March 13, 2013 Articles

The CFTC's New Era of Aggressive Enforcement

Recent provisions in the Dodd-Frank Act have expanded the CFTC's enforcement opportunities and have brought on increased enforcement actions.

By Vasu B. Muthyala and Laura L. Conn

The commodities and futures trading market has grown dramatically over the past few decades—and its primary regulator, the Commodity Futures Trading Commission (CFTC), has slowly been catching up and gathering steam along the way. What started as primarily a regulatory agency with little enforcement power now stands to take on a commanding posture more similar to that of the Securities and Exchange Commission. A combination of recent headline-catching scandals in the futures market, tweaks to its regulatory powers by the Dodd-Frank Act, and an influx of aggressive regulators have spurred a dramatic uptick in enforcement. Based on its emerging prominence and new powers, the CFTC will quickly become a much more feared Wall Street regulator.

Overview of CFTC and Its Enforcement Powers
The CFTC was created in 1974 to prohibit fraudulent conduct in the trading of futures contracts. Pursuant to the Commodity Exchange Act (CEA), the CFTC’s animating statute, the CFTC is tasked with guarding against fraud, manipulation, and abusive trading practices in the commodities and futures markets, and enforcing any civil violations of the CEA. The enforcement division of the CFTC has been slowly growing and is currently headed by David Meister, a former federal prosecutor.

Procedurally, following an investigation into possible CEA violations, the CFTC Enforcement Division may initiate an administrative proceeding. Possible sanctions imposed at the administrative level include monetary penalties, suspensions or restrictions on registration and trading privileges, and orders of restitution. The CFTC may also file a complaint in U.S. federal court for injunctive or ancillary relief. If the commission has evidence that an entity or a person has criminally violated the CEA, the matter may be referred to the Department of Justice (DOJ) for prosecution.

Over the years, the CFTC’s mandate was gradually expanded by Congress, but its enforcement powers remained somewhat limited in scope, as its purview was mostly cabined to the futures businesses. Additionally, under the CEA, to prove fraud or manipulation, the CFTC was required to prove intent—a tall prospect without specific types of evidence including incriminating emails or cooperators.

Recent Regulatory Changes
Recent anti-manipulation and anti-fraud provisions in the Dodd-Frank Act have expanded the CFTC’s enforcement opportunities dramatically. The anti-fraud provision now prohibits manipulation and fraud in connection with “any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity” and lowers the scienter standard for fraud-based manipulations. The CFTC no longer has to prove “intent,” an often tricky element to prove, which has curtailed past enforcement. These changes bring the elements that the CFTC must prove in the futures market in line with the SEC’s anti-fraud provisions.

In addition, Dodd-Frank expanded the CFTC’s jurisdiction to include derivatives such as credit default swaps, a $300 trillion market—thereby enlarging the field of enforcement at the same time as making enforcement actions easier to bring. David Meister, director of enforcement at the CFTC, has said that the Dodd-Frank Act has broadened the CFTC’s “horizons substantially” and that they now have a “bigger arsenal of . . . enforcement weapons, to use on a very wide jurisdictional landscape.” In line with this pronouncement, the CFTC filed 201 enforcement actions in the past two fiscal years, a substantial increase from previous years. The CFTC also opened a record number of investigations in that same time: 800 in total. As a result, in fiscal year 2012, the CFTC “obtained orders imposing more than $931 million in sanctions, including orders imposing more than $475 million in civil monetary penalties and directing the payment of more than $456 million in restitution and disgorgement.”

As the CFTC’s enforcement purview has expanded, its public role has also begun to emerge. The CFTC has been figuring prominently in several of the most notorious financial scandals in recent memory.

The Impact of Recent High-Profile Scandals

MF Global. In October 2011, it was revealed that MF Global had improperly moved and subsequently lost millions in client funds. MF Global was a jointly registered futures commission merchant and broker-dealer and, therefore, under the CFTC’s regulatory authority. But the CFTC did not detect the deficiencies in the customer funds until MF Global reported the problem to CME Group, the CFTC’s front-line self-regulatory organization, and the CFTC, during MF Global’s spiral towards bankruptcy. The size of the fund discrepancy, an estimated $1.6 billion, choked the value of the firm. Instead of initiating an action against a soon-to-be-defunct entity, the CFTC and the SEC determined that a Securities Investor Protection Corporation (SIPC)-led bankruptcy was the most prudent course as the CFTC investigated what happened. The scandal shed light on what many believed was a weak system of oversight, not designed to catch deceptive behavior related to client funds. The CFTC’s enforcement division is still investigating the actions of MF Global. Jill Sommers, the commissioner overseeing the regulatory investigation, has suggested that “a shortfall in customer accounts could amount to a violation” of the CEA, though it is not yet known if charges will be brought. Recently, Sommers abruptly decided to depart the CFTC, and it is unclear who will oversee the MF Global investigation going forward.

Following this scandal, the CFTC announced an extensive review of futures brokerage regulation to propose changes that would strengthen regulations around client funds, including changes to internal policies and procedures, the CFTC rules, and the law itself. The CFTC also performed an industry-wide spot check for any material breaches in customer-fund protections and reported no such breaches.

Peregrine Financial Group. In July 2012, a similar scandal emerged in the futures market. In Cedar Falls, Iowa, Russell Wasendorf, founder and president of Peregrine Financial Group, attempted suicide and left a note indicating potential wrongdoing at Peregrine, quickly prompting investigation into the company. It became clear that customer funds had been improperly used. The CFTC immediately came under fire for failing to catch the long-running scheme through its reporting requirements. The CFTC’s failure to catch Peregrine’s wrongdoing was particularly egregious following the CFTC’s review of dozens of brokers following the MF Global scandal. Gary Gensler, chairman of the CFTC, acknowledged that the system had failed to safeguard client funds even after being on alert post-MF Global.

After learning of the conduct, the CFTC filed a complaint against Peregrine and its founder, Wasendorf, alleging fraud and reporting false data related to over $200 million in client funds. The CFTC alleged that, in an effort to hide misappropriation of client funds, Peregrine had for years hidden its bank-account information from the CFTC by presenting the regulator with fraudulent documentation. (The CFTC had never required information directly from the financial institution holding client funds.) The CFTC case is ongoing. For his part, Wasendorf pled guilty and was recently sentenced to 50 years in prison, the maximum prison term allowed under his plea agreement. He was also ordered to pay restitution of over $215 million.

In addition to its administrative prosecution of Peregrine, the CFTC initiated changes to the regulations that require reporting information to come directly from bank accounts, and it no longer relies on the regulated entity to provide such information to the CFTC. The CFTC also voted to approve a “Corzine rule,” which would require companies to secure written approval before moving specified large amounts of client funds. These regulatory enhancements continue to enlarge the CFTC’s regulatory role as it tries to police novel behavior in the futures market.

The public scandals in the futures market and the prosecution of Peregrine have spurred new regulatory activity and have increased public pressure for the CFTC to be a more aggressive regulator.

The CFTC and LIBOR
On the heels of failures in MF Global and Peregrine, the CFTC has recently become the public-enforcement face for investigations and settlements in the London Interbank Offered Rate (LIBOR) scandal. In a series of its most aggressive enforcement actions to date, the CFTC brought and immediately settled charges against Barclays, UBS, and Royal Bank of Scotland for their roles in manipulating and false reporting concerning the LIBOR. The actions against these banks were settled in June 2012, December 2012, and February 2013, respectively.

The CFTC collected record civil monetary penalties of more than $1.25 billion against all three entities. This does not include the substantial penalties levied by the Department of Justice and foreign regulators, alongside whom the CFTC investigated these cases. In addition to the penalties, the CFTC required the banks to enter cease-and-desist orders against future violations, change the way LIBOR is established, and implement corrective measures to guard against any future manipulation attempts.

The CFTC’s action not only signifies an increase in the value of settlements, but also the CFTC’s efforts to take the lead in the investigation and prosecution. Chairman Gensler has made the CFTC the face of enforcement in these LIBOR actions, explaining: “The [Commodity Exchange Act] prohibits attempts to manipulate and falsely report information that tends to affect the price of a commodity—including interest rates like LIBOR.” The CFTC is still investigating more than a dozen other big banks, and further settlements are expected. Signaling the beginning of a more active enforcement phase for the CFTC, Chairman Gensler pledged that, “The CFTC has and will continue vigorously to use our enforcement and regulatory authorities to protect the public, promote market integrity, and ensure that these indices are free of manipulative conduct and false information.”

The Future of CFTC Enforcement
The CFTC’s rising profile, the new enforcement powers contained in Dodd-Frank, and the calls of its head to ramp up enforcement promise another increase in the number of cases brought by the CFTC, bringing it closer in line with the SEC’s reach in the securities market. The LIBOR actions will be the first of many as the CFTC establishes itself as a regulator with teeth. The LIBOR investigation would have fallen under the CFTC’s jurisdiction before Dodd-Frank, but its prosecution is evidence of the enforcement that Meister and Gensler have touted for months. While overshadowed by the LIBOR settlements, other recent enforcement actions have consisted of manipulations of futures contracts, numerous consumer-fraud actions—including a large Ponzi scheme—and foreign-exchange-currency enforcement actions. In addition, in the near future, the CFTC will presumably take the same proactive attitude toward enforcement of the vast swaps market over which it has jurisdiction going forward.

Additionally, another CFTC provision in Dodd-Frank may well spur the CFTC’s enforcement into new areas: the whistleblower provision. The Dodd-Frank Act also amended the CEA to add whistleblower incentives and protection. Under the act, whistleblowers who provide “original information to the Commission, which leads to successful enforcement of a Commission action resulting in sanctions exceeding $1,000,000” will receive 10–30 percent of the sanctions collected. Whistleblowers may also have a private cause of action for employment retaliation for whistleblower activities. While much has been made of this provision with respect to possible claims brought to the SEC, attorneys may also see an uptick of enforcement actions from the CFTC as employees who work in futures markets become more aware of the provision. Given the current atmosphere of bullish regulation, the CEA whistleblower provision may prove an additional component in the enforcement environment. The CFTC has certainly embarked on a new phase of rigorous enforcement, and several public blunders, coupled with its new powers from Dodd-Frank, promise that the CFTC’s enforcement will continue to grow at a fast clip.

Keywords: criminal litigation, Commodity Futures Trading Commission, CEA, Commodity Exchange Act, enforcement

Vasu B. Muthyala is a counsel and Laura L. Conn is a former associate with O'Melveny & Myers LLP in Washington, D.C.


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