the 5% limitation, it may not be useful to funds investing in commodities through a controlled foreign corporation (CFC)[9]because the rule treats the CFC itself as a fund and would measure notional value based on the NAV of the CFC.[10] In addition, the rule limits the ability of a fund to market itself as a vehicle to provide commodities exposure even if the de minimisthresholds are met.

CFTC Rule 4.13(a)(4) and Rule 4.13(a)(3) Exemptions

The CFTC had proposed to rescind the exemptions available to persons that operate pools exempt from registration under the Securities Act of 1933 (Private Funds) under both CFTC Rules 4.13(a)(3) and (4). The Final Rules, however, only rescinded Rule 4.13(a)(4) and retained the exemption under Rule 4.13(a)(3). Accordingly, advisers operating Private Funds (i) that are offered only to sophisticated investors referred to in CFTC Rule 4.7 as qualified eligible persons (QEPs), accredited investors, or knowledgeable employees; and (ii) where either the aggregate initial margin and/or premium attributable to commodity interests (both hedging and speculative) do not exceed 5% of the liquidation value of the pool’s portfolio or the net notional amount of the commodity interests held by the pool do not exceed the fund’s NAV will continue to be able to claim an exemption from registering an operator as a CPO. The rescission of Rule 4.13(a)(4) means that advisers operating Private Funds will no longer be able to claim exemption from CPO registration for funds that that are offered only to institutional QEPs and natural persons who meet both definitional and portfolio QEP requirements that hold more than a de minimis amount of commodity interests. As of December 31, 2012, a Private Fund that currently relies on this exemption will be required to register an operator as a CPO unless it is able to claim another exemption from CPO registration, such as that in CFTC Rule 4.13(a)(3).

Full registration as a CPO is a relatively involved process and typically takes from six to eight weeks to complete. Registration involves submission of Form 7-R for the CPO and Form 8-Rs for all natural person Principals and for all Associated Persons (APs), along with fingerprints for such Principals and APs, as well as proof that each AP passed the required proficiency exams (generally the Series 3 or 31). At least one Principal will be required to be registered as an AP. Fully registered CPOs will also be subject to CFTC and NFA regulation. Such regulation includes providing disclosure documents to pool participants that are subject to review by NFA and recordkeeping and periodic and annual reporting requirements, including delivery of audited annual financial statements.

Registered CPOs may rely on CFTC Rule 4.7 for relief from certain requirements. Rule 4.7 provides relief from the disclosure, recordkeeping, and reporting requirements for CPOs that offer interests in private pools investing in commodities solely to QEPs. Currently, Rule 4.7 provides that a CPO claiming relief under the rule is not required to provide its pool participants with audited annual financial statements. The Final Rules rescind this relief and require CPOs operating pools pursuant to relief under Rule 4.7 to have the annual financial statements for the pool certified by a public accountant.[11] The rules do not, however, rescind the other types of relief offered under Rule 4.7. Accordingly, a Private Fund that will now be required to register an operator as a CPO due to the rescission of Rule 4.13(a)(4) will be able to claim at least some relief from the disclosure, recordkeeping, and reporting requirements under the CFTC rules.

The rescinding of 4.13(a)(4) also means that a number of investment advisers will be required to register with the CFTC as CTAs. Investment advisers who currently operate under an exemption from CTA registration under CFTC Rule 4.14(a)(8), based on the fact that they provide advice only to pools that are exempt under Rule 4.13(a)(4), will be required to register as CTAs with the CFTC and become NFA members. These advisers will also be subject to the full scope of CFTC and NFA requirements applicable to CTAs.

The changes will impact a wide variety of private funds and other investment managers, such as family offices. Given that the CFTC invoked the Dodd-Frank Wall Street Reform and Consumer Protection Act as part of the basis for its decision to roll back Rules 4.13 and 4.14, it is surprising that the CFTC declined to adopt a carve out for family offices as Congress did in the case of SEC registration.

Annual Notice

Currently, Rules 4.5, 4.13, and 4.14 require persons claiming relief from registration with the CFTC to electronically file with NFA a notice claiming such exemption at inception. The Final Rules require that on an annual basis, in order to retain eligibility for the exemption, persons who are still eligible for relief under Rules 4.5, 4.13, and 4.14 must affirm the accuracy of their original notice of exemption, withdraw the exemption if they cease to conduct activities requiring registration or exemption from registration, or withdraw the exemption and apply for registration.

Copyright © 2012 by Morgan, Lewis & Bockius LLP.