The Commodity Futures Trading Commission (“CFTC” or “Commission”) may not be as familiar as it’s more well known counterpart, the Securities and Exchange Commission, but the agency nonetheless serves an equally vital function by ensuring stability and confidence in the derivatives markets. One of the ways the Commission maintains the integrity of the markets is by actively soliciting the public for information involving commodities fraud through its whistleblower program.
The Creation and Expansion of the CFTC
The passage of the Commodity Futures Trading Commission Act in 1974 substantially amended the Commodity Exchange Act (“CEA”) and led to the creation the CFTC. The Commission’s predecessor, the Commodity Exchange Authority, was limited to regulating only the agricultural commodities specifically enumerated in the Commodity Exchange Act. By expanding the definition of “commodity” to include transactions in futures and options in United States markets, as well as “any other board of trade, exchange, or market,” the regulatory authority of the newly-created CFTC was significantly expanded.
Today, the CFTC operates as an independent agency of the United States government that regulates and oversees domestic derivatives markets, including commodity futures, options and swaps markets. According to its mission statement, the Commission’s fundamental objective is to “promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.”
Since the 1970s, futures and options markets have expanded to include the trading of futures and options for many non-agricultural commodities, such as oil and gold, as well as financial instruments, including foreign currencies, stock indices, and Treasury debt instruments. The markets under the CFTC’s regulatory authority are significant because of their financial size and importance — trades in these markets amount to billions of dollars annually. Following the financial crisis of 2008, Congress authorized the Commission to regulate and reform the swaps market, another class of derivatives comprised of over-the-counter trading of custom contracts between private parties.
Commodities, Derivatives & Swaps
A commodity is a basic good for which there is demand, but is interchangeable with another commodity of the same type. In other words, there are no practical differences between two or more producers of the same commodity. Examples of commodities include beef, gold, corn and coal. The definition of commodities has expanded over time to apply to additional products including, most recently, certain cryptocurrencies. In 2014, the CFTC first stated its position that virtual currencies are a “commodity” subject to regulatory oversight pursuant to the CEA.
A derivative is a financial instrument, the value of which is based on one or more underlying assets. In practical application, a derivative is a contract between two parties with specific conditions that define the terms by which payments are made. The most common types of derivatives are forwards, futures, options, and swaps. The most common underlying assets are commodities, stocks, bonds, interest rates, and currencies.
A swap is a derivative contract that was first introduced in the late 1980s. A swap between two parties involves the exchange of agreed-upon cash flows of two financial instruments. The cash flows are usually based on a predetermined nominal value, referred to as the notional principal amount. Unlike most standardized options and futures contracts, swaps are not exchange-traded instruments. Rather, they are customized contracts traded in the over-the-counter market between private parties. Since swaps take place on the over-the-counter market, there is always the potential for default by a counterparty.
The CFTC Whistleblower Program
The CFTC whistleblower program was created as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank was enacted in 2010 in response to the financial crisis of 2008, the Bernie Madoff scandal, and other highly-publicized financial frauds. Section 748 of Dodd-Frank amended the CEA by adding Section 23, entitled “Commodity Whistleblower Incentives and Protection.”
Section 23 of the CEA, 7 U.S.C. § 26, authorizes the CFTC to issue monetary awards to whistleblowers who voluntarily report original information involving violations of the CEA. The information must lead to a successful enforcement action resulting in the recovery of monetary sanctions exceeding $1 million, or a related action. A “related action” is one brought by certain government entities based on the same original information provided by the whistleblower that resulted in the successful CFTC enforcement action. An eligible whistleblower can receive an award of between 10% and 30% of the monetary sanctions collected in either the CFTC action or a related action.
Since its inception in 2011, the CFTC whistleblower program has recovered more than $800 million in monetary sanctions, and awarded over $100 million to whistleblowers who provided original information or analysis that led to those successful recoveries. In the last two fiscal years, the CFTC awarded over $90 million to whistleblowers, an amount which represents 88% of the total sum awarded to whistleblowers since the program’s inception. The sharp increase in the monetary amount of the awards illustrates the Commission’s increased reliance on, and commitment to, whistleblowers.
The CFTC’s Whistleblower Office has actively promoted educational and outreach campaigns designed to reach potential whistleblowers through various means, including speeches, web postings, as well as appearances at seminars, conferences and industry trade shows. In May 2019, the Whistleblower Office started issuing “CFTC Whistleblower Alerts” which cover trending topics and issues on which the Commission has focused its recent investigative and enforcement efforts.
Spoofing and Market Manipulation
The CFTC’s latest Whistleblower Alert, issued in January 2020, deals with a disruptive trading practice known as “spoofing.” In its Interpretive Guidance and Policy Statement on Disruptive Practices, the CFTC explained that a violation of section 4c(a)(5)(C) of the CEA “occurs when the trader intends to cancel a bid or offer before execution.” Additionally, the prohibition against spoofing “covers bid and offer activity on all products traded on all registered entities . . . .”
The Interpretative Guidance lists certain types of disruptive conduct which the CFTC deems to constitute spoofing:
(i) submitting or cancelling bids or offers to overload the quotation system of a registered entity;
(ii) submitting or cancelling bids or offers to delay another person’s execution of trades;
(iii) submitting or cancelling multiple bids or offers to create an appearance of false market depth; and
(iv) submitting or canceling bids or offers with intent to create artificial price movements upwards or downwards.
The Commission further explained that a person must act with a degree of scienter beyond recklessness to violate the prohibition against spoofing in section 4c(a)(5)(C) of the CEA. In a similar context involving a violation of SEC Rule 10b-5, the United State Supreme Court defined scienter as “a mental state embracing intent to deceive, manipulate, or defraud.” Ernst and Ernst v. Hochfelder, 425 U.S. 185, 193-94 n.12 (1976).
The CFTC Recovers the Largest Monetary Penalty for Spoofing in History
In November 2019, the CFTC issued an order which included factual findings and the imposition of remedial sanctions against Tower Research Capital LLC (“TRC”), a proprietary financial services firm engaged in futures trading. For a period of at least twenty-one months, the Commission alleged that three TRC traders (“Traders”) engaged in a scheme whereby they placed orders they wanted filled on one side of the market (the “Real Orders”) while also placing orders on the opposite side of the market which they intended to cancel from the outset (the “Spoof Orders”).
Once the Traders received a full or partial fill of their Real Orders, they proceeded to cancel their Spoof Orders, which they allegedly never intended to complete in the first place. Through their actions, the Traders allegedly intended to send false signals to the market that they actually planned to buy or sell the contracts contained in the Spoof Orders. In furtherance of the alleged scheme, the CFTC claimed the Traders broke down larger orders into several smaller, randomly-sized orders in an attempt to camouflage their scheme from others in the market.
According to the CFTC, the ultimate objective of the Traders’ manipulative scheme was to induce other market participants to trade against the Real Orders. As an added benefit, the Traders anticipated the market would react by filling the Real Orders more quickly, at more favorable prices, or in larger quantities than usual. The CFTC alleged the Traders intended to create or exacerbate an order book imbalance, thereby creating a false impression of supply or demand in the market. Thus, the Commission charged that the Traders knew their Spoof Orders would create the false appearance of market depth and induce participants to make trades based on the misleading market activity created by the Spoof Orders.
The CFTC charged TRC with violations section 6(c)(1) of the CEA, 7 U.S.C. § 9(1), and Regulation 180.1(a)(1) and (3), 17 C.F.R. § 180.1(a)(1),(3), which make it is unlawful to intentionally or recklessly “(1) [u]se or employ, or attempt to use or employ, any manipulative device, scheme, or artifice to defraud;” or “(3) [e]ngage or attempt to engage, in any act, practice, or course of business, which operates or would operate as a fraud or deceit upon any person,” in connection with any contract for future delivery on or subject to the rules of a registered entity.
Based on the cited provisions, the CFTC charged that the Traders “employed a manipulative and deceptive scheme” when they placed the Spoof Orders with the intent to create the false appearance of market depth. By virtue of section 2(a)(1)(B) of the CEA, 7 U.S.C. § 2(a)(1)(B), and Regulation 1.2, 17 C.F.R. § l.2, TRC was liable for the alleged fraudulent conduct of the Traders because they acted within the scope of their employment with TRC while engaged in the prohibited conduct.
In order to settle the Commission’s charges, TRC agreed to, among other things, pay: (i) restitution of $32,593,849; (ii) a civil monetary penalty of $24,400,000; and (iii) disgorgement of $10,500,000. These amounts totaled a record-setting penalty of $67.4 million for a spoofing case.
The Importance of Legal Representation for Whistleblowers
The CFTC Whistleblower Program, as well as other those of other government agencies (e.g. the SEC and IRS), provide a process through which individuals can directly report fraud against the government without the assistance of a lawyer. However, if a whistleblower intends to file anonymously, the SEC and IRS whistleblower programs both require that he or she be represented by an attorney. In contrast, the CFTC allows an unrepresented whistleblower to proceed anonymously through the entire process.
While it may be tempting to “go it alone,” a whistleblower without legal representation faces a number of pitfalls that could preclude them from receiving an award, even after providing vital information and assistance that led to a successful recovery. In order to remain eligible for an award, the rules and procedures of a government agency’s whistleblower program must be followed closely. For example, there are strict deadlines for filing objections to a decision concerning an agency’s reliance on the information provided by the whistleblower, or the amount awarded following a successful recovery.
While every government agency protects the identity of a whistleblower to the fullest extent possible, a targeted company can sometimes still surmise the identity of a whistleblower. If, after learning of a whistleblower’s identity, a company retaliates against that person, the company may be subject to separate liability based on statutory protections that provide specific legal and equitable remedies for anyone subjected to their employer’s reprisals.
The experienced attorneys at McEldrew Young Purtell provide skilled assistance throughout the entire process of filing a whistleblower claim, beginning with a thorough review of evidence and the drafting of a submission designed to persuade the agency to undertake an investigation. If there is a successful recovery based on information provided, our whistleblower attorneys will monitor the notices posted on the agency’s website to ensure that a claim for an award is filed within the narrow time frame prescribed by agency rules.
McEldrew Young Purtell attorneys also evaluate the amount of an award to ensure it accurately reflects the significance of the information provided and the level of cooperation given during the agency’s investigation. If an award doesn’t fairly reflect the whistleblower’s contributions, we use the appeal process and work to secure a more just result. For a free, no obligation consultation, call McEldrew Young Purtell’s whistleblower attorneys at (215) 367-5151, or you can submit your information through the contact form on this website.