The CFTC’s First Insider Trading Case: In The Matter of Arya Motazedi
The first insider trading case brought by the United States Commodity Futures Trading Commission concluded in a settlement this month. In The Matter of Arya Motazedi, the CFTC found that, over the course of nearly three months, Arya Motazedi arranged 46 fraudulent transactions across multiple trading accounts he controlled, accruing personal profits at his employer’s expense. The Commission concluded that Motazedi’s conduct violated multiple sections of the Commodity Exchange Act (the “Act“) and regulations promulgated thereunder, and accepted a settlement offer from Motazedi that required disgorgement of profits, a hefty civil penalty, and a lifetime bar on futures trading.
Implications of Motazedi
Motazedi is the first case in which the CFTC charged an individual with trading on material, nonpublic information. As recently as 2009, the CFTC had asserted that it had “no jurisdiction over insider trading in any way.” The Dodd-Frank Wall Street Reform and Consumer Protection Act vested the CFTC with authority to promulgate anti-fraud regulations, including Rule 180.1. Even before Motazedi, the CFTC had stated expressly that it intended to interpret Regulation 180.1 and Section 6(c)(1) of the Act, another anti-fraud provision, broadly so as to “reach all manipulative or deceptive conduct in connection with the purchase, sale, solicitation, execution, pendency, or termination of any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity.” However, Motazedi marks the first time that the Commission acted on that expressed intent.
Prior to the promulgation of Rule 180.1, the CFTC generally needed to show actual price manipulation to enforce Section 6(c)(1) of the Act. The CFTC’s broad interpretation of Rule 180.1 in Motazedi makes it easier for the CFTC to pursue cases involving deceptive or manipulative trading. Motazedi shows that employing any manipulative device or making misleading statements may be sufficient to trigger liability if one departs from “standards of ordinary care” so as to make it “very difficult to believe” that one does not know what one is doing.
Motazedi also is interesting for borrowing language and standards used in securities insider-trading law and regulations, specifically Rule 10b-5.
Finally, Motazedi shows that penalties for insider trading involving futures are likely to be severe, involving not just disgorgement of ill-gotten profits, but also substantial civil penalties and bars against futures trading.
Motazedi was a proprietary trader in gasoline futures for a large, publicly traded corporation. He never registered with the CFTC.
The company’s guidelines prohibited employees from entering into transactions in personal accounts that posed conflicts of interest and also prohibited improper use of company proprietary or confidential information. The guidelines also prohibited employees from engaging in personal financial transactions in energy commodities. The CFTC determined that Motazedi had a relationship of trust and confidence with his employer.
In breach of both company guidelines and his confidential relationship with his employer, Motazedi repeatedly traded, in energy future contracts for gas and oil, in personal accounts he controlled. Motazedi exploited material, non-public information concerning his employer’s trading strategies that he gained through his position as a gasoline trader, including the times, volumes, and prices at which his employer intended to trade energy commodity futures for its proprietary account. Motazedi arranged 34 fraudulent trades between the employer’s account and his personal accounts at prices benefitting himself and harming the company. Some of these trades were “roundtrip” transactions, where Motazedi traded the same number of contracts at different prices, resulting in no net change in open positions held by the counterparties. Motazedi also engaged in “frontrunning” by placing orders for personal accounts ahead of orders for the employer’s account, hoping to capitalize on any price movement that might result from the company’s subsequent orders. Motazedi did not disclose his personal account trading to his employer. Motazedi’s improper trading resulted in profits to him in the amount of $216,955.80, at the company’s expense.
The CFTC observed that misappropriation includes “willful and blatant fraudulent activity” in violation of the anti-fraud provisions of the Act, specifically, Section 4b(a). After concluding that Motazedi’s actions were “intentional as opposed to accidental,” the CFTC found that, in engaging in frontrunning and other fraudulent trading activities, he had violated Section 4b(a).
Motazedi’s conduct also violated Section 4c(a) of the Act, which prohibits any person from entering into, offering to enter into, or confirming the execution of a fictitious sale-which involves giving the appearance of submitting trades to the open market while negating the risk or price competition incident to the market. Similarly, Motazedi violated Regulation 1.38(a), which requires all purchases and sales of commodity futures to be executed “openly and competitively.” Participation in the noncompetitive trade must be “knowing.”
Finally, the CFTC stated that trading on MNPI in breach of a pre-existing duty violates both Section 6(c)(1) of the Act and Regulation 180.1, which makes it unlawful to (1) use or employ, or attempt to use or employ, any manipulative device, scheme or artifice to defraud; (2) make, or attempt to make, any untrue or misleading statement of a material fact or to omit to state a material fact necessary to keep the statements made from being untrue or misleading; or (3) engage, or attempt to engage, in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person. The CFTC said that the scienter element of Rule 180.1 is satisfied by “intentional or reckless” conduct, and that reckless conduct may consist of an act or omission that “departs so far from the standards of ordinary care that it is very difficult to believe the actor was not aware of what he or she was doing.” Neither actual knowledge nor proof that the defendant intended to manipulate the market is required. The CFTC concluded that, by trading on MNPI concerning his employer’s trading strategy and engaging in trades in personal accounts that created conflicts of interest, Motazedi knowingly or recklessly misappropriated and misused his employer’s trading-related MNPI in violation of duties owed to his employer, and thereby violated Section 6(c)(1) and Rule 180.1.
On the basis of these facts and legal conclusions, the Commission ordered, among other things, that Motazedi: (1) cease and desist from violating the statutory and regulatory provisions at issue; (2) pay $216,955.80 (the amount of his profits), plus post-judgment interest, in restitution; (3) pay a civil monetary penalty of $100,000, plus post-judgment interest; and (4) permanently refrain from engaging in trading on or subject to the rules of any registered entity.
As always, businesses involved in trading commodities should review their policies and practices concerning insider trading to ensure that they are sufficiently robust in light of the shift in the CFTC’s enforcement approach signaled by Motazedi.