The Situation: The U.S. Commodity Futures Trading Commission ("CFTC"), a federal regulator of the global derivatives markets, has powers to investigate violations of its rules and the Commodity Exchange Act ("CEA") occurring both within the United States and overseas.
The Result: A non-U.S. person trading derivatives such as futures and options on a U.S.-registered exchange in Brazil or elsewhere in Latin America, or internationally, may be liable for breaches of the CEA and CFTC regulations, even if that non-U.S. person has no link to the United States. This may also be true with "over-the-counter" transactions in swaps or physical commodities that are conducted with a U.S. person or that otherwise have a connection to the United States.
Looking Ahead: Commodities, agricultural, financial and other firms in Brazil or elsewhere in Latin America involved in commodities and derivatives trading should understand the potential extra-territorial reach of the CFTC and put in place compliance processes that: (i) effectively mitigate against breaches of the CEA and CFTC regulations; and (ii) place the organization in the best possible position to quickly respond to an enforcement investigation by the CFTC (or other U.S. law enforcement agencies such as the Department of Justice ("DOJ")), possibly reducing any potential penalties.
Established in 1974 in Washington, D.C., the CFTC was originally responsible for overseeing and regulating the commodity futures and options markets in the United States. Initially, its primary focus was to regulate trading of futures related to agricultural commodities. Over time, the CFTC has evolved to become the U.S. federal regulator of the global derivatives markets, with extensive extra-territorial reach. The CFTC now regulates almost all types of derivatives, as well as the trading of the underlying assets to which those derivatives relate. Its jurisdiction has grown to encompass non-U.S. futures exchanges that permit access to trading by U.S. persons and—since 2010—swap transactions that have a direct and significant connection with activities in, or an effect on, U.S. commerce. The CFTC also has expansive enforcement powers with respect to trading of physical commodities where it is empowered to pursue cases for alleged market manipulation or other potential wrongdoing.
The CFTC has expansive authority to make rules, require reporting of market information, and bring actions either administratively or in U.S. courts for alleged violations of the CEA and associated regulations. As such, the CFTC maintains a robust enforcement program that takes action against derivatives and commodities market participants for fraud, market manipulation, disruptive trading, and violations of its regulatory requirements. The CFTC often acts in parallel with the DOJ, which has authority to prosecute criminal violations of the CEA and other related laws, including the U.S. Foreign Corrupt Practices Act ("FCPA") and the U.S. Bank Secrecy Act ("BSA"). As the CFTC Division of Enforcement's 2020 Annual Report highlighted, between 2017 and 2020, the CFTC and DOJ brought 46 cases in parallel joint enforcement, including at least one significant case involving alleged commodities fraud, market manipulation, and public official corruption in Brazil, Ecuador, and Mexico. The action by the CFTC and DOJ is expected to continue and, if anything, increase significantly in the years ahead.
Given the international expansion of U.S. companies and the growing interdependency of global economies—particularly as a result of the increasing digitization of the international markets—the CFTC's outlook has in turn become more global. The CFTC now seeks to more regularly enforce U.S. laws against U.S. and non-U.S. persons for potentially problematic trading in overseas markets, including when that trading is alleged to have had an adverse impact on U.S. persons and markets. This reach potentially includes non-U.S. persons operating in Brazil and throughout Latin America.
How Can the CFTC Exercise its Powers Over Non-U.S. Persons in the Region?
There are a number of ways in which the CFTC may exercise its powers over non-U.S. persons operating in Brazil and elsewhere Latin America. For example, the Brazilian exchange B3 S.A. – Brasil, Bolsa, Balcão ("B3 Exchange"), the Brazilian stock exchange market, is registered with the CFTC as a foreign board of trade ("FBOT"). This registration enables U.S. persons to have "direct access" to trade on those markets. In turn, FBOTs are required to:
- Report to the CFTC at least quarterly information on trading volume for each contract traded on the market and information relating to U.S. persons trading on the market;
- Provide this same information promptly upon any request from the CFTC; and
- Ensure that their U.S. members and participants—i.e., members and participants with "direct access"—submit to the CFTC's jurisdiction and provide the CFTC, DOJ, and U.S. National Futures Association (a self-regulatory organization) access to their books and records.
Accordingly, the CFTC has access to significant information about activity on FBOTs such as the B3 Exchange, and to even more detailed information about transactions that involve U.S. persons. The CFTC is therefore well positioned to evaluate activity on FBOTs for potential violations of the CEA and CFTC regulations.
Non‑U.S. persons who also trade on FBOTs might therefore also come within the scope of a CFTC investigation into such violations, which might possibly be conducted alongside the DOJ. The CFTC and DOJ also have the ability to access information and pursue potential wrongdoing pursuant to relevant bilateral and multilateral memoranda of understanding with the Brazilian version of the U.S. Securities and Exchange Commission, the Comissão de Valores Mobiliários ("CVM"), again potentially placing non-U.S. persons under CFTC scrutiny. CVM has actively cooperated with the CFTC in multiple cases, including in a 2019 action involving alleged commodities fraud by the manager of a commodities fund. The CFTC also may have jurisdiction with respect to certain over-the-counter transactions, such as swaps and physical commodities transactions. A transaction in a physical commodity that has some connection to "interstate commerce"—meaning a transaction between a person in a U.S. state or territory and someone anyplace outside that same state or territory—potentially falls within the CFTC's broad antifraud and antimanipulation authority under the CEA. The CFTC likewise has authority over swaps that have a direct and significant connection with activities in, or an effect on, U.S. commerce. The CFTC has been particularly active in policing "off exchange" transactions outside the United States that it suspects have adversely affected the markets for commodities and derivatives. The CFTC and DOJ in particular have recently focused on over-the-counter transactions that involve violations of both the FCPA and the CEA on the same or similar sets of facts, including the action noted above that included allegations of fraud, manipulation, and public official corruption in several Latin American countries.
What Are the Consequences of a CFTC Investigation?
The costs and consequences of a CFTC investigation can be considerable. The CFTC is empowered to seek civil monetary penalties and injunctive relief, and it will often require remedial measures as a condition of resolving a matter. Companies and individuals can be held directly liable for CEA violations, and individuals in positions of authority can also be liable as control persons. Monetary penalties can range considerably, from a few hundred thousand U.S. dollars for minor infractions to US$1bn or more for violations that involve aggravating factors such as significant market or customer harm or misleading the agency during the course of an investigation. Companies and individuals can potentially reduce penalty amounts by self-reporting violations, cooperating during investigations, and implementing remedial measures, as stated in existing CFTC guidance, including specific guidance issued by the CFTC in 2019 for CEA violations involving foreign corrupt practices (click here to access CFTC's policy statements, which provide more information on these matters).
The DOJ can also seek significant penalties in criminal proceedings for violations of the CEA or related laws.
What Should Businesses be Doing to Mitigate Enforcement Risk?
No one can predict whether or when an investigation may arise. However, designing an effective compliance program that positions your organization to reduce the likelihood of misconduct (and respond effectively to an inquiry from the CFTC or DOJ if necessary) is a crucial step in mitigating enforcement risk from the long arm of the U.S. regulators.
There are a number of important nuances that businesses in Brazil and throughout South America may wish to consider when designing and evaluating their compliance programs. These include:
- Ensuring your compliance program looks at your business in the same way the CFTC or its law enforcement partners would. In our experience, U.S. enforcement authorities typically look for whether a program specifically addresses U.S. legal issues and whether, in accordance with guidance from authorities like the DOJ Criminal Division, the program is "adequately designed for maximum effectiveness in preventing and detecting wrongdoing" and is "well-integrated into the company's operations and workforce";
- Mirroring the CFTC's use of data analytics by employing similar tools to monitor trading by your organization. Of course, this may also be done with a view to different or additional requirements that apply under applicable non-U.S. laws and the requirements of a given exchange; and
- Ensuring your compliance program contains clear guidelines for quickly responding to various regulatory inquiries with the same degree of care, whether such inquiries come from local regulators such as the CVM, foreign regulators such as the CFTC, or other participants such as brokers or clients. Your company's answers to an exchange or broker may very well wind up in the hands of law enforcement. Companies will be better positioned in responding to inquiries about their trading activities—regardless of the source—if their response procedures require thorough fact gathering, analysis, and a dialogue that involves all key internal stakeholders.
In the best-case scenario, an effective compliance program can deter employee misconduct in the first place. If employee misconduct does occur, a well-designed compliance program can help a company to gather the facts and implement a response quickly, potentially mitigating the company's civil and/or criminal exposure in the U.S. and locally. It can also increase the likelihood that misconduct is detected early, better positioning a company to consider self-disclosure, and allowing it to take advantage of the benefits available for cooperation and remediation. And in the event of an enforcement action, the design and effectiveness of a compliance program are variables that can impact the form and size of any resolution.
Three Key Takeaways
1. The CFTC is the U.S. federal regulator of the global derivatives markets and has extra-territorial reach.
2. The CFTC can potentially investigate and prosecute non-U.S. persons based in any Latin American country that trade commodities or certain derivatives such as futures, options on futures, and swaps regardless of their physical presence in the U.S.
3. Designing an effective compliance program that positions your organization to reduce the likelihood of misconduct (and, if necessary, to respond effectively to an inquiry from the CFTC) is a crucial step in mitigating enforcement risk from the long arm of the U.S. regulators.