A swap dealer agreed to pay a civil monetary penalty to settle CFTC charges related to providing inaccurate mid-market marks on swaps transactions and related reporting and supervisory violations.
In an Order, the CFTC determined that from 2013 to the present, Cargill, Inc. ("Cargill") provided to counterparties inaccurate marks as a result of the concern that providing full information about its markups would have the effect of reducing revenue. Cargill allegedly provided inaccurate values by recognizing ten percent of its expected revenue on the day of a swap and amortizing the remaining ninety percent over the next sixty calendar days. As a result of this calculation, Cargill's provided marks concealed ninety percent of expected revenue. The CFTC found that Cargill violated CFTC Rule 23.431 by not properly disclosing the use of this methodology to its counterparties. By employing this methodology and concealing such a large portion of its estimated revenue, the CFTC said, Cargill "may have prevented customers from making fully informed decisions about their options for hedging." The CFTC also found that Cargill provided the same inaccurate data to its swap data repository, in violation of CFTC reporting regulations.
The CFTC also charged Cargill with failing to have an adequate supervisory system and to diligently supervise. This charge was based on the mid-market mark violations, and on a finding that Cargill provided inaccurate information in reports to certain customers who used an automated hedging program run by the firm.
As a result of the misconduct, the CFTC accused Cargill of violating CEA Section 4s(h)(1), and CFTC Rules 23.431, 45.4(d)(2) and 166.3. Cargill agreed to pay a $10 million civil monetary penalty to settle the charges.
Commentary / Nihal Patel
The axiom goes, "hard facts make bad law," but here, one might say that easy facts make no law. This is the first significant CFTC enforcement action against a firm for failing to comply with the requirements of CFTC Regulation 23.431 to disclose pre-trade mid-market marks and daily marks. The facts here suggest that the CFTC found some level of intent to mislead. (The CFTC highlights in both the press release and the order that the firm thought that full disclosures would hurt revenue.) But for the majority of market participants, the question of what is the appropriate level of disclosure for pre-trade and daily marks remains less than clear. Unlike transactions in liquid products, the marking of swaps - particularly complex swaps like many of the swaps in this case - is more of an art than a science.
What this case seems to suggest is that while the CFTC may not demand that marks come in a particular form, it takes the disclosure of the pre-trade "mid-market" mark seriously (including disclosure as to markups and profits) and is likely to focus on process and disclosures. Firms are expected to meaningfully consider their business model and how they price swaps for customers, and to make sufficient disclosure for a counterparty to be able to determine the material incentives and conflicts for the dealer. The CFTC repeats language from the adopting release for 23.431, noting that "the [] daily mark requirement is meaningless unless the counterparty knows the methodology and assumptions that were used to calculate the mark."
Commentary / Bob Zwirb
Among the acts of the respondent that the CFTC found fault with here was the fact that "Cargill employees chose not to seek Commission guidance on Cargill's mid-market mark methodology for these swaps out of concern that the Commission would disagree with Cargill's methodology." At the very least, Cargill should have sought legal guidance from either in-house or outside counsel on a matter of such import before proceeding.
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