Spoofing Enforcement Heats Up with Recent Filing Wave and New Legal Charges

The U.S. Government’s fiscal year-end filing rush has resulted in a wave of new spoofing enforcement.  In August, the Fraud Section of the Department of Justice’s (“DOJ”) Criminal Division charged four individuals with spoofing in precious metals futures markets.  In September, the Commodity Futures Trading Commission (“CFTC”) brought overlapping charges against three of those individuals, and separately charged two trading firms and their employees.  Finally, in an independent development, the United Kingdom’s Office of Gas and Electricity Markets (“Ofgem”) announced its first-ever spoofing charges against an energy trading firm in September.

The new cases show that the DOJ’s Criminal Fraud Section and the CFTC are continuing to coordinate their enforcement activities.  On the same day, September 16, 2019, the DOJ unsealed the August indictment and the CFTC announced civil charges for the same conduct.  The agencies first unveiled their heightened coordination in this area in January 2018, when they initiated parallel spoofing takedowns that have since resulted in several guilty pleas, settlements, an acquittal (Flotron), and a hung jury (Thakkar).

In their recent filings, the agencies reveal new charging strategies.  The DOJ’s unsealed indictment includes the first-ever RICO charge for spoofing.  Both agencies are also charging attempted manipulation under the Commodity Exchange Act (“CEA”) in certain cases.  While attempted manipulation previously has been applied to spoofing, the DOJ and CFTC omitted the charge in their parallel actions in January 2018.

The new strategies may be belated responses to the DOJ’s April 2018 trial defeat in Flotron, in which the jury acquitted a trader of a single count of conspiracy to commit spoofing.  A broader menu of charges allows the DOJ to introduce a wider array of evidence at trial, and gives the jury more options to convict.

Spoofing enforcement has taken a new turn overseas as well.  On September 5, Ofgem announced its finding that Engie Global Markets (“EGM”) engaged in spoofing to manipulate wholesale gas prices between June and August 2016.  Ofgem’s press release defined spoofing as “manipulating prices by placing bids or offers to trade with no intention of executing those bids or offers in order to buy or sell at a higher or lower price and increase trading profits.”

Ofgem found that EGM’s spoofing conduct violated Article 5 (prohibition on market manipulation) of Regulation (EU) No 1227/2011 on wholesale energy market integrity and transparency.  This appears to be the first time that Ofgem has issued a fine for spoofing.

As the DOJ and CFTC continue to dedicate significant resources to spoofing enforcement, and overseas regulators, such as Ofgem, increasingly enter the mix, it is safe to assume that spoofing will continue to be a key risk area for commodities and derivatives traders and the firms and institutions that employ them.

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Governor Newsom Signs California’s Public Banking Act Into Law

On October 2, 2019, Governor Gavin Newsom signed California’s Public Banking Act, AB 857, into law.  California previously prohibited cities and counties from extending credit to any person or corporation, and required that local agencies deposit all funds to state or national banks.  AB 857 now permits cities and counties to establish a “public bank,” which is defined as “a corporation [organized as either a nonprofit mutual benefit corporation or a nonprofit public benefit corporation] for the purpose of engaging in the commercial banking business or industrial banking business, that is wholly owned by a local agency, local agencies, or a joint powers authority . . . .”

A city or county in California interested in establishing a public bank must create a separate corporation with an independent board of directors and obtain approval from the Federal Deposit Insurance Corporation (“FDIC”) for deposit insurance.  The city or county must also obtain a certificate of authorization to transact business from California’s Department of Business Oversight and conduct “a study to assess the viability of the proposed public bank.”  AB 857 caps the number of public banks in California to no more than two new licensees per calendar year, and no more than ten in existence at one time.  California joins North Dakota as the only other state to allow public banks.

Under the new law, cities and counties may lend available funds to public banks, deposit funds in public banks, and invest in public banks, subject to certain requirements.  In addition, public banks in California are authorized to make distributions to local agencies that are shareholders of the public bank.  Public banks are required to conduct retail activities in partnership with local financial institutions, and are prohibited from competing with local financial institutions.  Specifically, public banks can only engage in retail activities without partnering with a local financial institution if those retail activities are not offered or provided by local financial institutions in the jurisdiction of the local agencies that own the public bank.

In practice, supporters expect public banks to use local revenues as a deposit base for nonprofit, community-based lending at lower interest rates than private banks.  Critics of public banks caution against the government becoming involved in the business of banking, which they argue may result in inefficiencies, corruption, and self-dealing.

Federal Financial Supervisory Authority Publishes English Version of Guidance on Outsourcing to Cloud Service Providers

In November 2018 the Federal Financial Supervisory Authority (“Bundesanstalt für Finanzdienstleistungsaufsicht”, “BaFin”) and Deutsche Bundesbank published a guidance on outsourcing of services to cloud service providers (“Guidance on Cloud Services”). According to BaFin and Deutsche Bundesbank the Guidance on Cloud Services has not stipulated any new requirements, but has condensed the already existing general requirements in terms of outsourcing projects and the procurement of IT-services with regard to cloud services. It is addressed to credit institutions, financial services institutions, insurance undertakings, pension funds, investment services enterprises, capital management companies, payment institutions and e-money institutions. Now, BaFin and Deutsche Bundesbank have published an official English version of the Guidance on Cloud Services which is available here. The Guidance on Cloud Services addresses important issues as (e.g.) information and audit rights; rights to issue instructions; data security/protection; termination provisions; chain outsourcing and information duties; and applicable law. Some of these points are regulated in a similar way to the current EBA Guidelines on outsouring arrangements which have integrated the former EBA Recommendations on outsourcing to cloud service providers.

CFPB Director Kraninger Declares For-Cause Removal Provision of the CFPA Unconstitutional

On September 17, Consumer Financial Protection Bureau (“CFPB”) Director Kathleen Kraninger sent letters to House Speaker Nancy Pelosi and Senate Majority Leader Mitch McConnell stating that the CFPB “has determined that the for-cause removal provision of the Consumer Financial Protection Act . . . is unconstitutional.”  The Bureau now affirms that the for-cause removal provision unduly interferes with the President’s executive authority under Article II of the Constitution. This view is contrary to the position taken by the Bureau in litigation throughout its history, but consistent with the views of the President and Department of Justice (“DOJ”).

On the same day, the Bureau, through the DOJ, filed a brief in CFPB v. Seila Law, which describes the Bureau’s new position.  The brief responds to Seila Law’s recent petition to the Supreme Court to review the constitutionality of the for-cause removal provision and urges the Supreme Court to grant the petition to resolve this issue.  In the letters, Director Kraninger also stated that she has instructed CFPB attorneys not to defend the for-cause removal provision in lower courts, including in CFPB v. Nationwide Biweekly Admin., No. 18-15431 (9th Cir.), and Community Fin. Servs. Assoc. v. CFPB, No. 1:18-cv-00295 (W.D. Tex.), among other cases.  However, Director Kraninger made clear that her determination “does not affect [her] commitment to fulfilling the Bureau’s responsibilities,” and,  if the Supreme Court determines that the for-cause removal provision is unconstitutional, her view is that the rest of the Consumer Financial Protection Act would remain “fully operative.”

CFTC Becomes Third Federal Financial Regulator to Approve Volcker Rule Reforms

On Monday, September 16, the Commodity Futures Trading Commission (the “CFTC” or the “Commission”) announced that it has approved final regulations (the “final rule”) that will streamline and clarify the Volcker Rule – a statutory provision that generally prohibits banking entities from engaging in proprietary trading, or from taking an ownership interest in, sponsoring, or having certain other relationships with hedge funds or private equity funds (collectively “covered funds”).  The final rule has already been approved by the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, but remains to be approved by the Securities and Exchange Commission and the Board of Governors of the Federal Reserve System. Continue Reading

Treasury and HUD Propose Housing Finance Reforms

On September 5, 2019, the Treasury Department (“Treasury”) and the Department of Housing and Urban Development (“HUD”) released complementary proposals that, if implemented, would result in extensive changes to federal regulation of housing finance.  The plans respond to a Presidential Memorandum of March 27, 2019, directing Treasury and HUD to develop housing reform proposals consistent with the goals that the memorandum sets out.

Among other things, under the Treasury Plan, Fannie Mae and Freddie Mac (two government-sponsored enterprises or “GSEs”) would be recapitalized by the private sector, leave their conservatorships, and have more limited powers in the mortgage market.  The GSEs would be re-chartered with a charter issued by the Federal Housing Finance Agency (“FHFA”), the agency that now oversees and acts as conservator for the GSEs.  This charter would also be available to other guarantors of mortgage-backed securities (“MBS”).  The plan recommends that the implicit guarantees of the GSEs be replaced by an explicit paid-for guarantee from Ginnie Mae of the repayment of principal and interest on qualifying MBS collateralized by eligible conventional mortgage loans.  Ginnie Mae, a government corporation within HUD, already provides such a guarantee to MBS collateralized by affordable loans issued under various government programs.

The HUD Plan urges that the Federal Housing Administration (“FHA”) be restructured as an autonomous government corporation within HUD and that FHA’s various programs be revised in several respects.

The two plans include well over 100 recommendations for legislative and regulatory changes.  While several of the proposals would require Congressional action, many may be effected through rulemaking or other agency action.  Whatever the form in which the proposed changes are implemented, the recommendations are complex, and the impact of the changes will very much depend on the particulars of new legislation or regulation.

Details of the two plans follow after the jump. Continue Reading

CFPB Fall Preview

As we turn the page on the summer, the Consumer Financial Protection Bureau is poised to be active – and actively overseen – in the months ahead.  Here’s an overview of some of the issues and events ahead.  

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CFTC Settles Wheat Manipulation Case against Kraft and Mondelēz

On August 14, 2019, the U.S. District Court for the Northern District of Illinois entered a consent order (the “Consent Order”)—agreed to by the U.S. Commodity Futures Trading Commission (the “CFTC”), Kraft Foods Group Inc. (“Kraft”) and Mondelēz Global LLC (“Mondelēz”)—to resolve long-running market manipulation litigation between the parties.

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Agency Heads Speak on CRA Reform

In the past few weeks, both Federal Deposit Insurance Corporation (“FDIC”) Chairman Jelena McWilliams and Comptroller of the Currency Joseph Otting have spoken publicly about ongoing efforts by their agencies, and by the Federal Reserve Board, to reform regulations implementing the Community Reinvestment Act (“CRA”).

The federal bank regulatory agencies have been working on reforms to the CRA regulations for over a year.  In April of last year, the Treasury Department released a report outlining potential changes to the CRA.  In August, the OCC published an advanced notice of proposed rulemaking (“ANPR”) describing, among other things, a proposed “metrics-based framework” for assessing compliance with the CRA.  The OCC’s proposed framework would:  (i) rely more heavily on quantitative benchmarks to assign CRA ratings; (ii) change the geographical assessment area for certain banks, including to consider their online presence in addition to their physical branches; and (iii) expand the types of activities considered in CRA evaluations.  Finally, in June, the Federal Reserve Board published a summary of feedback received during a series of 29 roundtable discussions with bankers and community members on the CRA.

Speaking at the end of July, Chairman McWilliams indicated that it would still be some months before the agencies were ready to publish a proposed rule, and signaled that the agencies were attempting to think “outside of the box.”  As an example, Chairman McWilliams noted that the agencies were considering whether to provide CRA credit for investments in rural broadband.  Such investments may already qualify for CRA credit under existing OCC guidance, but the Chairman’s statement suggested that the relevant rules might be relaxed or extended to other investments in digital infrastructure.

Last week, Comptroller of the Currency Joseph Otting provided another preview of aspects of the proposed rule.  Most of the reforms that the agencies have previously discussed in public would expand banks’ ability to obtain CRA credit.  Consistent with that approach, Comptroller Otting stated last week that the agencies were considering whether to make CRA credit available for investments in Opportunity Zonesi.e., zones designated by states, with the concurrence of the Internal Revenue Service, as “economically distressed,” and where new investments may be eligible for preferential tax treatment.  On the other hand, Comptroller Otting also suggested that the agencies are considering whether to restrict the ability of banks to receive CRA credit when they originate mortgages to high-income families and individuals who move into lower-income areas.  That may happen, for example, in gentrifying neighborhoods where the average incomes of new buyers may significantly exceed the average incomes of existing residents.

Neither Chairman McWilliams nor Comptroller Otting offered a firm estimate of when the agencies would publish a proposed rule.  And neither commented on whether, or to what extent, the new rule would adopt the proposals in the ANPR.  Nevertheless, their comments clarify that the agencies are working actively on CRA reform, and that they may be considering proposals that go beyond the OCC’s ANPR, in addition to the proposals set out in the ANPR itself.

IRS Ramps Up Efforts to Target Taxpayers Who Deal in Cryptocurrency

Last July, the IRS announced its Virtual Currency Compliance Campaign, designed to intensify the IRS’s efforts to counter the underreporting of income related to cryptocurrency use. Through the campaign, the IRS will address noncompliance through taxpayer education, increased audits and initiations of criminal investigations.

This past week the IRS began sending “educational” letters to more than 10,000 taxpayers who either potentially failed to report income and pay the tax from cryptocurrency transactions, or did not report their transactions properly. The IRS sent out three variations of the letters — Letter 6173, Letter 6174, or Letter 6174-A — depending on the severity of the perceived violation. Letters 6174 and 6174-A ask taxpayers to review their returns and file an amended return if necessary; Letter 6173 is a more serious warning that also requires a signature under perjury from the taxpayer affirming U.S. tax law compliance.

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