Even as recent headlines have criticized Trump administration’s regulatory enforcement record, pointing to a “62 percent drop in penalties imposed and illicit profits ordered returned by the S.E.C., to $1.9 billion under the Trump administration from $5 billion under the Obama administration,” the Commodities Futures Trading Commission (“CFTC”) has taken a different tack. The CFTC Chairman made a speech in early October emphasizing the agency’s recent increase in monetary penalties and describing this past year as “among the most vigorous in the history of the CFTC.”
Immediately prior to these remarks, the agency announced its intention to prioritize regulation of insider trading on the derivatives market. In late September, the CFTC announced the formation of an Insider Trading and Information Protection Task Force in conjunction with a new insider trading enforcement action. However, as the CFTC increases its attention on insider trading in the derivatives market, the agency must provide more clarity as to the behaviors it intends to pursue.
CFTC Pushes into the Insider Trading Realm
The announcement of the new Insider Trading and Information Protection Task Force so soon after Chairman Giancarlo’s much publicized remarks indicates that insider trading investigations will be a larger regulatory priority for the CFTC going forward.
The CFTC, which is responsible for regulating swaps, futures, and commodities markets, opened its first insider trading case in October of 2015, and its second in October 2016. At the time it appeared possible that these two instances were aberrational and it was unclear on what legal theory they proceeded on. Both cases resulted in settlement, so no judge has yet opined on the legal theories at play. Traditionally, insider trading has been investigated primarily by the Securities and Exchange Commission (“SEC”) pursuant to its authority under Rule 10b-5 of the Securities and Exchange Act of 1934 and its regulation of equity markets.
On September 28 of this year, preceding Chairman Giancarlo’s remarks in Minnesota, the CFTC announced a new Insider Trading and Information Protection Task Force in conjunction with announcing a new civil enforcement action in the U.S. District Court for the Southern District of New York against a broker, EOX Holdings LLC (“EOX”), and one of its registered associates, Andrew Gizienski. The CFTC describes its new commission as a coordinated effort across offices, with members in its Chicago, Kansas City, New York, and Washington, DC offices with the mission of “thoroughly investigat[ing] and, where appropriate, prosecut[ing] instances in which individuals have abused access to confidential information.” Offered as examples of such misconduct are the misappropriation of confidential information, front-running, unlawfully prearranging trades, and improperly disclosing a client’s trade information. However, all three enforcement actions thus far have followed a single narrow fact pattern, meaning that the contours of the agency’s agenda are untested and unclear.
The EOX/Gizienski complaint alleges that Gizienski misused material, nonpublic customer information in connection with block trades of energy futures contracts in violation of the Commodity Exchange Act (“CEA”) and CFTC rules. Specifically, the CFTC alleges that Gizienski “exercised discretionary trading authority over an account belonging to a friend,” while both disclosing to his friend confidential information about his other customers “breach of a pre-existing duty of trust and confidence owed to those customers” and further used this confidential information to make trades on the friend’s discretionary account. The CFTC also asserts claims against EOX for alleged violations of applicable recordkeeping rules and for failure to supervise under CFTC Rule 166.3.
CFTC Authority to Investigate Insider Trading
The CFTC derives its authority to investigate and prosecute insider trading from Section 753 of the Dodd Frank Act, which prohibits “fraud and manipulation in connection with any swap, or contract of sale of any commodity in interstate commerce, or contract for future delivery.” Echoing the language of SEC Rule 10b-5 (which makes it illegal to use or employ any device, scheme or artifice to defraud in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement any manipulative or deceptive device or contrivance), this legislation enabled the CFTC to promulgate Rule 180.1. Relevant to insider trading, Rule 180.1 prohibits:
trading on the basis of material, nonpublic information in breach of a pre-existing duty (established by another law or rule, or agreement, understanding, or some other source), or by trading on the basis of material nonpublic information that was obtained through fraud or deception.
The derivatives markets function quite differently from the securities markets, and has traditionally allowed the use of nonpublic information in trading. However, from this use of similar language it can be inferred that the CFTC intends to mirror the SEC’s framework of insider trading liability.
Insider Trading within the CFTC’s Ongoing Priorities
The EOX enforcement action and the accompanying announcement have revealed that the CFTC has decided to continue including insider trading in its regulatory agenda. However, that is where the certainty ends.
The derivatives market differs from the securities market in that trading on non-public information has long been practiced and considered common, accepted, and lawful. Unlike the securities market, in the derivatives market there is no fiduciary duty to shareholders either to disclose or abstain from trading on nonpublic information. In fact, the law firm Covington & Burling suggests that “trading on the basis of material nonpublic information is the crux of how derivatives markets operate.” The three cases brought so far have essentially followed the same narrow fact pattern — “an employee taking advantage of knowledge gained through his employment to benefit himself at the expense of his company and its clients” — making it whether the CFTC will expand this liability framework going forward.
This is causing uncertainty for legal advisers trying to advise clients on how to reduce liability. For example, the law firm Akin Gump has urged asset managers and energy managers using in Asset Management Agreements and Energy Management Agreements to clarify that there is no duty of confidentiality but has not publicized further clarity. Their limited ability to gauge the scope of liability in this area underscores how ambiguous the CFTC has been so far. The CFTC should consider issuing a press release or regulation with more information about what set of behaviors the task force will be addressing and what compliance functions it expects, so that companies can tailor their actions more effectively.