Today, the Commodity Futures Trading Commission (Commission or CFTC) and the Securities Exchange Commission (SEC) announced settlement agreements with LJM Funds Management Ltd., LJM Partners Ltd. (together with LJM Funds Management Ltd., LJM), Anthony J. Caine (Caine), and Anish Parvataneni (collectively, Defendants). As described in the Complaint,[1] the Defendants violated multiple provisions of the Commodity Exchange Act (CEA) and the Commission’s Regulations by engaging in deceptive and manipulative practices in connection with transactions involving commodities over an extended period of time.[2]
As stated more comprehensively in the Complaint, Defendants’ violations of the CEA and Regulations were rooted in deceptive and manipulative practices.[3] Defendants made intentional and reckless decisions to make false or misleading statements when describing their risk management practices to prospective and existing commodity pool participants.[4] In doing so, Defendants significantly downplayed worst-case losses by stating they were, in the most aggressive analysis, capped at 40%, when internal emails show that one of LJM’s controlling persons, Caine, knew that losses could reach 100%.[5] Further, Defendants advertised that their risk management included historical analysis when their risk management did not, committing a series of acts which put investors’ hard-earned funds at levels of risk they were not adequately informed of.[6]
Further, Defendants continuously misled investors about the risk profile of its portfolio over the course of two years by maintaining that its risks remained consistent with historical practices.[7] Instead, Defendants’ risk profile had significantly deviated from their traditional norms and nearly doubled the size of potential losses associated with a significant drop in the S&P and an upward spike in volatility – which is exactly what happened. None of these changes were disclosed to investors and, eventually, it was the investors who paid the price, suffering substantial losses due to the Defendants’ conduct as LJM collapsed.
Careful risk management enables market participants to detect and address the kinds of volatility that led to LJM’s collapse. Effective risk management oversight enhances the integrity and stability of global derivatives markets.
Where risk management fails or is completely neglected, we must endeavor through enforcement actions to achieve greater accountability, reduce repeated compliance failures through both general and specific deterrence,[8] and enable the Commission to maximize the use of limited resources.
LJM’s Implosion
In late 2017, Defendants knew that LJM’s portfolio risk was increasing and that their investment strategies left investor assets vulnerable to a market move. Defendants were also aware that the risk profiles for certain of their investment strategies were becoming increasingly risky but made no efforts to reduce the risk levels of their investment strategies or disclose to investors that their risk of loss was skyrocketing. Instead of telling investors the truth and revealing the risks that investors faced, Defendants intentionally misrepresented the rising risk levels that threatened investors’ assets.
LJM’s high-risk investment strategies imploded on February 5-6, 2018, when the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) spiked more than 20 points. LJM lost almost $1 billion in customer assets and LJM shuttered its doors.
Deterring Deceptive and Manipulative Practices
LJM intentionally deceived commodity pool and mutual fund investors. The penalties imposed should reflect our commitment to protecting investors and serve to deter future misconduct by the Defendants and dissuade any future bad actors from electing to deceive investors by misrepresenting risk levels associated with their investment strategies.
Many hard-working investors who suffered significant losses as a result of LJM’s misrepresentations may question whether today’s settlement achieves these goals. I continue to have questions regarding the Commission’s calculation of civil monetary penalties, particularly in enforcement matters that involve intentional, willful deception of vulnerable investors. I have previously raised my concerns regarding the methodology for calculating civil monetary penalties and urged CFTC staff leadership and my fellow Commissioners to provide greater clarity and transparency regarding the Commission’s civil monetary penalty calculation methodology. In addition, I have consistently questioned the impact of lower penalties. Reduced penalties may not achieve deterrence, which is a foundational goal of our enforcement regime.
It has been suggested that we can distinguish the poor risk management decisions at LJM from a sham business that was created solely for the purpose of separating unwitting investors from their money. I disagree. Investors in LJM’s commodity pools and mutual funds selected their investment based on what was represented to them as a lower risk profile. Defendants’ choice to then expose investors’ assets to excessive risk levels violated the compact of trust and confidence that the investors had with LJM. Even if the risk management decisions could be excused, the affirmative acts of deception should not be overlooked.
Promoting Customer Protection Through Disclosure and Supervision
If our mission is to protect investors from the devastating effects of fraud, the businesses that set out to engage in fraud cannot be distinguished from those that start out well-intentioned but later adopt deception as a mantra. A well-heeled firm that has gained the public’s trust and confidence by demonstrating the ability to operate in accordance with the rigorous compliance and reporting obligations of U.S. financial markets regulation that later transforms into a vehicle of garden-variety fraud is, perhaps, more concerning than the fly-by-night fraudster selling snake-oil from the trunk of his car.
Disclosure has served as a foundation in U.S. financial markets regulation for almost a century for a reason. Creating sunlight in contexts where conflicts of interest and asymmetries of information flourish in the shadows is one of most time-tested means of protecting customers, preserving investor capital, and fostering healthy markets.
Moreover, supervision is a cornerstone of customer protection. From its inception in the 1970s, the Commission has emphasized that supervision is a linchpin in our regulatory framework. Under Regulation 166.3, each Commission registrant “must diligently supervise the handling by its partners, officers, employees and agents (or persons occupying a similar status or performing a similar function) of all commodity interest accounts carried, operated, advised or introduced by the registrant and all other activities of its partners, officers, employees and agents (or persons occupying a similar status or performing a similar function) relating to its business as a Commission registrant.”[9]
I commend the Division staff who investigated and resolved this case and worked with the SEC on a parallel case.
[1] Complaint, CFTC v. LJM Funds Management Ltd, et al., No. 1:21-cv-02863 (N. D. Ill. May 25, 2021), ECF No. 1 (Complaint).
[2] Complaint ¶¶ 95-112.
[3] Id. The deceptive and manipulative practices and failure to supervise described in the Complaint violated Sections 4o(1)(A)-(B); 4c(b); and 6(c)(1) of the CEA and Regulations 33.10, 180.1(a), and 166.3.
[4] Specifically, Section 4o(1)(A)-(B) of the CEA states that it is unlawful for a commodity pool operator (CPO) or a commodity trading advisor (CTA) to “employ any device, scheme, or artifice to defraud any client or pool participant or prospective pool participant.” 7 U.S.C. § 6o(1)(A)-(B). Section 4c(b) of the CEA and Regulation 33.10 make it unlawful for a person to enter into a transaction that involves any commodity regulated under the CEA known as an “option” contrary to any other rule or regulation of the Commission which would prohibit such transaction and makes it unlawful to directly or indirectly cheat, defraud, or deceive any other person in connection with such transactions. 7 U.S.C. § 6c(b); 17 C.F.R. § 33.10. Further, Section 6(c)(1) of the CEA makes it unlawful to use “any manipulative or deceptive device, in contravention of such rules and regulations as the Commission shall promulgate” in connection with the contract of sale of commodity or future delivery of a commodity in interstate commerce. 7 U.S.C. § 9(1); see also 17 C.F.R. § 180.1(a).
[5] Complaint ¶¶ 46-79. In an internal email, Caine admitted “In extreme cases, theoretically we model to 100% loss.” Complaint ¶ 55.
[6] Id.
[7] Complaint ¶¶ 71-79.
[8] References to general deterrence describe the effect on the general public of observing consequences of compliance failures or misconduct and the impact of such observations on their future conduct. Specific deterrence refers to the impact of a consequence on the future behavior or conduct of a party that has engaged in conduct that leads to a penalty.
[9] 17 C.F.R. § 166.3. See also Adoption of Customer Protection Rules, 43 Fed. Reg. 31886, 31889 (July 24, 1978)(“the basic purpose of the rule is to protect customers by ensuring that their dealings with the employees of Commission registrants will be reviewed by other officials in the firm.”).
