The CFTCs Enforcement of Misuse of Non-public Information

Futures Industry Association FIAThe Commodities Futures Trading Commission (CFTC) may not be using proper terminology when it refers to insider trading.

The Futures Industry Association held its most recent webinar entitled “The CFTC Increases its Focus on Insider Trading in the Commodities and Derivatives Markets.”

Attorneys from the law firm, Willkie Farr and Gallagher LLP, hosted the webinar and one of the points they made was that what the CFTC refers to as insider trading is more properly called misuse of non-public information (MNPI).

Insider trading, the lawyers noted, is the use of information company insiders to trade that company’s stock or stock option, since the CFTC oversees derivatives.

Lawyers argued that this is rare in derivative markets

The attorneys said the waters are even more murky because in the derivatives market, sometimes insiders are encouraged to trade on certain “inside information” in order to make proper hedge positions.

Misuse of Non-public Information (MNPI) Vs. Insider Trading

Instead, they referred to the term misuse of non-public information (MNPI)

In the 1983 film Trading Places, the two villains, the Duke brothers, received a crop report- or at least they thought they did- before it was published and traded on it.

This would be one example of MNPI, as opposed to insider trading; in this case, the information was not about a stock, but something broader, hence, the broader term.

CFTC Often Gets it Wrong

One case sited in the webinar was CFTC Vs. EOX Holdings and Andrew Gizienski; press release from September 28, 2018, from this case is an example of how the CFTC gets it wrong. The title of the release was “CFTC Charges Block Trader Broker with Insider Trading.”

However, the actual offenses would be better characterized as MNPI.

“According to the Complaint, beginning in or about August 2013 through May 2014, Gizienski exercised discretionary trading authority over an account belonging to a friend, while continuing to broker block trades for other EOX customers and while continuing to have access to material, nonpublic information relating to EOX customers.” The press release stated.“The Complaint alleges that, during this period, Gizienski disclosed to his friend confidential information about other customers, such as their identities, trading activity, and positions, in breach of a pre-existing duty of trust and confidence owed to those customers.  As further alleged, Gizienski also traded the discretionary account while in possession of, and on the basis of, confidential information relating to EOX customers.”

The CFTC also formed the Insider Trading Task Force on September, 28, 2018.

Front Running

HSBCOne example of MNPI in the derivatives market is so-called front running, which the CFTC defines as, “With respect to commodity futures and options, taking a futures or option position based upon non-public information regarding an impending transaction by another person in the same or related future or option. Also known as trading ahead.”

In 2016, two executives from HSBC got caught up in a forex front running scheme. Here’s part of an article from 2016.

“The HSBC complaint charged Mark Johnson, the head of global foreign exchange cash trading at HSBC, and Stuart Scott, a former HSBC foreign exchange supervisor, with trading ahead of a client’s conversion of $3.5 billion into British Pound Sterling in October 2011.

“The complaint alleges Johnson and Scott misused, for HSBC’s own accounts, confidential information from the pending order to buy Sterling using proceeds from the sale of a subsidiary of the client. The alleged front running was designed to spike the price of the British Pound, which generated approximately $8 million for HSBC, but harmed HSBC’s client.”

Another example of front-running cited by the webinar was the Motzedi case. Here’s part of the CFTC press release.

Here’s part of the CFTC press release from the Motazedi case, from December 2015, “The U.S. Commodity Futures Trading Commission (CFTC) today issued an Order filing and simultaneously settling charges against Arya Motazedi of Miami, Florida, for engaging in fraudulent transactions in the New York Mercantile Exchange’s (NYMEX) RBOB Gasoline Physical futures contract and CL Light Sweet Crude Oil futures contract involving two personal accounts he owned or controlled and a company account he traded for his former employer.

According to the Order, between September 3 and November 26, 2013, Motazedi noncompetitively prearranged at least 34 trades between his former employer’s account and the personal accounts at prices which disadvantaged his former employer’s account, in that Motazedi caused the employer’s account to buy at higher prices and sell at lower prices in trades opposite the two personal accounts. The Order also states that Motazedi defrauded his employer by placing orders for the personal accounts ahead of orders he placed for his former employer’s account (a practice known as “front running”) on at least 12 occasions, and thereby generated additional profits for himself to the detriment of his former employer. According to the Order, Motazedi’s trading activity caused his former employer $216,955.80 in trading losses.”

US Vs. Salman

A US Supreme Court case cited in the webinar was U.S. Vs. Salman, a 2016 case.

The reason this case is important is because it establishes that the one giving the tip does not have benefit financially.

“The case, Salman v. United States, concerned trading by Bassam Salman based on information from his future brother-in-law, then a member of Citigroup’s health care investment banking group.” The New York Times wrote in 2016 about the case.“Prosecutors claimed that the brother-in-law, Maher Kara, passed information to his brother, Mounir Kara, known as Michael, who then passed the information to Mr. Salman.”

Later the times quoted Justice Sam Alito in his decision, “Maher would have breached his duty had he personally traded on the information here himself then given the proceeds as a gift to his brother,” Justice Alito wrote. “It is obvious that Maher would personally benefit in that situation. But Maher effectively achieved the same result by disclosing the information to Michael and allowing him to trade on it.”

Who is Wilkie, Farr, and Gallagher

Wilkie, Farr, and Gallagher, had its origins in 1888; it has nine offices in six countries and has developed a huge reputation in its corporate division, including dealing a great deal with securities law.

“At the center of almost any securities litigation is a company’s financial reporting —  the process by which it captures and reports its financial performance and related disclosures.  The key differentiating feature of the Securities Litigation & Enforcement Practice of Willkie Farr & Gallagher is its dominance in the area of financial reporting and the proceedings surrounding it.  As described by Chambers USA – America’s Leading Lawyers for Business, the practice group is ‘the best in the city for financial reporting issues.’”The company says on its website.

Willie, Farr, and Gallagher represented SAC Capital, and its principle hedge fund legend Steve Cohen; they also represented Facebook in suits related to derivatives of its Initial Public Offering.