CFTC Settles Charges against JPMorgan
Commentary by Bob Zwirb and Steven Lofchie
The CFTC issued an Order and settled charges against JPMorgan Chase regarding the employment of a "manipulative device" in connection with JPM's trading of certain credit default swaps ("CDS"). The CFTC alleges that, when JPM sold a "staggering volume" of these swaps in a concentrated period, JPM, acting through its traders, recklessly disregarded prices that are established on "legitimate forces of supply and demand." According to the Order, JPMorgan violated CEA Section 6(c)(1) ("Enforcement Powers of the Commission") and CFTC Rule 180.1 ("Prohibition on the Employment, or Attempted Employment of Manipulative and Deceptive Devices").
In order to settle the charges, JPMorgan has agreed to pay $100 million in a civil monetary penalty, and to continue to implement written enhancements to its supervision and control system in connection with swaps trading activity.
CFTC Commissioner Bart Chilton issued a statement of concurrence with the Order, applauding the Dodd-Frank provision which he believes provides the CFTC with more flexibility to go after reckless manipulation in the markets. Commissioner Chilton highlighted the importance of firms admitting wrongdoing. He went on to commend the Division of Enforcement for doing an "exemplary job" on the case and closed by asking Congress to allow the CFTC to use money collected from enforcements to fund the CFTC.
CFTC Commissioner Scott O'Malia issued a dissenting statement regarding the case. He explained that he would have preferred that the CFTC take a twofold approach. First, he explained that the CFTC should have taken more time to investigate if the company was liable for a more serious violation: price manipulation. Second, he stated that the courts must decide this case in order to test the "manipulative device" charge and set a precedent. On the other hand, he questioned whether any standard actually exists that constitutes manipulative behavior.
See: CFTC Order; Press Release; Commissioner Chilton Statement; Commissioner O'Malia Statement.
Related news: JPMorgan Chase Agrees to Pay Penalties (September 19, 2013); Department of Justice Files Charges against Two Former JPM Traders in Connection with Multi-Billion Dollar Trading Loss (August 14, 2013).
Commentary
The two separate statements by Commissioners Chilton and O'Malia illustrate a sharp divide over what the CFTC must show to prove manipulation. The rule being applied here, CFTC Rule 180.1, is, as Commissioner Chilton observed, the result of a new Dodd-Frank provision that provides the CFTC with the authority to go after "reckless" manipulation. The rule, which is patterned after SEC's Rule 10-5, makes it unlawful to use or employ, or to attempt to use or employ, "any manipulative device, scheme, or artifice to defraud" in connection with any commodity (in interstate commerce), swap, or futures contract. Under this new fraud-based standard, the CFTC need not show that a respondent has a specific intent to create an artificial price (instead, recklessness will suffice), nor that it has the ability to cause such a price or that its conduct resulted in movement in the market price - traditional elements of manipulation pre-Dodd-Frank.
In interpreting the new anti-manipulation authority granted to it by Congress, the CFTC stated at the time that it would view this authority as "a broad, catch-all provision reaching fraud in all its forms - that is, intentional or reckless conduct that deceives or defrauds market participants" - and that it would give that section of the Act (CEA Section 6(c)(1)) "a broad, remedial reading" embracing "any manipulative or deceptive contrivance" that defeats "the integrity of the markets" subject to the Commission's jurisdiction.
This means that the CFTC has virtually unlimited discretion to treat any fraudulent practice as "manipulation" without having to prove many of the traditional elements of manipulation as it was required to do in the past. The rule, thus, represents an effort to make it easier for the CFTC to prevail in manipulation cases. It is no secret that the agency and its supporters had long been concerned with the enforcement division's lack of success in winning manipulation cases. By getting Congress in Dodd-Frank to in effect "move the goalposts," it appears that the CFTC will have a much easier time in obtaining settlements from even the most deep-pocketed respondents.
Much of what Commissioner O'Malia complained about in his dissent must be seen in this light. Under traditional manipulation law, the government previously was required to focus on what constituted a real market price, what was an artificial price, whether the accused intended to distort prices, and whether he had the capacity to do so. Here, there appears to be no need to address such concerns, a problem that is "compounded," as Commissioner O'Malia points out, when the alleged wrongdoing occurs in the OTC market, where it is conceptually difficult, if not impossible, to discern what is "real" and what is "distorted."
Commentary
There are two aspects of the disciplinary action and Commissioner Chilton's statement of support that are problematic.
First, in the middle of the Order, the Commission inserted a long digression under which it explained why its rules regarding risk management under Dodd-Frank are such a positive development, and, had they been in force earlier, might have prevented JPM's losses.
As a general matter, this digression within a disciplinary action seems inappropriate. It raises the question of whether the purpose of the disciplinary action is in fact to punish wrongdoing and it opens up a policy question as to whether the CFTC's rules on risk management are essential or even necessary. Given that JPM is primarily regulated as a bank, why would it not be sufficient for the banking regulators to make and enforce rules regarding the bank's risk management? Under the CFTC's view, since JPM's problems primarily involved trading in securities, the SEC also should have brought a disciplinary action for poor risk management.
Second, Commissioner Chilton's assertion that the CFTC should be entitled to keep the amount of the sanctions that it collects from JPM is worrisome. If regulators were allowed to effectively profit from being able to use the sanctions they collected in order to expand the resources of their organizations and, thus, the power of their organizations, there would be a very severe conflict of interest problem that seems inconsistent with the way in which government should work.