by T. GormanPosted on Posted in SECActions

Risk controls and automated market systems have been a key topic for market regulators in view of recent markets events. This week the CFTC issued a concept release titled Risk Controls and System Safeguards for Automated Trading (here). The Release seeks comments regarding risk controls in a series of areas.

The Release is based on a recognition that the derivative markets have experienced a “fundamental evolution” in recent years from largely human-centered trading to highly automated and interconnected trading.” While traditionally market participants initiated, communicated and executed orders, automated trading environments in use now are “characterized precisely by their high degree of automation, and by the wide array of algorithmic and information technology systems that generate, risk manage, transmit and match orders and traders . . .” While these systems provide what the Release acknowledges as “a number of benefits,” they also present certain “challenges unique to their speed, interconnectedness and reliance on algorithmic systems.”

As the markets evolved a number of market events have raised public, Commission and industry awareness. Those include the May 2010 so-called “flash crash,” the errant proprietary orders at Knight Capital in August 2012 and the recent NASDAQ outage.

To date recommendations and best practices concepts have been advanced from a number of sources. Those include the CFTC’s Technology Advisory Committee, the Futures Industry Association’s Principal Traders Group and Market Access Working Group the International Organization of Securities Commissions and the European Securities and Markets Authority.

Likewise, the CFTC has addressed the issues and adopted rules. For example, last year it required certain market participants to establish risk-based limits based on position size, margin requirements or similar factors. Other recent rules require that designated contract markets establish and maintain risk control mechanisms to prevent and reduce the potential for price distortions and market disruptions. Rules related to trading practices, including trading in automated environments, have also been adopted.

In seeking comment on the question of whether additional regulation is required, the agency acknowledged that market participants have also taken a number of steps to manage risk associated with automated trading. Accordingly, the Release “seeks public comment on the extent to which measures already in place may be sufficient to safeguard markets in automated trading environments.”

The Concept Release is designed to address four specific broad areas: 1) pre-trade risk controls; 2) post-trade reports and other post-trade measures; 3) system safeguards; and 4) additional protections that might be implemented by one or more categories of Commission registrants or other market participants. To facilitate comment and discussion the Release poses a series of questions and asks that a number of issued be addressed keyed to specific topics and points which include:

  • Whether a definition of high frequency trading should be developed;
  • If message and execution and throttles should be applied by certain market participants;
  • How volatility alarms might be calibrated;
  • Self-trading controls such as specific practices or tools that have been effective;
  • Whether price collars should be used on all exchanges;
  • The application of maximum order sizes;
  • What types of triggers are more or less effective in mitigating the effects of market disruption;
  • What positions should be included in credit risk limit calculations;
  • Trade cancellation or adjustment policies;
  • Order cancellation capabilities;
  • Crisis management procedures;
  • Risk event notification requirements;
  • ATS or algorithm identification;
  • Registration of firms operating ATSs; and
  • Policies and procedures to identify “related contracts.”

Finally, the Release requests comment on issues regarding improved surveillance. “For example, the Commission request comments regarding any surveillance tools that it should deploy . . . “

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by T. GormanPosted on Posted in SECActions

The SEC filed two more offering fraud cases this week. In both cases investors were assured of the security of their investment. In both cases investors were at times promised large returns. In both investors lost. One action settled while the other did not. SEC v. Elrod, Civil Action No. 13-CV- 02449 (D. Col. Filed Sept. 9, 2013); SEC v. Projaris Management, LLC, Civil Action No. 1:13-cv-00849 (D.N.M. Filed Sept. 9, 2013).

Elrod is an action which names as defendants Brian Elrod and Nova Pack. Over an eight month period beginning in March 2007 Mr. Elrod, aided by defendant Pack who acted as an unregistered broker, raised over $2 million from 12 investors who purchased promissory notes. Investors were assured that their money was secure. The funds would be used to expand a group of finance companies. Above average returns of 12% to as much as 24% would flow to the investors, according to the claims of the defendants. In fact, much of the money went to the defendants. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a).

Each defendant settled, consenting to the entry of a permanent injunction. The Order as to defendant Elrod prohibits future violations of each of the Sections cited in the complaint except Exchange Act Section 15(a). He also agreed to pay disgorgement of $1,720,491, prejudgment interest and a penalty equal to the amount of the disgorgement. The Order as to defendant Pack prohibits future violations of Exchange Act Section 15(a) and requires the payment of disgorgement in the amount of $171,500 along with prejudgment interest. Payment, along with a penalty was waived based on financial condition. See Lit. Rel. No. 22794 (Sept. 9, 2013).

Projaris is an action against the management company, its founder Joe Lawler, his four sons, an employee of the management company, Pamela Hass and Victory Partners Financial. In this case about $1.4 million was raised from investors over about four years beginning in May 2008. Investors were told their funds would be part of a pooled investment. Funds would be used to purchase metals, commodities and real estate. The pool would also invest overseas.

In fact about $835,000 of the investor funds were never invested. Rather, the money was diverted to the defendants. The complaint alleges violations of Securities Act Sections 5(a), 5(c), 17(a)(1) and 17(a)(2) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See Lit. Rel. No. 22793 (Sept. 9, 2013).

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