by Douglas K. Yatter, Sohom Datta, and Cameron J. Sinsheimer
This is Part III 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. For Part II, discussing recent enhancements in the CFTC’s ability to detect insider trading, and four of the CFTC’s foundational insider trading cases, click here.
Three additional settlements recently announced by the CFTC further reinforce the agency’s interest in identifying and deterring misappropriation of confidential information. The latest matters also herald the arrival of criminal enforcement by the DOJ in this area.
Resolving Old Business
On August 4, 2020, the CFTC announced a consent order (the Byrnes Consent Order) settling its long-running case against the New York Mercantile Exchange and two of the exchange’s former employees, Byrnes and Curtin.[1] CFTC v. Byrnes, et al., filed in February 2013 based on conduct from 2008 to 2010,[2] involved charges under the CFTC’s pre-Dodd-Frank authority for misuse of confidential information by exchange personnel.[3] On February 19, 2021, the CFTC announced a consent order (the Eibschutz Consent Order) resolving its action against the last of the defendants in this case, a broker of energy futures and options.[4]
As set forth in the consent orders (the facts of which the defendants neither admitted nor denied), Byrnes and Curtin on multiple occasions disclosed to Eibschutz certain “confidential information about derivatives trading activity that [they] obtained during the course of their employment” with the exchange.[5] These disclosures “pertained to trading activity in options on commodity futures, principally in the crude oil and natural gas markets,” and included, “among other things, the identities of counterparties to specific options trades, whether a particular counterparty purchased or sold the option, whether it was a call or a put, the volume of contracts traded, the expiry, the strike price, and the trade price.”[6] The consent orders stated that Byrnes and Curtin “knew or recklessly disregarded that they should not disclose the trade information” to Eibschutz and that “the information was both nonpublic and material.”[7] The Eibschutz Consent Order stated that he “solicited and received from Byrnes and Curtin confidential information” and thereby “willfully aided and abetted Byrnes and Curtin’s wrongful conduct.”[8]
In Byrnes, the CFTC took a broad view of confidentiality duties underlying the alleged violation, relying on CFTC Rule 1.59(d) and also citing the exchange’s Code of Conduct and Employee Handbook.[9] Byrnes is also an example of the CFTC’s efforts to hold an employer liable for the conduct of its employees, as it charged the exchange itself for Byrnes and Curtin’s violations even though their actions violated the exchange’s policies.[10] The Eibschutz Consent Order also demonstrates that the CFTC will utilize other forms of liability, such as aiding and abetting, to hold others accountable too.
In the consent orders, the defendants agreed to pay a total of more than $4 million in civil monetary penalties, and the three individuals were permanently barred from trading commodity interests or registering with the CFTC.[11]
In announcing the Byrnes Consent Order, the CFTC’s Director of Enforcement at the time, Mr. McDonald, noted that it “sends a strong message that the CFTC will work tirelessly to protect our market participants against unlawful disclosures of their confidential information to ensure that the fairness and reliability of our markets are not compromised,” and that employers may be held “responsible for violations of the CEA or CFTC regulations by their officials, employees, and agents within the scope of their employment or office.”[12] Thus, while the underlying conduct predated the expansion of the CFTC’s authority to police its markets more broadly for insider trading, this case stands as a marker of the agency’s ongoing commitment to use its authority aggressively to address this type of conduct.
Mapping a New Frontier
On September 30, 2020, the CFTC issued an order against Marcus Schultz, an energy trader, for misappropriating his employer’s confidential trading information, among other charges.[13] Schultz gave his employer’s block trade information to a broker, with whom he orchestrated a series of trades in which the broker, Schultz, and others traded with Schultz’s employer at non-bona fide prices. According to the CFTC, the broker and other traders shared their trading profits with Schultz,[14] who defrauded his employer by “creating the false impression that he was executing trades at bona fide prices that were in [the company’s] best interest, when in fact he was executing trades at prearranged bids and offers that were designed instead to enable [the scheme participants] to make a profit on offsetting trades with other market participants.”[15]
As in prior cases, the duty allegedly violated by Schultz’s conduct flowed from his employment. The CFTC stated in the order that, as an employee of his company and under the employment agreements, policies, and procedures that governed his employment, Schultz owed his employer a duty to keep inside information confidential.[16] According to the order, Schultz’s misappropriation of confidential information extended beyond the company’s trading information to include information related to his employer’s analysis of a United States Energy Information Administration Natural Gas Storage Report, a weekly report that measured natural gas held in underground storage.[17] The CFTC found that Schultz shared information about the report with another person, anticipating that the person would trade on the basis of the information, and that Schultz would receive a share of profits from this trading.[18]
Although Schultz sometimes acted on the confidential information by trading personally, this case is also an example of the CFTC using Rule 180.1 against a tipper who shared information with others so they could trade on that information, with tipper and tippee sharing the benefits. Notably, the recipient of the misappropriated information in this case was a broker who facilitated trades and might otherwise have been regarded as an appropriate recipient of order information. But the CFTC found that Schultz disclosed the information to the broker “under the guise of seeking [the broker’s] assistance in locating a counterparty” for his employer’s order, when instead he was doing so to enable the broker and others to trade at non-bona fide prices against the company rather than to maximize the company’s profit.[19] The CFTC found that Schultz concealed the true nature of these trades from his employer by documenting them as ordinary trades, continuing to incur brokerage commissions, and concealing the source of payments he received from the group’s profits. The CFTC also found that Schultz made false statements to regulators “concerning his knowledge of and authorization for brokers to take the other side of his orders through an account they owned or controlled,” falsely denying that he had “given permission to [the broker] to take the other side of his orders as part of their fraudulent scheme.”[20]
In the CFTC settlement, Schultz agreed to disgorge $427,067.45 and pay a civil monetary penalty of $669,750.[21] The order also barred Schultz from trading or seeking registration for a period of six years.
Importantly, Schultz’s conduct was also the subject of a criminal case brought by the DOJ, marking the first instance of parallel criminal enforcement in a matter involving the misappropriation theory of insider trading in the commodities markets.[22] In the criminal case, filed in federal court in Houston, the government alleged that Schultz engaged with others in a conspiracy to violate the CEA and Rule 180.1 to “enrich themselves from the profits derived from fraudulent and unlawful trading practices and misappropriation of material, nonpublic information.”[23] Schultz pleaded guilty to conspiracy pursuant to a sealed plea agreement, with sentencing currently scheduled for June 2021.[24]
On February 1, 2021, the DOJ announced that a second energy trader, John Ed James, one of the recipients of the information divulged by Schultz, also pleaded guilty to conspiracy to commit commodities fraud and wire fraud pursuant to a plea agreement. Largely tracking the charges against Schultz, the DOJ accused James of misappropriating confidential information and entering into noncompetitive trades to fill Schultz’s orders and offsetting transactions in the market at a profit for personal gain.[25] His sentencing is currently scheduled for April 2021.[26]
As the DOJ has noted, this pair of actions marks its “first effort to prosecute insider trading in the commodity markets under Section 180.1.”[27] This matter is also the latest example of the close collaboration between the CFTC’s Division of Enforcement and the Fraud Section of the DOJ’s Criminal Division. The agencies’ cooperative enforcement efforts now extend beyond matters involving disruptive trading and market manipulation to include trading based on misappropriation of confidential information, among other areas. As the DOJ noted in its recent report on the Fraud Section’s activities in 2020, its prosecutors now “focus on identifying and prosecuting complex fraud, price manipulation, and insider trading cases involving core U.S. commodities markets and closely related securities instruments.”[28] In announcing the CFTC’s order against Schultz and acknowledging the DOJ’s assistance in the case, the CFTC’s Director of Enforcement at the time stated that “[m]isappropriating material, confidential information in order to engage in fictitious trading undermines the integrity of the futures markets and will not be tolerated.”[29] These statements indicate that the agencies will continue to collaborate closely in this new area of enforcement.
Footnotes
[1] CFTC Press Release, NYMEX and Two Former Employees to Pay $4 Million for Disclosing Material Non-Public Information (Aug. 4, 2020), https://www.cftc.gov/PressRoom/PressReleases/8216-20.
[2] Compl. for Inj. and Other Equitable Relief and Civil Monetary Penalties Under the CEA, CFTC v. Byrnes, No. 13-cv-1174 (S.D.N.Y. Feb. 21, 2013), ECF No. 1 (“Byrnes Compl.”). On May 8, 2013, the CFTC amended this Complaint to add Eibschutz as a defendant, charging him with aiding and abetting the other defendants’ conduct. Amended Compl. for Inj. and Other Equitable Relief and Civil Monetary Penalties Under the CEA, CFTC v. Byrnes, No. 13-cv-1174 (S.D.N.Y. May 8, 2013), ECF No. 19 (“Amended Byrnes Compl.”).
[3] Byrnes Compl. at 15; Amended Byrnes Compl.at 18-21 (setting forth allegations under CEA Section 9(e)(1) and Rule 1.59(d)).
[4] Eibschutz Consent Order, CFTC v. Byrnes, No. 13-cv-1174 (S.D.N.Y. Aug. 3, 2020), ECF No. 241.
[5] Eibschutz Consent Order at 6; Byrnes Consent Order, at 5, CFTC v. Byrnes, No. 13-cv-1174 (S.D.N.Y. Aug. 3, 2020), ECF No. 227.
[6] Byrnes Consent Order at 6; Eibschutz Consent Order at 6.
[7] Id.
[8] Eibschutz Consent Order at 6-7.
[9] Byrnes Consent Order at 7; Eibschutz Consent Order at 7; see also Byrnes Compl. at 8, 17-18 Amended Byrnes Compl. at 8, 19. Regulation 1.59(d)(1)(ii) provides that “[n]o employee, governing board member, committee member, or consultant shall … [d]isclose for any purpose inconsistent with the performance of such person’s official duties as an employee … any material, non-public information obtained through special access related to the performance of such duties.” 17 C.F.R. § 1.59(d)(1)(ii).
[10] Byrnes Consent Order at 7 (finding that Byrnes and Curtin “were acting as agents and employees” of the exchange and the exchange was liable as principal under CEA Section 2(a)(1)(B), 7 U.S.C. § 2(a)(1)(B), for acts of its agents).
[11] Id. at 8-9; Eibschutz Consent Order at 9.
[12] CFTC Press Release, NYMEX and Two Former Employees to Pay $4 Million, supra note 34.
[13] Order Instituting Proceedings Pursuant to Secs. 6(c) and 6(d) of the CEA, Making Findings and Imposing Remedial Sanctions, In re Schultz, CFTC Dkt. No. 20-76 (Sept. 30, 2020) (“Schultz CFTC Order”).
[14] CFTC Press Release, CFTC Orders Texas Man to Pay Over $1 Million for Misappropriating Confidential Information, Fictitious Trading, and False Statements (Sept. 30, 2020), https://www.cftc.gov/PressRoom/PressReleases/8266-20.
[15] Schultz CFTC Order at 2.
[16] Id. at 7.
[17] Id. at 4.
[18] Id.
[19] Id. at 3-4.
[20] Id. at 5.
[21] Id. at 10-11.
[22] Compl., United States v. Schultz, No. 20-cr-270 (S.D. Tex. June 29, 2020), ECF No. 1.
[23] Id. at 7.
[24] United States v. Schultz, No. 20-cr-270 (S.D. Tex. July 20, 2020), ECF Nos. 19, 27.
[25] Compl. at 7, United States v. James, No. 20-cr-695 (S.D. Tex. Dec. 28, 2020), ECF No. 1 (“James Compl.”) (charging James with conspiracy to commit commodities fraud in violation of 18 U.S.C. § 1348 and wire fraud in violation of 18 U.S.C. § 1343); Plea Agreement at 8, United States v. James, No. 20-cr-695 (S.D. Tex. Feb. 1, 2021), ECF No. 20. James also admitted that he and others agreed to falsely document certain proceeds as income on IRS forms in part to conceal the true nature of the funds and to make the illicit profits appear to be legitimate income. James Compl. at 7.
[26] Order, United States v. James, No. 20-cr-695 (S.D. Tex. Feb. 1, 2021), ECF No. 21.
[27] U.S. Dep’t of Justice Press Release, Former natural gas trader pleads guilty for role in commodities insider trading scheme (Feb. 1, 2021), https://www.justice.gov/usao-sdtx/pr/former-natural-gas-trader-pleads-guilty-role-commodities-insider-trading-scheme.
[28] U.S. Dep’t of Justice, Fraud Section Year In Review 2020 (Feb. 2021), https://www.justice.gov/criminal-fraud/file/1370171/download.
[29] CFTC Press Release, CFTC Orders Texas Man to Pay Over $1 Million, supra note 47.
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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