On September 26, the Commodity Futures Trading Commission (“CFTC”) issued an order setting charges against Asset Risk Management, LLC (“ARM”), a registered commodity trading adviser (“CTA”) headquartered in in Houston, Texas for failing to register as a Swap Execution Service (“SEF”). This order represents the CFTC’s first attempt to sanction an entity otherwise registered by the CFTC under its recently expanded interpretation of what constitutes a SEF. This expansive interpretation was articulated in September 2021 in a controversial CFTC Staff Notice, CFTC Staff Letter No. 21-19 (“Notice”), which significantly changes the market’s understanding of what a SEF.
Instead of providing greater certainty to the market, the opinion accomplished the opposite; further, the ARM’s execution action demonstrates an increased risk for CFTC-registered and non-registered swap market participants of being assessed against an excessive notion of SEF and/or potentially facing charges of aiding and abetting to have a business relationship with these entities.
The order finds that, for several years, ARM operated an unregistered SEF that offered customers the ability to execute natural gas and crude oil swaps by accepting bids and offers made by multiple participants on a system or a trading platform in various swap terms and volumes. To communicate with customers and counterparties and execute swaps, ARM used various means of interstate commerce, including telephone, instant messaging and email.
As CTA, ARM provided advice relating to these energy swaps and assisted its clients in executing swaps under their existing ISDA agreements with various swap counterparties. It is true that ARM customers were able to execute swaps with multiple other participants; however, it is also clear that ARM was not operating a trading facility as commonly understood. Instead, the CFTC argued that ARM provides participants with the “ability” to execute trades with other participants and “facilitates” the execution of trades.
This enforcement action is a classic example of regulation by enforcement because the notice was not adopted by the CFTC in accordance with the requirements of the Administrative Procedure Act (“APA”). In fact, in 2018, then-CFTC Chairman J. Christopher Giancarlo introduced a formal rule proposal in which a virtually identical interpretation of the concept of SEF was introduced. However, this regulation was officially withdrawn by then-CFTC Chairman Heath Tarbert in 2020. The publication and enforcement of the notice serves as the CFTC’s backdoor approach to amending the 2013 SEF rule. without following APA procedures.
All market participants should assess their swap execution processes in light of the CFTC Notice and Order ARM.
© Copyright 2022 Cadwalader, Wickersham & Taft LLPNational Law Review, Volume XII, Number 286