Merrill Lynch Commodities, Inc. agreed to pay sanctions of US $36.5 million to settle allegations by the US Department of Justice and the Commodity Futures Trading Commission related to alleged spoofing activity by at least two of its traders from 2008 through 2014. 

According to the CFTC, on numerous occasions during the relevant time, the MLCI traders and affiliates they employed placed small orders on one side of a Commodity Exchange, Inc. futures market to execute a larger order or multiple orders on the opposite side of the same market with the intent to induce execution of their smaller order. As soon as the small order was filled in whole or in part, the traders would cancel the larger orders.

The CFTC charged in an enforcement proceeding that this conduct constituted traditional manipulation or attempted manipulation at all times and, after August 15, 2011, spoofing as well as fraud-based manipulation and attempted manipulation. (Click here to access post-August 2011 relevant provisions: Commodity Exchange Act § 4c(a)(5)(C), 7 U.S.C. § 6c(a)(5)(C); here for §§ 6(c)(1) and 6(c)(3) of the Act, 7 U.S.C. §§ 9(1), (3) and here for CFTC Regulations 180.1 and 180.2.) In a non-prosecution agreement with MLCI, the DOJ implied that the firm’s conduct may have touched prohibitions against wire fraud, securities and commodities fraud and spoofing. (Click here to access 18 U.S.C. § 1343 andhere for 18 U.S.C. § 1348.)

In accepting MLCI’s settlement offer, the CFTC acknowledged the firm’s cooperation and remediation. The CFTC assessed a specific fine of US $11.5 million, and restitution and disgorgement totaling US $13.5 million to be offset by amounts paid for the same purpose to DOJ. MLCI agreed to pay US $25 million to the DOJ which includes a criminal fine, forfeiture and restitution.

The DOJ previously filed criminal actions against Edward Bases and John Pacilio, former precious metals traders at MLCI, for wire and commodities fraud related to spoofing in early 2018. (Click here for background in the article “CFTC Names Four Banking Organization Companies, a Trading Software Design Company and Six Individuals in Spoofing-Related Cases; the Same Six Individuals Criminally Charged Plus Two More” in the February 4, 2018 edition of Bridging the Week.)

MLCI is a subsidiary of Bank of America Corporation.

Legal Weeds: Recently, Mr. Bases and Mr. Pacilio sought to dismiss their indictments charging them with wire and commodities fraud, arguing that their alleged spoofing did not involve a material misrepresentation that “falsely and fraudulently represented to market participants that [they] were willing to trade [orders] when, in fact, they were not” as charged by the DOJ. This is because, claimed the defendants, all their open-market orders were real and genuine, as any counterparty could have accepted them, and the defendants would have performed on their executed trades. They claimed that a criminal allegation of commodities and wire fraud required them to place orders that were fake; they claimed their orders were real. (Click here for background in the article “Spoofing Is Not Fraud Argue Traders Subject to Criminal Prosecution” in the December 2, 2018 edition of Bridging the Week.)

Compliance Weeds: In September 2017, Merrill Lynch, Pierce, Fenner & Smith Incorporated agreed to pay a fine of US $2.5 million to resolve charges brought by the CFTC that, from January through October 2010, the firm failed diligently to supervise responses to a CME Group Market Regulation investigation related to block trades executed by its affiliate, Bank of America, N.A. (“BANA”) on the Chicago Mercantile Exchange and the Chicago Board of Trade. The CFTC also charged Merrill – a CFTC-registered futures commission merchant – with having inadequate procedures related to the preparation and maintenance of records related to block trades, and for failing to prepare and/or maintain records related to certain block trades, as required by Commission regulation, from at least January 2010 through June 2012.

In connection with the exchanges’ investigation, Merrill appears to have solely passed along to the exchanges information provided to it by BANA which later on was recognized to be incomplete. Later it was also recognized that BANA personnel had been impermissibly front-running a counterparty’s block trades.

Although BANA admitted to impermissibly pre-hedging block trades and agreed to material sanctions for that offense, an important fallout of Merrill's CFTC settlement order is the suggestion that registrants may have an affirmative obligation of some kind to ensure that information and analysis they obtain from accountholders is accurate prior to passing it along to regulators even when they have no notice that such information may be inaccurate. Such an expectation appears too burdensome and practically unrealistic. (Click here for further background in the article “FCM Agrees to Pay US $2.5 Million CFTC Fine for Relying on Affiliate’s Purportedly Misleading Analysis of Block Trades for a CME Group Investigation” in the September 24, 2017 edition of Bridging the Week.)