Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

On Monday, April 29, the Commodity Futures Trading Commission reiterated that wash trades (transactions without intent to take genuine, bona fide positions in the market, such as simultaneous purchases and sales designed to negate each other so that there are no changes in financial position) are “grave violations” when they penalized two traders $400,000 and prohibited them from trading for 140 days.  In the Matter of Kevin McLaren and Edward Gorman, CFTC Docket No. 13-22, April 29, 2013.

McLaren and Gorman entered into wash trades when they knowingly prearranged the execution of calendar spread trades opposite each other. Specifically, each entered into buy and sell orders for 25 March 2010/September 2010 corn futures calendar spread contracts at identical prices within two seconds of each other.  Two seconds later, they placed offsetting sell and buy orders within one second of each other for the identical number of March 2010/September 2010 corn futures calendar spread contracts at prices identical to those in the previous transaction.

The CFTC said that these transactions were wash trades because they involved (1) the purchase and sale (2) of the same delivery month of the same futures contract (3) at the same (or similar) price. Further, the transactions had the requisite scienter, i.e., the intent at the time the transactions were initiated to negate market risk (to a level where the transactions had no practical risk) or price competition.

There are two takeaways from this case.  First, the CFTC has long said that wash trades are “grave violations,” even in the absence of customer harm “because they [wash trades] undermine confidence in the market mechanism that underlies price discovery.  In Re Piasio, [1999-2000 Transfer Binder] Comm. Fut. L. Rep ¶ 28,276 at 50,691 (CFTC Sep. 20, 2000).  Second, because McLaren and Gorman were experienced traders (both became registered as floor brokers in 1982 and have been registered as floor traders since 2007), they should have known the CFTC’s concerns with such trades, and the attributes of such trades, and proceeded accordingly.  They did not and now each will have to pay a fine of $200,000. Moreover, each are prohibited from “directly or indirectly engaging in trading on or subject to the rules of any registered entity” and all registered entities must “refuse them trading privileges” for a period of 140 days.