Insider Trading in Commodities Markets: An Evolving Enforcement Priority (Part II of IV)

by Douglas K. Yatter, Sohom Datta, and Cameron J. Sinsheimer

This is Part II of a four-part post. For Part I, discussing the CFTC’s historical authority to bring insider trading actions, and the CFTC’s expanded authority after the Dodd-Frank Act, click here.

Expansion of CFTC Resources to Detect and Deter Insider Trading

In 2018, to enhance its efforts to identify and take action against insider trading, the CFTC announced the formation of an Insider Trading and Information Protection Task Force (Task Force). The CFTC described the Task Force as “a coordinated effort across the Division to identify and charge those who engage in insider trading or otherwise improperly use confidential information in connection with markets regulated by the CFTC.”[1] The Task Force has endeavored to “thoroughly investigate and, where appropriate, prosecute instances in which individuals have abused access to confidential information — for example, by misappropriating confidential information, improperly disclosing a client’s trading information, front running, or using confidential information to unlawfully prearrange trades.”[2] The Division of Enforcement has noted the ongoing importance of this effort, including in its FY2019 Annual Report, which emphasized that “[i]llegal use of confidential information can significantly undermine market integrity and harm customers in our markets.”[3]

As in other types of market misconduct, such as manipulative and disruptive trading, the CFTC has emphasized data analytics as an important tool to detect and investigate potential insider trading. With vast markets to oversee and a comparatively small staff, the CFTC has invested significant resources in market surveillance and data analysis tools. The agency has described this investment as “a multi-year project to enhance our ability to detect misconduct through the use of data analytics. As part of this effort, we have developed an ability to identify, in the trading data, forms of misconduct that we might otherwise have been unable to detect.”[4] For insider trading enforcement, this effort may include processing large amounts of trading data to identify trades that appear to benefit from market-moving news or events, among other forms of quantitative analysis.

In December 2019, the Director of the Division of Enforcement at the time, Jamie McDonald, noted the significant role data analytics could play in insider trading enforcement: “[E]arly returns on our investments in data analytics have been positive,” and “[w]e expect the longer-term impact of our efforts to be even more substantial, as we continue to prioritize detecting and prosecuting misconduct that can undermine the integrity of our markets, like the various forms of insider trading prohibited in the derivatives and commodities markets.”[5]

In its own oversight function, the CME Group has also brought disciplinary actions involving trading in its markets based on misappropriation of confidential information, basing its actions on CME Rule 432, which generally prohibits fraud, bad faith, and conduct inconsistent with just and equitable principles of trade.[6] Surveillance by the exchange is thus an important part of the evolving enforcement landscape for insider trading as well.

Enforcement Actions Since the Dodd-Frank Act

Since 2011, the CFTC has taken a deliberative approach to identifying and pursuing cases involving misappropriation of confidential information, with just a handful of actions since its first such case in 2015. Slowly but surely, these cases have entrenched Rule 180.1’s application to insider trading in the commodities markets. This section provides an overview of the CFTC’s first few actions and the most recent developments, all of which show how the agency’s use of this authority may continue to evolve.

Foundational Cases

In the Matter of Motazedi

On December 2, 2015, the CFTC announced its first insider trading enforcement action based on misappropriation of confidential information under Rule 180.1.[7] In the Matter of Arya Motazedi involved a gasoline trader who, on 12 occasions, placed oil and gas futures trades for his personal account ahead of trades for his employer’s account. The CFTC found that Motazedi misappropriated the company’s confidential information regarding “times, amounts, and prices at which the company intended to trade energy commodity futures.”[8] It further found that “Motazedi misappropriated and used his employer’s nonpublic, material trading information to orchestrate trades between his employer’s proprietary trading account and personal trading accounts, and to frontrun his employer’s orders to benefit the personal trading accounts to the detriment of his employer.”[9] Without admitting or denying the charges, Motazedi settled with the CFTC and agreed to pay restitution of $216,955 and a civil monetary penalty of $100,000.[10] He also received permanent trading and registration bans.[11]

In the Matter of Ruggles

On September 29, 2016, the CFTC brought another insider trading enforcement action involving an employee trading oil and gas futures, In the Matter of Jon P. Ruggles.[12] Like Motazedi, the CFTC found that Ruggles used his knowledge of his employer’s trading strategies, which he was responsible for implementing, to enter trades in personal accounts that would be executed against his employer’s trades or the trades of other market participants, at prices beneficial to himself. The CFTC concluded that this conduct breached the individual’s duty to his employer not to misappropriate material nonpublic information. Ruggles settled with the CFTC without admitting or denying the charges, agreeing to disgorge more than $3.5 million in profits and pay $1.75 million in penalties. He also received permanent trading and registration bans.[13]

CFTC v. EOX Holdings LLC and Gizienski

On September 28, 2018, the CFTC filed its first federal court action involving allegations of insider trading under Rule 180.1, against an introducing broker and one of its employees.[14] The complaint in CFTC v. EOX Holdings LLC et al. alleged that the individual misused confidential trading information of certain customers to benefit a favored customer with whom he wanted to pursue business opportunities. In particular, the CFTC alleged that the individual (a) disclosed other customers’ identities, trading activities, and positions to the favored customer to benefit the favored customer in his own trading; and (b) breached a duty of confidentiality to the firm’s customers that arose from various sources, including its written customer agreements, CFTC Regulation 155.4 (trading standards for introducing brokers), and futures exchange rules.

In the pending federal court action, the defendants initially filed a motion to dismiss, arguing among other points that the misappropriation theory of insider trading “applied only when an individual owes a fiduciary duty to the principal whose information was allegedly misappropriated.”[15] On September 26, 2019, the district court rejected the defendants’ position, ruling that misappropriation theory is not limited to fiduciary relationships, and that the CFTC’s allegations of breach of a legal duty of trust and confidentiality were sufficient to satisfy the pleading standard.[16] The case has proceeded into discovery, and there are indications that settlement may be under discussion.[17]

In addition to providing a court’s view of the scope of the duties on which the CFTC may rely in pursuing misappropriation charges, EOXhas demonstrated an important evolution in the types of situations that may lead to enforcement. In Motazedi and Ruggles, the individual in possession of the confidential information was also the person alleged to have traded on the information. In contrast, EOX presents aspects of a “tipping” case, in which the individual who shared confidential information did so to benefit another person rather than simply trade for himself. In securities cases, insider trading often involves situations in which a person with inside information (the tipper) tips off another person who then trades on that information (the tippee).[18] With CFTC Rule 180.1 modeled on SEC Rule 10b-5, practitioners anticipated that the CFTC would pursue tipper-tippee cases in its markets, and EOX provided the first example.[19] Perhaps not coincidentally, it was in the press release announcing the EOX case that the Division of Enforcement publicized the formation of its Task Force.

In the Matter of Classic Energy LLC and Webb

On September 30, 2019, the CFTC brought an enforcement action against a Houston-based brokerage firm and its president.[20] The firm facilitated block trades between customers in natural gas futures. In its order, the CFTC stated that the individual defrauded customers by executing block trades between customers’ accounts and a personal trading account, without disclosing to his customers that he was acting as counterparty. The CFTC stated that this activity knowingly or recklessly defrauded the customers by using material nonpublic information about their orders to trade against them, contrary to duties owed to the customers and in violation of Regulation 155.4.[21] Without admitting or denying the charges, the respondents agreed to settle with the CFTC by disgorging $413,065 in profits and paying $1.5 million in penalties. The individual also received a two-year trading and registration ban. Like the few cases before it, In the Matter of Classic Energy LLC and Mathew D. Webb shows the CFTC will cast a wide net in identifying contractual, statutory, or regulatory duties as bases for misappropriation claims.

Footnotes

[1] CFTC Press Release, CFTC Charges Block Trade Broker with Insider Trading (Sept. 28, 2018), https://cftc.gov/PressRoom/PressReleases/7811-18.

[2] Id.

[3] CFTC, FY2019 Division of Enforcement Annual Report, at 11 (Nov. 25, 2019), https://www.cftc.gov/PressRoom/PressReleases/8085-19 (follow “FY2019 Division of Enforcement Annual Report” hyperlink).

[4] Id. at 13.

[5] Matt Robinson & Benjamin Bain, Wall Street Is Being Hunted by Futures Cops for Government Leaks, Bloomberg, Dec. 12, 2019, https://www.bloomberg.com/news/articles/2019-12-12/wall-street-is-being-hunted-by-futures-cops-for-government-leaks.

[6] CME Rulebook, Chapter 4 Enforcement of Rules, at 18, https://www.cmegroup.com/content/dam/cmegroup/rulebook/CME/I/4/4.pdf.

[7] Order Instituting Proceedings Pursuant to Secs. 6(c) and 6(d) of the CEA, Making Findings and Imposing Remedial Sanctions, In re Motazedi, CFTC Dkt. No. 16-02 (Dec. 2, 2015) (“Motazedi CFTC Order”).

[8] Id. at 3.

[9] Id. at 5.

[10] All values are in US$.

[11] Id. at 10. In a parallel disciplinary action, the CME found Motazedi to have used personal accounts to round-turn or front-run the account he traded on behalf of his employer. The CME fined Motazedi $100,000, required him to pay his employer $216,955.80 in restitution, and suspended him from CME Group trading floors and electronic trading for five years. See Notice of Disciplinary Action, NYMEX 14-9723-BC (Dec. 2, 2015).

[12] Order Instituting Proceedings Pursuant to Secs. 6(c) and 6(d) of the CEA, Making Findings and Imposing Remedial Sanctions, In re Ruggles, CFTC Dkt. No. 16-34 (Sept. 29, 2016) (“Ruggles CFTC Order”).

[13] Id. at 10. In a parallel disciplinary action, the CME found Ruggles to have used his wife’s accounts to trade opposite his employer, offset positions opposite his employer, or front-run his employer’s orders. The CME fined Ruggles $300,000, required him to disgorge profits of $2,812,126.20 (with offsets for any amount paid in connection with his CFTC settlement), and banned him permanently from CME’s trading floors and platforms. See Notice of Disciplinary Action, NYMEX 12-9153-BC-1 (June 13, 2016).

[14] Complaint for Injunctive Relief, Civil Monetary Penalties, and Other Equitable Relief, CFTC v. EOX Holdings LLC, No. 18-cv-8890 (S.D.N.Y Sept. 28, 2018), ECF No. 1.

[15] Defs.’ Joint Mem. in Support of Mot. to Dismiss, at 12, CFTC v. EOX Holdings LLC, No. 18-cv-8890 (S.D.N.Y Dec. 3, 2018), ECF No. 24.

[16] Mem. Op. & Order, at 28, CFTC v. EOX Holdings LLC, No. 19-cv-02901 (S.D. Tex. Sept. 26, 2019), ECF No. 74 (“EOX Mem. Op.”) (declining to dismiss charge based on defendants’ argument that “the duties of trust and confidentiality that plaintiff alleges the defendants owed to EOX customers ‘by rule, by agreement, and by understanding,’ are not fiduciary or fiduciary-type relationships”) (citation omitted).

[17] See, e.g., Defs.’ Mot. to Compel Disc., CFTC v. EOX Holdings LLC, No. 19-cv-02901 (S.D. Tex. June 30, 2020), ECF No. 103; Minute Entry, CFTC v. EOX Holdings LLC, No. 19-cv-02901 (S.D. Tex. Dec. 15, 2020) (noting settlement conference and ongoing negotiations).

[18] In securities cases, tipper liability generally requires that the tipper disclosed material nonpublic information in breach of a duty of trust and confidence owed to the source of the information for a personal benefit. SEC v. Obus, 693 F.3d 276, 288 (2d Cir. 2011); see also Salman v. United States, 137 S. Ct. 420, 428 (2016). Tippee liability requires that “(1) the tipper breached a duty by tipping confidential information; (2) the tippee knew or had reason to know that the tipper improperly obtained the information; and (3) the tippee, while in knowing possession of the material nonpublic information, used the information by trading or tipping for his own benefit.” Obus, 693 F.3d at 289.

[19] As the court noted, the CFTC asserted claims against EOX and Gizienski for alleged violations of Regulation 180.1(a) “arising from multiple instances in which Gizienski allegedly traded on the basis of material, nonpublic information or tipped material.” EOX Mem. Op. at 7.

[20] Order Instituting Proceedings Pursuant to Secs. 6(c) and 6(d) of the CEA, Making Findings and Imposing Remedial Sanctions, In re Classic Energy LLC, CFTC Dkt. No. 19-50 (Sept. 30, 2019) (“Classic Energy CFTC Order”).

[21] Id. at 2.

Douglas Yatter is a partner in the New York office of Latham & Watkins and Co-Chair of the firm’s Commodities and Derivatives Regulation and Enforcement Practice. Sohom Datta and Cameron Sinsheimer are associates in the firm’s New York office.

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