CME Group publishes new FAQ on supervisory obligations

CME has issued a revised Market Regulation Advisory Notice on Supervisory Responsibilities of Employees and Agents, which includes a new “FAQ on Supervisory Responsibilities” (the “MRAN”). CME market participants—both traders and intermediaries—will want to study the document carefully. Indeed, the MRAN emphasizes that the duty of due diligence (including the duty to develop and diligently enforce supervisory programs that are reasonably designed to detect and deter violations of the exchange’s rules) is owed not only to members but to any person subject to the exchange’s jurisdiction—which means, under CME Rule 418, any person “initiating or executing a transaction on or subject to the exchange’s rules, directly or through an intermediary,” as well as any person “for whose benefit such transaction was initiated or executed.”

The duty of supervision extends to the conduct of a market participant’s “employees and agents” – where the term “agents” includes automated trading systems and algorithmic trading programs, as well as “third-party vendors, outside counsel, and others acting on behalf of a party within the scope of their employment or office.” Market participants should note that CME Rule 433 holds them “strictly liable for the acts, omissions, or negligence” of such employees and agents while they are acting. The market regulator does not expect intermediaries – executing brokers and clearing members – to supervise the trading activities of their clients, but they are expected to “take reasonable measures to prevent” a breach of the exchange rules upon receiving notice of such a breach.

The MRAN FAQ notes that CME Market Regulation has made extensive use of allegations of supervisory failure in recent disciplinary actions, listing 19 cases in which supervisory failures were alleged. These alleged failures fall into three groups:

• Prevention. Market Participant fails to prevent violations. This could include failure to adopt and implement policies and procedures reasonably designed to meet exchange requirements or to train employees and agents on the policies and procedures (including their updates). Market Participants should maintain records of such training and tailor training to related exchange activity (if your traders use block trades in asset classes for which the procedures differ, ensure that the training highlights the relevant changes). Additionally, Market Participants should be careful when drafting exchange policies and procedures to ensure that these documents do not impose supererogatory obligations (beyond those required by the exchange policies and procedures), as failure to comply with the policies and procedures as drafted may also constitute a failure of oversight.
• Detection. The Market Participant fails to detect the breach. This may include a failure to monitor or supervise the market activities of an employee or agent (including employee communications). The longer the failure to supervise and the greater its scope and breadth, the more likely it is to give rise to a finding of failure to supervise. Whether the breach was initially detected by the Market Participant or by the exchange is also important.
• Adjustment. Needless to say, market participants should take prompt corrective action when they detect non-compliant behavior, but there are instances where a respondent has ignored or failed to promptly respond to exchange notifications that should have prompted corrective action. Corrective measures can include improved training and internal disciplinary actions, as well as modifications to automated systems and programs. Evidence that the correction was effective (i.e., prevented recurrence) is helpful.

The failure of the CME to supervise activities often exposes flaws inherent in automated systems and trading strategies and the failure of the market participant to (i) conduct testing prior to implementation (prevention); (ii) monitor closely (detection); or (iii) take prompt corrective action when systems or strategies become disruptive to the market.

The MRAN FAQ provides guidance specifically aimed at intermediaries, including CME Clearing Members. Interestingly, MRAN reminds firms that handle client orders or settle client contracts of their obligation to monitor CME disciplinary matters in terms of trading suspensions or prohibitions, as such firms will be expected to enforce the terms of such exchange orders against existing clients (including where a client accesses the execution or settlement service via an omnibus account).

CME MRAN and FAQs are available here.