Navigating CFTC Enforcement in 2023: Key Takeaways for Hedge Funds, Stakeholders, Startups, and Fintech Firms in 2024

R Tamara de Silva

In fiscal year 2023, the Commodity Futures Trading Commission (CFTC) stepped up its enforcement efforts, filing 96 cases against various market participants. These actions are important for maintaining market integrity in the futures and derivatives sectors. This analysis delves into these actions, offers practical steps to avoid violations, and examines the implications of off-channel communications.

Key Statistics

• Total Actions Filed: 96
  • Administrative Cases: 62
  • Civil Injunctive Cases: 34

Categories of Violations

1. Fraud (59 actions-17 of which involved failure to register)
   • Sam Bankman-Fried and FTX Trading Ltd.: Charged with orchestrating a massive fraud scheme involving the FTX cryptocurrency exchange and Alameda Research.
   • Vista Network Technologies and Armen Temurian: Accused of running a Ponzi scheme, defrauding investors with false promises of high returns from digital asset trading.
   • Multiple cases involving firms that claimed to be registered and represented themselves to the public as such but were not.
   • CFTC v. Alexander Mashinsky and Celsius Network, LLC: Charged with failure to register fraud and material misrepresentations in connection with the operation of its digital asset-based finance platform.
2. Reporting and Recordkeeping (12 actions)
   • HSBC Bank USA and HSBC Securities: Penalized for failing to maintain accurate records of their swaps transactions.
   • Goldman Sachs & Co. LLC: Multiple actions highlighted failures in recordkeeping and reporting.
3. Supervision and Financial Integrity (9 actions)
   • Goldman Sachs & Co. LLC: Charged with failing to supervise traders properly, leading to regulatory breaches.
   • Mizuho Capital Markets LLC: Penalized for inadequate supervisory procedures.
4. Manipulative Conduct and Spoofing (5 actions)
   • Avraham Eisenberg: Charged with manipulative schemes to affect digital asset prices.
   • HSBC Bank USA: Engaged in spoofing activities to manipulate futures contract prices.
5. Trade Practice Violations (3 actions)
   • Prime Agricultural Investors Inc.: Engaged in wash trading to create misleading trading activity.
   • Challenger Life Company Limited: Involved in fictitious trades that distorted market prices.
6. Registered Entity Violations (3 actions)
   • Binance Holdings Limited and Changpeng Zhao: Charged with operating an illegal exchange and failing to implement anti-money laundering measures.
   • Deridex Inc.: Penalized for system safeguard violations.
7. Illegal Off-Exchange Contracts (2 actions)
   • ZeroEx Inc.: Charged with offering illegal off-exchange digital asset trading.
   • LYFE S.A.: Penalized for off-exchange transactions.
8. Misappropriation of Confidential Information (2 actions)
   • Lee Tippett: Charged with misappropriating confidential trading strategies.
   • Dichao Xie: Found guilty of using proprietary information for unauthorized trades.
9. Statutory Disqualification (1 action)
   • Allianz Global Investors US LLC: Disqualified for significant regulatory breaches.

Off-Channel Communications: A Growing Concern

Off-channel communications refer to using unofficial methods like personal text messages, WhatsApp, and other non-approved channels for business communications. This issue has become significant because CFTC regulations require supervision and recordkeeping of by regulated entities of their communications and other documents related to their regulated businesses. Off-channel communications are not supervisered, or archived.

The CFTC's enforcement actions have shown that many firms failed to preserve these communications, leading to substantial penalties. For instance, JPMorgan Chase was fined $75 million for the widespread use of unapproved communication methods by its employees, violating the firm’s policies and CFTC Rules 1.35, 23.201, and 23.202 under the Commodity Exchange Act ( “CEA”).

Because off-channel communications can't be effectively monitored, they bypass compliance protocols designed to archive and review business-related interactions. The inability to monitor these communications increases the risk of misconduct and regulatory violations. According to CFTC regulations, all business-related communications must be archived for at least five years, with electronic records required to be readily accessible throughout this period.

The CFTC charged ZeroEx Inc. for offering illegal off-exchange digital asset trading. ZeroEx developed and deployed the 0x Protocol and Matcha, a front-end application allowing users to trade digital assets across various blockchains. Some of these digital assets were leveraged tokens providing 2:1 exposure to digital assets like ether and bitcoin. These leveraged tokens are considered retail commodity transactions, which must be offered on a registered exchange according to the CEA and CFTC regulations. ZeroEx was fined $200,000 and required to cease its illegal activities.

LYFE S.A. faced similar charges for offering off-exchange contracts. The firm offered digital asset transactions without proper registration, violating the CEA. Such actions bypass the regulatory framework designed to ensure market transparency and protect investors.

Implications for Fintech Firms

The enforcement actions against ZeroEx and LYFE S.A. underscore the importance of regulatory compliance for fintech firms, especially those operating in the digital asset space. Key implications include:

1. Need for Registration- Firms must ensure they are properly registered with the CFTC or relevant regulatory bodies when offering leveraged or margined commodity transactions. When in doubt about whether registration is required or to confirm that it is not, these firms would be well advised to seek out experienced regulatory legal counsel in futures space.
2. Compliance with Trading Regulations - All transactions must comply with the CEA and CFTC regulations, particularly those involving retail customers and digital assets.
3. Recordkeeping- It is important for regulated entities in the derivatives markets, to ensure that they retain all business communications in accordance with their legal responsibilities and compliance protocols.

Spoofing and Manipulative Conduct Cases

Spoofing and manipulative conduct cases in 2023 involved various types of contracts, not limited to digital assets. Notable cases include:

• HSBC Bank USA- Engaged in spoofing and manipulative trading related to swaps with bond issuers.
• Logista Advisors LLC and Andrew Serotta- Involved in spoofing and manipulation of crude oil and natural gas futures contracts.
• JPMorgan Chase & Co.- Charged with spoofing and manipulation in precious metals and U.S. Treasury futures contracts.

These cases highlight the broad scope of markets affected by such conduct, from digital assets to traditional commodity futures. The CFTC’s enforcement actions reflect its commitment to maintaining market integrity across all trading platforms.

Enforcement Comparison: 2023 vs. 2022

In 2023, the CFTC filed 96 enforcement actions, up from 82 actions in 2022. This increase reflects the agency's intensified focus on areas such as digital assets, manipulation, and spoofing. The CFTC also imposed higher monetary penalties in 2023.  Complete list of CFTC enforcement actions in 2023 can he found here.

Costs of Enforcement Actions for Hedge Funds and Institutional Investors

Enforcement actions by the CFTC can have significant financial and reputational costs for hedge funds. Fines and penalties can amount to millions of dollars, as seen with JPMorgan Chase's $75 million fine for off-channel communications violations. But beyond the financial penalties which may not be as meaningful for the largest institutions, the impact on hedge funds can be larger. Enforcement actions can damage a firm's reputation, leading to the loss of investor confidence and potential withdrawals. Institutional investors, who are often the primary investors in hedge funds, may reconsider their investments in funds that have faced significant regulatory actions. The scrutiny and potential loss of trust can deter future investments and affect the overall valuation and performance of the fund​.

NB: This article is for informational purposes only and does not constitute legal advice. For specific legal guidance, consult with a qualified attorney.

R. Tamara de Silva, is a futures and derivatives lawyer in Chicago who helps entities and individuals navigate these complex regulatory landscapes. For legal guidance to ensure compliance and mitigate risks, contact De Silva Law Offices.