Author: MIL-OSI Publisher

Source: US Commodity Futures Trading Commission

I respectfully dissent from the Commission’s[1] enforcement action settling charges against Piper Sandler Hedging Services, LLC (“Piper Sandler” or “Respondent”).

Despite the Commodity Futures Trading Commission imposing more than $1.1 billion in offline communication-related civil monetary penalties across more than 20 recent actions[2], I fear this particular case sends the message that everything is a business record, even if such a conclusion has no foundation in the Commodity Exchange Act (“CEA”) or CFTC regulations.

Enforcement is one of many tools available in our regulatory toolbox to promote a culture of compliance with our regulated entities.  Our policy divisions can conduct targeted examinations, issue guidance, and work with our self-regulatory organizations on their compliance efforts.  Our enforcement authorities should not be our default tool and should only be wielded after ensuring our expectations for compliance with our regulations are clearly communicated to impacted entities.  Only after the Commission fulfills that fundamental responsibility should we use our enforcement function to pursue those who either have no interest in complying or who have failed in their attempts to comply.

As I have said before, regulation through enforcement is the antithesis of regulatory clarity and transparency.[3]  Unfortunately, without providing additional clarity into how our Division of Enforcement is approaching recordkeeping requirements, including those in Regulation 1.35 which are implicated in today’s settlement, regulated entities and their associated persons are left to determine what constitutes a violation under the looming threat of a visit from our enforcement attorneys.

Transaction-Related Records Should Be Preserved

I do not dispute that business related records identified under the CEA and CFTC regulations must be preserved to facilitate an effective regulatory and enforcement program, and I have approved other offline communication cases when the surrounding circumstances warrant such support.  However, the mere existence of business-related communications occurring through unofficial channels is not necessarily a violation.  The threshold inquiry is whether an entity failed to preserve a record they were required to preserve.

Conclusory statements in settlement orders that business related communications occurred via unofficial channels offer no explanation on how a particular respondent violated the CEA or CFTC regulations.  More importantly, these statements fail to offer any guidance to other similarly situated entities on compliance with these requirements to avoid becoming the next respondent in a CFTC enforcement matter.

Recordkeeping Requirements Are Not One Size Fits All

The CEA and CFTC regulations do not require every record of every business activity to be preserved.  Instead, Congress developed a recordkeeping framework which varies based on the category of the entity.[4]  Under this umbrella, the Commission and its staff have developed recordkeeping requirements tailored to respective market participants.

For example, Section 4g(a) of the CEA requires introducing brokers (IBs), to “keep books and records pertaining to such transactions and positions … as may be required by the Commission.”[5]  Compare that to Section 4n of the CEA, which requires registered commodity pool operators and commodity trading advisors to “maintain books and records and file such reports in such form and manner as may be prescribed by the Commission.”  It is significant that Section 4g of the CEA, the section at issue in today’s enforcement action, is limited to records pertaining to transactions and positions, whereas Section 4n of the CEA lacks such limitation.[6]

            Regulation 1.35 – Tailored Transactional Records

The Commission has consistently respected these statutory distinctions when adopting numerous modifications to Regulation 1.35, its principal recordkeeping rule for intermediaries, including IBs.

Regulation 1.35 imposes categorical recordkeeping requirements on futures commission merchants, retail foreign exchange dealers, IBs and designated contract market and swap execution facility members.[7]  In fact, the basic provisions of Regulation 1.35 have remained in place since as early as 1938.[8]  Importantly, Regulation 1.35 requires preservation of records related to transactions and has never, or at least for the past 86 years, contained a general mandate to preserve all records.[9]

Regardless of intermediary, Regulation 1.35 identifies two major types of records required to be maintained: (1) transaction records (consisting of both “commodity interest and related records” and “original source documents”); and, (2) pre-trade communications (both “oral” and “written”).[10]  All of the key record types defined in Regulation 1.35 are framed around the statutory construction discussed above and therefore, must be related to transactions—in a commodity interest and any related cash or forward transactions.[11]  Furthermore, Regulation 1.35(a) requires the records, except for pre-trade communications, to be “kept in a form and manner that allows for the identification of a particular transaction.”[12]  When the Commission first added the “particular transaction” provision to the regulation, it stated the purpose of the rule would be satisfied “when a market participant can identify those records that pertain to a particular transaction,”[13] versus requiring that all records on all transactions be maintained in a specific manner.

The rule has been expanded several times as both new registrants have been added to the Commission’s jurisdiction and as technological changes have necessitated revised requirements.[14]  In each case, the Commission has carefully balanced the application of these requirements, not only on different market participants and intermediaries, but also by size and type within certain categories.  These revisions were done to acknowledge that for certain intermediaries, particularly IBs, the burden and costs associated with complying with Commission’s recordkeeping requirements may be significant without substantial benefit.[15] 

Most importantly in this regard, small IBs – those earning less than $5 million in aggregate gross revenue over a three-year period – have been specifically carved out of certain recordkeeping requirements in Regulation 1.35.  Again, this was done citing the Commission’s concerns “regarding costs and the availability of relevant technology,” and further noting such a balancing would, “achieve the Commission’s objectives and the benefits of promoting market integrity and protecting customers albeit at lower cost.”[16]  Like many rules in Part 1 of the CFTC’s regulations, Regulation 1.35’s requirements vary by entity size and type, reflect the Commission’s long history of carefully weighing the cost and benefits of recordkeeping requirements, and strategically balance these policy considerations.

Any action by the Commission should respect these important considerations made when adopting our rules around recordkeeping requirements.  Recognizing that our rules must evolve as technology and businesses evolve, the Commission’s approach to this evolution should be clear and should only occur in a public and transparent manner.  Using enforcement to influence that change is the opposite of clarity and transparency.

The Pitfalls of Interpreting Settlements

Despite statutory and regulatory intricacies, of the more than 20 recent settlements related to violations of both Section 4g of the CEA and Regulation 1.35, most of these settlement orders[17] include essentially the same boilerplate language in the legal discussion section of the order.  

The sole application of law to facts in the legal discussion section of these orders is or closely mirrors the following, “[a]s a result of the widespread use of unapproved methods of communication by [firm or their] employees, which communications were not preserved and maintained, [respondent[s]] failed to keep full, complete, and systematic records of all transactions relating to its business of dealing in commodity interests, in violation of Section 4g of the Act and Regulation 1.35.”[18]

Unfortunately, neither the fact nor the summary sections of these orders facilitate a greater understanding of the regulation, the alleged violation, or how the regulation has been applied in the settlement.  Furthermore, these orders refer to “business-related communications”, “messages related to [ the respondent’s] business as a Commission registrant”, “unapproved communication methods … to engage in firm business”, and “conducted firm business via unapproved methods.”  These generic references, such as “business” and “firm”, fail to describe the substance of the communications at issue or to explain the kind of record that serves as the basis for the alleged violation.  Without more information and context, others subject to the same regulations have limited ability to understand potential compliance risks and costs when deciding whether to remain in or to exit a line of business subject to CFTC regulation.

No doubt, the inability to accurately gauge compliance risks and the costs of records management systems could lead to further consolidation in the industry, a trend we are already witnessing.

A Clearer Path Forward

Without additional context or further clarification by the Commission, entities subject to Section 4g of the CEA and Regulation 1.35 are left with little insight into how the Division of Enforcement construes violations when settling these matters.

Unfortunately, I cannot support further settlements with IBs concerning offline communications violations until such time as the Commission as a whole, not just the Division of Enforcement, uses the actual words of the statute and the implementing regulation to clarify how an IB can properly comply with recordkeeping requirements.

For these reasons, I respectfully dissent.

MIL OSI USA News –