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July 10, 2019  

Industry Lawyers Take Stock of CFTC Case

Lawyers advising commodity-trading advisors say the CFTC’s action against Elephas Investment last week highlights the challenges of complying with position limits on agricultural futures.

On July 2, the futures commission fined the Hong Kong manager $160,000 for exceeding the number of CBOT contracts a speculative trader can hold for soft red winter wheat. Elephas also paid a penalty of more than $166,000 to CME Group, which operates the CBOT exchange.

On Nov. 29, 2017, according to the CFTC order, Elephas held a net long position in December 2017 CBOT futures amounting to 1,680 contracts. The firm apparently didn’t realize it was the first day of the spot month, at which point the monthly position limit for soft red winter wheat drops from 3,000 to just 600 contracts.

“This is a really good caution, a trap for the unwary, that we unfortunately see from time to time,” said Deborah Monson, who heads the derivatives and commodities practice at law firm Ropes & Gray.

While position limits on agricultural futures have been around since the 1930s, they still can be tricky to navigate, Monson and other lawyers said.

“The CFTC’s recent enforcement case is not a surprise, and firms should implement internal controls over their traders to ensure they don’t inadvertently breach the required limits,” said Daniel Viola, a regulatory partner at Sadis & Goldberg. “Firms that maintain multiple traders may also have to aggregate all positions across the firm.”

Monson said the Elephas case underscores the importance of establishing a “robust monitoring system. Pre-trade check, post-trade check, keeping numbers up to date — because limits change from time to time, as well as in the spot month.” Ropes & Gray is preparing a client advisory on the matter that it plans to send out next week.

The CFTC enforces position limits on nine agriculture contracts, including several types of wheat, to blunt the influence of financial speculators on commodity prices. Following the 2007-2008 financial crisis, the commission considered proposals to expand coverage to a total of 28 commodities, including energy and metals. Although CFTC chairman Christopher Giancarlo endorsed such a move, the debate has turned into a “long, drawn-out saga,” Monson said. And with Giancarlo stepping down next week, the issue isn’t likely to be resolved anytime soon.

Monson said the Elephas case holds lessons for CTAs globally — including the fact that a firm doesn’t have to be registered with the CFTC to be subject to its position limits. They “apply to anyone who is using the U.S. market, whether from within the U.S. or not,” she said.

And it doesn’t matter whether a violation was an accident. “Intent is completely irrelevant,” Monson added. “It is very straightforward.”