Last week the CFTC settled charges against Powerline Petroleum for allegedly misleading clients by failing to adequately disclose that Powerline acted as the counterparty to its clients’ block trade transactions—not merely as a broker. The settlement order also finds that Powerline purportedly failed to disclose that it charged clients a markup over the cost at which it was able to execute those block trades. (Notably, in a strongly worded dissenting statement, Commissioner Summer K. Mersinger objected to certain aspects of the settlement order as “inconsistent with the Commission’s prior treatment of similar cases and fundamentally unfair.”)

In a parallel proceeding by NYMEX, an exchange disciplinary committee found that Powerline solicited its customers for various block trade strategies. Once the customer agreed to a strategy, Powerline would contact a broker to obtain a market for the strategy, allegedly “for its own benefit.” In doing so, the exchange alleges,

“Powerline acted on nonpublic information to obtain a better price from the broker than Powerline solicited from its customer. Once the broker found a counterparty to take the opposite side of Powerline’s trade and after this trade was consummated, Powerline returned to its customer and unwound its position opposite its customer near the originally quoted price.”

On those findings, NYMEX determined that Powerline had executed pre-hedged trades for its own account, in violation of the exchange rule that prohibits a broker acting as an “intermediary” from pre-hedging a block trade with a customer in any account that is proprietary to the broker. Under all US exchange rules, the “broker as intermediary” may enter into transactions to offset the position only after the block has been consummated with a customer. (See this Katten advisory for a handy summary of exchange rules on block trades, EFRPs and other trade practice issues.)

The Powerline settlements are among several recent disciplinary matters alleging that futures market participants were on the wrong side of the pre-hedging prohibition for intermediaries – see the links below for recent settlements by COMEX and ICE Futures US, as well. These matters hold some important object lessors for market participants looking to minimize their enforcement risk, including (without limitation): it’s not a sufficient defense that your counterparty believed the price it was filled at to be fair and reasonable; and it’s not sufficient disclosure just to tell your counterparty that you are acting as a principal.

The CFTC’s Powerline order is here; Commissioner Mersinger’s dissenting statement is here. The NYMEX Powerline disciplinary notice is here. Two recent ICE Futures US settlements are here, and here. And the COMEX disciplinary notice is here.