FCM Penalized for Failure of Supervision with No Underlying Violation of Law
Commentary by Bob Zwirb
The CFTC issued an Order filing and simultaneously settling charges against an FCM for failing to diligently supervise its officers and employees relating to its business as an FCM in violation of Commission Rule 166.3. The FCM failed to implement adequate customer credit and concentration risk policies and controls in 2008 and part of 2009, allowing one account ("Account") to acquire a massive options position that it could not afford to maintain. Ultimately, the FCM was forced to take over the Account and lost a substantial sum. The Order requires the FCM to pay a civil monetary penalty of $1.5 million, retain an independent consultant to review its internal controls and procedures, and cease and desist from violating its supervisory obligations.
See: Order; Press Release.
Commentary
The CFTC order finds that the FCM failed to diligently supervise its officers and employees with respect to an account controlled by two of its customers who traded natural gas futures, swaps, and option contracts. The order alleges that the FCM violated the CFTC's supervision requirements found in CFTC Rule 166.3, but does not find any underlying violation to which such supervision might relate. This is a fundamental concept in the CFTC's enforcement program that market participants might not be fully aware of, i.e., that an FCM or, for that matter, any other CFTC-registered entity, may violate Regulation 166.3 even if it does not violate any specific supervisory requirement imposed by either statutory provision or regulatory rulemaking. As the CFTC notes, "proof of an independent substantive violation is not a necessary element to establish a breach of the duty imposed by Rule 166.3."
Thus, a violation for failure to supervise under Rule 166.3 is an independent violation for which no underlying rule violation is necessary. Registered entities should beware.