Statement Of CFTC Commissioner Caroline D. Pham On Self-Reporting And Cooperation Credit In Enforcement Actions

While I support the Commission’s administrative settlement with Raizen Energia SA and Raizen Trading SA (collectively, Raizen, a sugar commercial end-user), I do not agree with the decision to not provide recognition and cooperation credit for Raizen’s self-reporting of the violations. It is my view that Raizen promptly self-reported the violations to the Division of Enforcement (DOE) once it had completed an internal investigation to determine the facts and circumstances and if any violations had occurred that would require self-reporting. Further, Raizen completed extensive remediation efforts and enhanced its compliance program prior to settlement.

This case is an example of why I have repeatedly raised concerns regarding the CFTC’s contradictory approach to self-reporting by market participants of potential violations and the standard applied for “prompt” self-reporting, and therefore, whether the CFTC will provide recognition and cooperation credit. The CFTC often reiterates that cooperation credit is an important incentive to encourage self-reporting. I have also encouraged self-reporting in previous statements.[1] However, by creating an impossible-to-meet standard for receiving cooperation credit, or by being arbitrary in the application of any standard, the CFTC’s policy on self-reporting looks a lot like bait-and-switch.

I have also previously raised concerns regarding the CFTC’s enforcement approach to non-material operational or technical issues. It is absurd to take the position that in order to receive cooperation credit, every incident of non-compliance would need to be self-reported to DOE. Consider a common scenario for a swap dealer: that would mean that every error in just one data field out of hundreds, for each individual trade, would need to be self-reported to DOE as a violation of swap data reporting regulations. That is clearly an unrealistic and unworkable expectation. Yet that is exactly the position on self-reporting and cooperation credit that the CFTC takes in its administrative settlements for non-material operational or technical issues in the absence of any harm.[2]

And, I have also raised concerns over the CFTC’s position that issues that are self-reported and disclosed in a swap dealer’s annual compliance report as required under CFTC regulations[3] are disqualified from consideration for cooperation credit, even where the firm makes a standalone, prompt self-report of a material non-compliance issue to the CFTC. Since swap dealers and futures commission merchants (FCMs) are required to file annual compliance reports which must be certified by the chief compliance officer or chief executive officer[4] as accurate and complete in all material respects under penalty of law, that means that those registrants will never qualify for cooperation credit in the majority of the CFTC’s enforcement actions, which are increasingly for compliance violations like trade reporting, recordkeeping, or documentation—not fraud, abuse, or manipulation, the main intent for the enforcement authority granted to the CFTC.

This resulting “examination by enforcement” is why I have continually advocated for the CFTC to instead create a Division of Examinations that is appropriately resourced and staffed with trained and well-qualified examiners to handle supervisory matters in partnership with the National Futures Association (NFA). Then, the CFTC would finally no longer be an outlier among both U.S. and non-U.S. regulators.[5]

“Prompt” Self-Reporting of Issues

In several recent matters, the CFTC’s position has been that self-reporting six months after the initial discovery of a potential non-compliance issue—during which time an internal review is performed and completed by the market participant—does not constitute “prompt” self-reporting. But it is more appropriate to consider whether the self-report was made promptly after a firm makes a determination in good faith that a material non-compliance issue has occurred, not from when the potential issue was first discovered. There may not be enough information at the time of initial discovery to determine if a non-compliance issue is material. Further, the issue must be fully scoped and any information validated in order to make a legal determination of material non-compliance.

Even if the CFTC wanted to start the clock for self-reporting from the time of initial discovery of a potential material non-compliance issue, six months is a reasonable time to complete an internal review—particularly if the facts and circumstances are complex with respect to products, jurisdictions, legal entities, organizational structure, governance, size, activities, operations, and so on. In addition, it is reasonable for a market participant to wait until the internal review or investigation is completed and the findings are validated before making a self-report to DOE, due to the serious legal liability issues.

For example, self-reporting to authorities involves appropriate management review and governance processes, including by senior or executive management. Those governance processes—as they should—take time to ensure careful due diligence, accuracy, and completeness.

Updates to Self-Reported Issues

Even more concerning, the CFTC has sought to bring fraud charges against market participants for allegedly making false statements to the CFTC when a market participant later discovers that the information provided in a self-report was not entirely accurate—even when it thought the information was accurate at the time of the disclosure to the CFTC.[6] Put another way, when market participants have new and better information and they voluntarily update DOE, the CFTC tries to charge them with fraud. That is going to discourage prompt self-reporting to the CFTC, because market participants will need to take additional time to make sure any information provided to DOE is as accurate and complete as possible to try to mitigate the risk of being charged with making fraudulent false statements to the CFTC.

The CFTC’s approach to self-reporting and approach to charges of making false statements create an inherent conflict and a Catch-22 for market participants. The CFTC should rethink its policy in these areas because if the CFTC wants potential material non-compliance issues to be self-reported promptly after the time of initial discovery, market participants need to be assured that they will not be charged with making false statements to the CFTC when more and better information becomes available.

I believe the CFTC must provide clarity on the standard for “prompt” self-reporting, including a safe harbor from charges of making false statements if the self-reported information is later supplemented or corrected. Until the CFTC provides a clear standard and applies it in a uniform manner, the inherent conflict and untenable legal risk associated with self-reporting prior to the completion of a full internal review or investigation will not be resolved, and the CFTC will not be effective in achieving its public policy objectives to encourage self-reporting of issues.

Roles and Responsibilities for CFTC Divisions

In addition, the CFTC has maintained the position that self-reporting to the Market Participants Division (MPD) does not qualify for consideration for cooperation credit—even though MPD is the operating division with responsibility for rulemaking, interpretation, and oversight of registration and compliance requirements for CFTC registrants. Further, under CFTC regulations, registrants such as swap dealers are required to disclose material non-compliance issues to MPD, and have extensive additional compliance reporting requirements. The standard for materiality under CFTC regulations for purposes of compliance disclosures and reporting is also different than the standard of materiality that DOE applies in its enforcement actions.

As I have previously emphasized, the CFTC is one agency. It is nonsensical that self-reporting to the primary division that supervises a registrant as required under CFTC regulations does not constitute self-reporting for purposes of cooperation credit because there was no double-reporting to DOE. I believe that the CFTC’s current approach to self-reporting is siloed and duplicative, usurps the roles and responsibilities of the primary operating division, and undermines the function and application of longstanding CFTC regulations for proper governance and disclosure of non-compliance issues by registrants.

Proposed Improvements to CFTC Internal Governance and Procedures

The Commission cannot allow the tail to wag the dog. That is why I have proposed for the past two years that the CFTC enhance and document its internal procedures for coordination among the primary operating divisions—MPD, the Division of Market Oversight (DMO), and the Division of Clearing and Risk (DCR)—and DOE in order to improve regulatory clarity and consistency in the interpretation and application of CFTC regulations, improve internal governance, and minimize the CFTC’s internal conflicts of interest.

It has been my observation that most of the CFTC’s improper changes in the interpretation of decades-old CFTC regulations in violation of the Administrative Procedure Act due to the lack of a rational basis, reasoned decision-making, and public notice-and-comment—namely, regulation by enforcement—is because of unclear roles and responsibilities among CFTC divisions.

Accordingly, to address the root cause of the CFTC’s disjointed approach to our regulations, my proposed enhancements include requiring the appropriate primary operating division to approve enforcement recommendations and supporting memoranda to the Commission that involve the interpretation and application of CFTC registration and compliance requirements (but not allegations of fraud or manipulation).

Another one of my proposed enhancements is to implement procedures and criteria for enforcement referrals by a primary operating division. This would be published on the CFTC’s website to provide fair notice and due process for CFTC registrants and CFTC registered entities like designated contract markets (DCMs) and swap execution facilities (SEFs). These are common-sense improvements that prior CFTC leadership has attempted to implement. It is now beyond obvious that these procedures are necessary to ensure the protection of basic rights that Americans expect from their government.

I also propose that CFTC registrants and registered entities should self-report material non-compliance issues to the primary operating division that is responsible for their ongoing monitoring and oversight—MPD, DMO, or DCR. Then, that primary division would apply consistent criteria to determine whether to make an enforcement referral to DOE. In the future, I propose that if the Commission establishes a Division of Examinations, that would be the appropriate division to receive self-reports of material non-compliance issues and make enforcement referrals in consultation with the primary operating division. This is the common approach taken by other regulators. The public has a right to know what the CFTC expects, and that the CFTC will stick to that and not constantly change the rules for the CFTC’s convenience.

These improvements to the CFTC’s internal governance and procedures would be an important first step towards transparency, ensuring regulatory clarity and consistency, and upholding the rule of law. A GAO study, as I have previously suggested, would identify even more improvements to make the CFTC more effective in carrying out our mission.[7]

Conclusion

We should encourage and recognize CFTC registrants that proactively take ownership of their mistakes and work to prevent future violations. Meeting the desire to cooperate with an illusory choice that risks alleged charges of making fraudulent false statements is no way to incentivize good behavior. This is made even worse by the CFTC’s lack of clear guidance for how and when registrants should engage on a potential violation. The CFTC must develop a better approach to self-reporting and cooperation credit to encourage firms to come forward with issues and recognize firms that take accountability measures, so that the CFTC can more efficiently deploy our limited resources to target true bad actors and promote market integrity. I hope that the CFTC will finally take these concerns seriously and implement the improvements that I have outlined.