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On December 18, the U.S. District Court for the Southern District of New York entered a Consent Order against a foreign bank (the “Bank”), imposing a civil monetary penalty of $35 million and enjoining future violations by the Bank for engaging in more than 1,000 illegal wash sales, fictitious sales, and noncompetitive transactions over a three-year period, settling a complaint that was filed by the Commodity Futures Trading Commission in October 2012.

The Illegal Transactions

The Order states that the Bank violated Section 4c(a) of the Commodity Exchange Act (the “Act”) and CFTC Regulation 1.38(a) by knowingly entering into purchases and sales of narrow-based stock index futures (NBI) and single stock futures (SSF) contracts “with the express or implied understanding that the positions later would be offset or delivered opposite each other and which were offset or delivered by sales and purchases of NBI and SSF contracts by [the Bank’s] subsidiaries.” Specifically, Bank employees knowingly structured and executed NBI and SSF block trades on the One Chicago, LLC futures exchange that were equal and offsetting in all respects and thus achieved “wash results.” In each block transaction:

(1) the futures contracts which the Bank sold and which its subsidiaries bought were the same,
(2) the purchase and sale prices for the futures contracts were the same,
(3) the delivery month of the futures contracts was the same,
(4) the purchases and sales were executed at the same time,
(5) the size of the offsetting purchases and sales were the same, and
(6) the Bank “Corporate Group” was not exposed to risk in the futures market.

The Order further states that the Bank employees who oversaw the NBJ and SSF trading knew that: (i) the offsetting transactions would negate, and did negate, the market risk inherent in futures market transactions; and (ii) profits and losses from the futures trades that accrued to the the Bank counterparties to the trades were ultimately consolidated in the Bank’s overall profits and losses, and therefore resulted in no consolidated profits or losses to the Bank Corporate Group. Because the profits and losses that accrued to the Bank counterparties from the trades netted to zero when they were consolidated in the Bank Corporate Group’s overall profits and losses, the trades amounted to “fictitious sales” under Section 4c(a) of the Act

The court also found that, the Bank violated the OneChicago exchange’s written rules, and thus engaged in “noncompetitive transactions,” in that the Bank did not report the express or implied understanding to enter the later, offsetting segments of its NBI and SSF trades to the OneChicago exchange “without delay.”

According to the Order, senior Bank personnel designed the trading strategy in part to achieve certain tax benefits for the Bank Corporate Group.

CFTC Division of Enforcement Signals “Vigorous Enforcement” of Wash Sales Prohibition

CFTC Director of Enforcement Aitan Goelman stated about the case: “Illegal wash trades may seem innocuous. They are not. They provide misleading signals to the market and are thus prohibited, whether their purpose is to lessen a foreign tax bill or another reason. This matter clearly demonstrates that the CFTC will vigorously enforce this prohibition to protect the integrity of our markets.”