On September 30, 2019, the Commodity Futures Trading Commission (“CFTC”) issued a series of consent orders sanctioning six financial institutions—all provisionally registered swap dealers—and imposing a combined $6 million in penalties arising from swap reporting and risk management failures. For the first time in history, the CFTC charged an entity with violating swap-dealer risk management regulations and also charged two other entities with supervision failures stemming from overlooked reporting failures. These charges send a strong message and hold important implications not only for these entities and other swap dealers, but for any entity that reports to the CFTC: the CFTC takes swap reporting requirements seriously, because the CFTC stressed that information provided pursuant to CFTC swap reporting requirements is essential to its enforcement efforts, and entities with CFTC swap reporting obligations in turn must incorporate reporting obligations into their risk management strategies.
In one of the orders, the CFTC premised its charges against the swap dealer on numerous reporting and risk management failures, imposing a $650,000 fine for the swap dealer’s failure to establish an appropriate risk management system for swap activities or to properly report certain swap data. The CFTC noted that the swap dealer did not designate a governing body or senior management to “fulfill the requisite oversight duties under CFTC regulations.” According to the CFTC, the swap dealer also failed to (1) separately consider certain risks associated with its swap activities and incorporate those into its risk management program; (2) properly approve its risk tolerance limits, risk management program and policies and procedures, and trading policies; and (3) properly review its quarterly risk exposure reports, annual audits of its risk management program, and its business continuity and disaster recovery plan. With respect to the risk management violations, CFTC Director of Enforcement James McDonald remarked that this order represents “the first action the CFTC has brought regarding violations of these particular swap-dealer risk management regulations” and warned that the CFTC will “continue to focus on enforcing these critical requirements.”
The CFTC charged a second financial institution with failing to comply with its swap dealer data reporting obligations, failing to implement required policies and procedures, and related supervision failures, finding “widespread and systemic” failures in all asset classes and across reporting obligations under the Commodity Exchange Act (“CEA”) and Parts 20, 43, 45, and 46 of the CFTC’s accompanying regulations. In particular, the CFTC found that the financial institution failed to implement policies and procedures sufficient to determine whether its counterparties were U.S. persons (or conduits or affiliates thereof) and lacked an effective system to supervise certain activities related to its business. The financial institution received a $2.5 million civil monetary penalty—a substantially reduced amount based on its self-reporting and remediation efforts—and also agreed to comply with certain undertakings, including continued remediation efforts regarding swap data reporting and provision of periodic updates to the CFTC.
In a third consent order, the CFTC charged another bank with numerous violations of the CEA and CFTC swap reporting regulations under Parts 23, 43, and 45 stemming from the firm’s inadequate supervision of its swap dealer over a five-year period. The CFTC found that the firm failed to correctly report hundreds of thousands of swap transactions to a swap data repository (“SDR”) as a result of inadequate supervision partially attributable to the firm’s repeated hiring of compliance personnel who lacked the requisite technical expertise. The firm agreed to a $1 million civil monetary penalty, which reflected a reduction based on the firm’s substantial cooperation during the investigation and remedial efforts.
A fourth financial institution was charged with submission of inaccurate large trader reports (“LTRs”) between July 2012 and June 2017—a period during which almost every LTR submitted contained errors (millions of errors in total), in violation of Part 20 of the CFTC’s regulations. The CFTC’s order imposed an $850,000 civil monetary penalty, among other sanctions, which reflected a reduction in light of the institution’s cooperation and substantial remediation.
The CFTC’s order against a fifth bank—the world’s largest custody bank and asset servicing company—is premised upon conduct between December 31, 2012 and at least 2018. The CFTC found that during this period, the bank failed to correctly report hundreds of thousands of swap transactions to an SDR, in violation of the CEA and CFTC regulations 43.3 and 45.3. These errors included failing to correctly report tens of thousands of foreign exchange (“FX”) swaps, failing to report tens of thousands of swap transactions with affiliates, and failing to correctly report “bunched trades” (transactions with investment managers acting as agents for one or more principals). The CFTC assessed a $750,000 civil monetary penalty, among other sanctions, which reflected a substantial reduction in light of the bank’s cooperation during the investigation and remedial efforts.
The sixth order involved another financial institution that failed to properly report legal entity identifiers (“LEIs”), primary economic terms, and continuation data to its SDR; failed to file LTRs for its physical commodity swaps; and failed to timely report certain trades to its SDR, in violation of Parts 20, 43, and 45 of the CFTC reporting requirements. The bank agreed to pay a $300,000 civil monetary penalty, but the order acknowledged that the bank self-reported the SDR reporting issues before it knew the full extent of its violations and fully cooperated with the CFTC’s investigation. The order also recognized the bank’s remediation of its swaps reporting issues, including those made in connection with transactions that are no longer on its books.
These six orders provide valuable insight into the CFTC’s priorities and decision-making processes, and the risks facing swap dealers and other entities with swap reporting and swap risk management obligations:
Data Is King
According to CFTC Director of Enforcement James McDonald, accurate reporting is “essential to effective fulfillment of the regulatory functions of the CFTC, including meaningful surveillance and enforcement programs.” In short, the CFTC relies on organizations to report accurate data. Reporting failures thwart the CFTC’s regulatory role and undermine market integrity, so the CFTC takes reporting violations seriously—and will punish them accordingly.
Relatedly, an accidental, as opposed to intentional, reporting failure will not absolve a party from liability. In either instance, the CFTC may hold a party liable and will consider repeated reporting failures indicative of failure to supervise, regardless of intent. Accordingly, it is essential that entities hire appropriately experienced personnel, understand and accurately implement CFTC reporting requirements, and where appropriate, seek advice of counsel familiar with these requirements.
Significance of Remediation and Cooperation
All six entities received reduced penalties as a result of their remedial efforts and cooperation with the CFTC, and in some instances preemptive self-reporting. Accordingly, companies under investigation (or that discover reporting failures even absent an investigation) should consult counsel familiar with the CFTC’s reporting requirements and enforcement priorities to assess the potential benefits of proactive reporting, cooperation, and remediation.
Incorporating Reporting into Risk Management Strategy
To minimize the risk of reporting violations and associated CFTC charges, swap dealers and other companies with CFTC swap reporting obligations should incorporate swap reporting into their risk management strategies, including assigning the reporting function to a governing body, such as a high-level risk manager; conducting a self-assessment; monitoring and conducting periodic audits or spot checks of the reporting function; establishing baseline standards and hiring criteria for employees responsible for CFTC reporting; and ensuring adequate supervision and oversight. As the CFTC explained in its first order, robust swap risk management efforts are not just essential to the individual entities that adopt them—they are essential to reducing systemic risk across financial markets.
 The CFTC substantially reduced the monetary penalty based on the bank’s cooperation and remedial efforts. Id.