The SEC has released its report on hedge funds. The report includes a number of recommendations, including the recommendation that the Commission consider requiring hedge fund advisors to register as IAs.
One generally does not think of the SEC as being a regulator with much of a sense of humor. I happened to come across an item on the SEC web site recently that made me think that the Commission is able, at least on occasion, to manage a wry smile. The SEC web site has a "fast answers" section, intended for investors. The section indicates one of the top inquiries as "Is the Andrew Carlssin case for Real?" Never having heard of this individual, I clicked to find out that Mr. Carlssin is an urban legend, an individual who is supposed to have traveled through time, then returned to the present day to use the knowledge gained to make a fortune trading. The urban legend continues that, for his troubles, Mr. Carlssin became the subject of a SEC enforcement action.
While this is new to me, it's apparently been around for awhile, because the SEC web page indicates that is was last updated in March 2003. So why does this indicate to me that the SEC may possibly have a sense of humor? Because the answer concludes:
The reports appear to be a hoax. The SEC has not, in fact, brought an enforcement action against any such person.
The SEC has finally published the new investment adviser custody rules.
The proposed NYSE and NASD business continuity rules (originally submitted to the SEC over a year ago) have been revised and republished for comment in the Federal Register. The rules were designed to be virtually identical, so that firms that are members of both SROs will be able to comply. A new twist is that the proposed rules have added the following requirement:
Each member must disclose to its customers how its business continuity plan addresses the possibility of a future significant business disruption and how the member plans to respond to events of varying scope. At a minimum, such disclosure must be made in writing to customers at account opening, posted on the member's Internet Web site (if the member maintains a Web site), and mailed to customers upon request.
What do you suppose they mean by "events of varying scope"? Is this going to require that the firm describe how it intends to respond to everything from a public transit strike up to nuclear war?
UPDATE: The SEC released a policy statement on business continuity planning for SRO markets and ECNs.
The U.S. Treasury published a notice in the Federal Register regarding the Customer Identification Program requirements that all financial institutions (including BDs, FCMs and IBs) must implement by October 1st.
The release dealt with two issues: whether to require financial institutions to make and retain photocopies of customer identification documents (FinCEN decided against such a requirement) and whether financial institutions should be permitted to accept the Matricula Consular, a Mexican consular identification document (FinCEN refrained from expressly permitting or prohibiting accepting this card).
The Treasury, noting that over 34,000 comments were received on these two issues, stated:
Despite the volume of comments received, the comments presented no new arguments or information relative to the requirements of the final rules that Treasury and the financial regulators did not already consider in developing the final rules.
There's a Bruce Springsteen song called "57 channels and nothing on." Compare that to Treasury -- 34,000 comments, none of which say anything Treasury has not thought of.
The WSJ reports (subscription required) that a SEC report on regulation of hedge funds will be released soon, perhaps as early as Monday. It is believed that the report will recommend that hedge fund managers be required to register as investment advisers.
The NASD released a notice to members regarding amendments to its non-cash compensation rules. An example of non-cash compensation is offering all-expense paid vacations to registered representatives for selling certain securities. Now, it's certainly true that undisclosed non-cash compensation represents a conflict of interest. So there's certainly a valid reason for the rule revision. And the revision doesn't appear to be a major one -- merely explicitly extending the non-cash compensation rules for mutual funds and variable products to certain other products. Even so, the NTM (which was posted on September 24th) includes the statement that
The rule amendments were effective immediately upon filing with the Commission, which was April 7, 2003.
That means that it took almost six months for the NASD to notify firms of the new rule. While it may seem overly compulsive to some, my feeling is that if something is important enough to require revising a rule, then it's important enough to tell the firms when the revision goes into effect.
Both the CBOT and CME have been on a run of "grandfatheritis" lately. Both exchanges have issued rule revisions or interpretations that have included implicit or explicit grandfathering clauses. For example, the CBOT recently changed its rules regarding how a firm can qualify as member firm of the exchange. (Member firms have the right to trade CBOT products at member clearing rates. The clearing rate is the fee charged by the exchange for every contract traded. Both exchanges clearing rates vary depending upon the nature of the account doing the trading. Exchange members pay the least per contract traded; public customers pay the most. For a firm engaging in high volume trading for its own account, access to the member clearing rate is an enormous benefit). It used to be that an individual exchange member could register his membership on behalf of a firm. As of September 1st, however, any firm wanting to become a CBOT member firm must purchase its own CBOT full membership (currently offered at about $450,000. See the current offer by clicking here. This rule will help to support membership prices (full membership prices are up almost $100,000 in the last couple of months), but represents a new (and high) barrier to entry. However, any firm that acquired member firm status prior to September 1st based upon the registration of an individual's membership on its behalf are "grandfathered."
The CME also has grandfathered. The exchange recently issued a notice regarding when firms that engage in proprietary trading (i.e., trading for the firm's own account) are entitled to the lowest member rates. The notice includes a provision that an individual trader that has an ownership interest in the member firm must have an investment of at least $500,000 in the member firm to be entitled to have his trading kept separate from the trading of the other individuals trading on behalf of the firm. Previously (and unacknowledged in the notice), the CME permitted entities such as LLCs to make such a $500,000 investment into a member firm and then segregate the trading of such investing LLC and its traders, effectively allowing a separate entity to daisy-chain onto the member firm's right to member rates. Again, if a firm was already doing this as of the date of the notice, it's grandfathered.
I recognize that both exchanges were in difficult position. They had rules or policies in place that permitted entities to effectively gain access to exchange member rates without having to buy the requisite number of exchange memberships. I understand both why the exchanges felt they needed to change this and why the exchanges felt that they could not just make a sweeping rule change -- many firms had relied on the prior rules in structuring their arrangements. To have simply changed the rules without grandfathering existing firms would really have pulled the rug out from many firms.
Still, it seems unfair that both exchanges currently have two set of rules -- one for firms that already had their arrangements in place and one for firms that are looking to gain entry.
Back in August, the Massachusetts securities commissioner filed charges against Morgan Stanley for a sales campaign that gave undisclosed incentives to reps to sell Morgan Stanley's in-house products. One of the most damaging pieces of evidence against Morgan Stanley was an email, written by a supervisor, prohibiting others from putting anything in writing about the program.
That email made Morgan look terrible -- the firm appeared to be trying to hide a knowing violation of its own procedures. Why prohibit emails about the program unless you knew it was wrong?
Today, just over a month after the Massachusett action, the NASD announced settlement of an action against Morgan Stanley arising from the sales promotion. Morgan agreed to be censured and will pay a $2.0 million penalty.
In announcing the settlement, the NASD stated:
Morgan Stanley apparently attempted to shield this focus on sales of its own mutual funds from the public as much as possible to avoid public relations ramifications. This is evidenced from electronic mail messages by a regional manager directing branch managers and other employees to refrain from putting in writing details regarding contests promoting Morgan Stanley mutual funds.
The speed and size of this settlement reflects the hopelessness of Morgan Stanley's position. When you know that you're going be hit hard by the regulators, often the best strategy is to end it quickly rather than engage in endless negotiations to try to whittle down the penalties. The distraction of protracted negotiations with regulators often costs firms more in lost business than can be saved in reduced penalties. Good traders know that taking the loss on a losing trade is better than trying to turn a loser into a winner. Morgan Stanley is just trying to take its loss and move on.
Actually, in light of the fact that the SEC has announced its intention to focus on conflicts of interest, Morgan Stanley is probably thankful that it settled with the NASD when it did. Now all it has to worry about is a follow on action from the SEC.
Eurex announced today that "Eurex US" will begin trading in February 2004 (only five months away!) Eurex US will offer look-alike futures contracts on the CBOT's interest rate contracts -- the US 30-year bond, 10-year note, 5-year note and 2-year note.
One major selling point of these contracts is the fees that will be charged. Reuters reports that most volume will be priced at 20 cents or less per contract. That's not much more than the basic most favorable rate available to CBOT members for electronic trading although once volume discounts are factored in, the CBOT rates can be lower. (Note: the link is to the CBOT's exchange fee grid -- the most favorable member rates are found in row 1).
Exchange fees on proprietary trading have developed into one of the most aggravating issues in recent years for CBOT member firms. It's aggravating for the member firms because many firms perceive a certain arbitrariness in how the exchange sets its exchange fee rates and it's aggravating because the firms feel that complying with the rules for receiving the best rates on proprietary trading results in certain compromises in their risk management.
A "one size fits all" fee structure sidesteps that aggravation entirely. That will cause a lot of guys to want to trade on Eurex US. Provided there's an acceptable level of liquidity, they will.
The NFA recently updated its summary of regulatory requirements for futures firms doing business in security futures products. Short and to the point, the summary is a useful checklist for any futures firm doing SFPs.
William Donaldson, chairman of the SEC, addressed the annual NASAA conference over the weekend. Since NASAA is a group of state securities regulators and since Donaldson had recently criticized actions by New York and Oklahoma (WSJ article, subscription required) in bringing enforcement actions without coordinating with the SEC, I'm sure some were expecting fireworks.
Donaldson's speech, though, appeared aimed at making nice with NASAA. It did, however, include the following statement:
So, if there is overall agreement that the SEC should act as the national rulemaker, and that both federal and state authorities should act as enforcers, where does the difficulty arise?
In other words, just do what we tell you and everybody will get along fine.
UPDATE: On September 16th, the SEC and New York AG Eliot Spitzer jointly announced the filing of criminal and civil charges against a broker from Bank of America who was involved in executing late mutual fund transactions for Canary Capital. The joint announcement indicates that the SEC and Spitzer are at least on speaking terms, which probably cannot be said about the SEC and Drew Edmondson, attorney general of Oklahoma.
The SEC amended custody rules for investment advisers today. The new rules are not yet available on the SEC's website, but a summary may be found here. The IA custody rules have always been a trap for the unwary. Hopefully, operating under the new rules will be simpler.
Stephen Cutler, director of the SEC's enforcement division, spoke at a compliance conference this week. His topic was conflicts of interest at financial services firms. He concluded:
Scour your firms for the conflicts I've described and for those I haven't. Be creative in your approach. Shed the blinders of "industry practice" that may have made it possible for you not to see the conflicts that surround you daily. Just because the industry has always done something "that way," don't assume it's acceptable.... Once you've systematically identified the conflicts within your firm, work to address them, and inform us of any violative conduct. For if we find it on our own, I assure you that the consequences will be worse.
The SEC recently filed charges against three former traders at Knight Securities. Knight makes markets in numerous Nasdaq securities. According to the SEC, these traders had a friend open an online account at another firm. They then entered trades through this account in the same thinly-traded securities in which they made markets. The SEC asserts that the bids and offers they put up were intended to cause Knight's account to lose money and the friend's account to make money.
Earlier posts (here and here) described the battle between the NYSE and LaBranche, a specialist firm at the NYSE. The NYSE is investigating specialist firms and demanded that LaBranche produce all email; LaBranche produced what it said was all business-related email but refused to produce certain "personal" email. The NYSE responded by saying that all email really means all email; LaBranche continued to refuse to produce the personal email.
The dispute regarding the email went to a NYSE hearing panel. The panel found (link is to WSJ, subscription required) that LaBranche failed to cooperate with an investigation. The panel censured LaBranche and assessed a $150,000 fine.
LaBranche turned over the disputed emails but is now appealing the penalty to the NYSE board. LaBranche's argument, that the NYSE's jurisdiction is only over business matters, is a good one. A Reuters story quotes LaBranche's attorney as saying that the appeal is being made "on principle." Unfortunately for LaBranche, the NYSE board is probably preoccupied with the current to-do regarding Richard Grasso's compensation. While Grasso is probably much more sympathetic to arguments seeking to uphold rights to privacy than he was a few weeks ago, I suspect that the NYSE board now feels obligated to demonstrate how tough it can be (One recent WSJ article on Grasso's compensation was entitled: "Where was the NYSE Board?"). That makes it likely that the LaBranche appeal will get turned down fast.
The CFTC has announced enforcement actions against two floor brokers at the Nymex. One broker has settled; one is going to fight. The CFTC is asserting that the brokers engaged in wash sales, i.e., they intentionally traded equal quantities at the same price, creating the appearance of activity without exposure to market risk.
What's interesting here is why the brokers engaged in wash trading: to improve their rates for timely submission of trading cards. The Nymex, like the CBOT and CME, requires that trading cards of floor traders be submitted to clearing firms within a set time after the trades on the cards are made. Submit a certain percentage of cards after the deadline and the exchange will fine the trader. The CFTC is basically asserting that the traders were "banking" timely submitted cards to be able to submit more cards late and still stay within the permitted percentages.
The rules requiring prompt submission of trading cards were motivated by the belief that the longer trading cards stayed in traders' hands, the greater the potential for mischief in the form of changing prices, changing quantities, etc. I guessing, however, that no one thought that enacting these submission rules would lead to wash trading.
The SEC has filed insider trading charges related to trading in cash U.S. government bonds that occurred in 2001, on the day that the Treasury Department announced that it would cease issuing 30-year bonds. Treasury announced the decision at a news conference that was "embargoed," that is, where attendees were prohibited from releasing the news for a period of time. One of the press conference attendees, however, called a number of firms prior to the time the embargo was lifted.
Stephen Cutler, director of enforcement for the SEC, stated:
What messages do these cases send? Acting quickly on market-moving news after it becomes fully public is one thing; tipping by a recipient of embargoed news, and trading based on such a tip, is quite another.