by T. GormanPosted on Posted in SECActions

Almost five years ago the Dow Jones Industrial Average dropped about 600 points in five minutes, creating chaos in the markets and huge losses for many. The market debacle became known as the flash crash. The causes were investigated and debated. The SEC compiled a report. The debate continued.

Now the Department of Justice claims to have found part of the answer – a foreign trader conducting a manipulation scheme, at least according to charges recently unsealed. U.S. v. Sarao, Case No. 1:15-cr-00075 (N.D. Ill. Filed Feb. 11, 2015). Defendant Navinder Singh Sarao is a futures trader from Hounslow, United Kingdom. A ten count criminal complaint charges him with wire fraud and commodities manipulation.

Mr. Sarao used an automated program to manipulate the market for E-Mini S&P 500 futures contracts on the Chicago Mercantile Exchange on May 6, 2010, contributing to the overall market chaos that day the Government claims. The scheme apparently was not new or novel. It involved the use of the E-Mini which is an index futures contract based on the Standard & Poor’s 500 index. The manipulation techniques employed was dynamic layering.

Mr. Sarao implemented the scheme by placing multiple orders simultaneously to sell at various price points. This created the appearance of market liquidity and substantial supply. The orders were modified periodically to ensure they were priced near the market. This created an imbalance in the market for E-minis and exerted pressure on the market, although the orders were typically cancelled. When the market fell Mr. Sarao is alleged to have used futures contracts to repurchase at a lower price point. When it rose he took the opposite action.

Another manipulative trading technique contributed to the overall chaos, according to the charging papers. Mr. Sarao is alleged to have “flashed” a large 2,000 lot sell order on one side of the market, executed another large order on the other side of the market and then cancelled the order. This created price movement which Mr. Sarao exploited, according to the criminal complaint. On May 6 five years ago as the price of the E-mini fell, the DJI followed.

The Government is currently seeking extradition of Mr. Sarao from the U.K. to Chicago for trial.

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by T. GormanPosted on Posted in SECActions

Conflicts of interest involving market professionals continue to be a focus of SEC enforcement. In many cases the conflict is uncovered by the inspection staff, OCIE. This time, however, the information came from an article published by the Wall Street Journal. In the Matter of BlackRock Advisors, LLC, Adm. Proc. File No. 3-16501 (April 20, 2015).

Respondent BlackRock Advisers is a registered investment adviser with about $452 billion in assets under management. Respondent Bartholomew Battista is the CCO of BlackRock. Daniel Rice III is a managing director and co-portfolio manager of energy sector assets held in BlackRock registered funds, private funds and separately managed accounts. His compensation derives in part from the management fees of the managed funds and separate accounts.

In December 2006 Mr. Rice formed Rice Energy Irrevocable Trust to hold interests in Rice Energy, a name given to a then projected series of entities that would be formed. Those entities would be funded with about $2.4 million in gifts and a $23.5 million term loan from Mr. Rice. The next month Mr. Battista reviewed and discussed the matter with Mr. Rice. BlackRock concluded that the proposal did not present any conflict of interest. In February Mr. Rice formed the series of companies which were collectively known as Rice Energy.

By March 2010 Rice Energy concluded a deal which traced to mid-2008 under which Foundation Coal, which has recently completed a merger with ANR, entered into a joint venture with Rice Energy. At the time of the deal funds and separate accounts managed by Mr. Rice held over two million shares of ANR stock. By the end of the second quarter of 2010 ANR acquired Massey Energy whose shares were already held by funds and separate accounts managed by Mr. Rice.

In January 2010 Mr. Rice told BlackRock that he wanted to serve on the board of directors of the joint venture. BlackRock’s Legal and Compliance Department reviewed the matter and concluded that there were potential conflicts of interest in entering into the joint venture in view of the portfolio holdings managed by Mr. Rice. The deal also raised concerns regarding access to ANR specific information that could be beneficial to Mr. Rice rather than his clients. Nevertheless, BlackRock permitted Mr. Rice to continue under certain restrictions. There was no follow-up by the firm.

BlackRock did not inform the boards of directors of the Rice-managed registered funds or advisory clients about Rice Energy. No disclosure was made. Disclosure came in June 2012 when the Wall Street Journal published three articles about Mr. Rice and Rice Energy.

The Order alleges violations of Advisers Act Sections 206(2), engaging in a course of conduct which constitutes a fraud and deceit, and Section 206(4)-7, failing to adopt and implement reasonable procedures to prevent the violation. In addition, Respondents caused certain BlackRock funds to violate Investment Company Act Rule 38(a)-1(a) which requires registered investment companies, through their chief compliance officer, to provide a report at least annually to the fund’s board of directors addressing each material compliance matter that occurred since the date of the last report.

To resolve the matter BlackRock agreed to a series of undertakings which include the retention of an independent compliance consultant who will prepare a report. The firm will adopt the recommendations. In addition, BlackRock consented to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Battista also consented to the entry of a cease and desist order but based on Advisers Act Section 206(4) and a related rule and Investment Company Act Rule 38a-1. The firm agreed to pay a penalty of $12 million while Mr. Battista will pay $60,000. This is the first case to charge a violation of Investment Company Rule 38a-1.

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