A Timely Reminder from CME Market Regulation of the Broad Reach of the Duty to Supervise

The CME has issued a revised Market Regulation Advisory Notice on Supervisory Responsibilities for Employees and Agents that includes a new “FAQ Related to Supervisory Responsibilities” (the “MRAN”). CME market participants – traders and intermediaries alike – will want to study the document closely. Indeed, the MRAN emphasizes that the duty of diligent supervision (including the duty to develop and diligently enforce supervisory programs that are reasonably designed to detect and deter violations of Exchange rules) belongs not just to members but to any person within the jurisdiction of the exchange – meaning, per CME Rule 418, any person “initiating or executing a transaction on or subject to the Rules of the Exchange directly or through an intermediary,” as well as any person “for whose benefit such a transaction has been initiated or executed.” 

The duty of supervision extends to the conduct of the market participant’s “employees and agents” – where the term “agents” includes automated trading systems and algorithmic trading programs, as well as “third-party vendors, outside counsel, and other persons acting for the party within the scope of their employment or office.” Market participants should bear in mind that, pursuant to CME Rule 433, they are “strictly liable for the acts, omissions, or failures” of such employees and agents when so acting. Market Regulation does not expect intermediaries – executing brokers and clearing members – to supervise the trading activity of their customers but would expect them “to take reasonable measures to prevent” a violation of Exchange rules when on notice of such violation.      

The MRAN’s FAQ notes the CME Market Regulation has made liberal use of the failure to supervise charges in recent disciplinary actions, listing 19 instances in which supervisory failures have been alleged. Those alleged failures fall into three buckets: 

• Prevention. The market participant fails to prevent violative conduct. This may involve failing to adopt and implement policies and procedures reasonably designed to comply with exchange requirements, or to train employees and agents in exchange rules and procedures (including updates thereto). Market participants should retain records of such training and tailor training to related exchange activity (if your traders use block trades in asset classes the procedures for which vary, make sure that the training highlights the relevant variations). In addition, market participants should take care in drafting exchange policies and procedures that those documents do not impose supererogatory obligations (over and above what’s required under exchange rules and procedures), since failure to adhere to the policies and procedures as drafted may also constitute a failure to supervise.
• Detection. The market participant fails to detect violative conduct. This may involve failure to monitor or surveil market activity of an employee or agent (including employee communications). The longer a failure of surveillance endures and the greater its scope and breadth, the more likely it will sustain an inference of failure to supervise. It also matters whether the violative activity is initially detected by the market participant or by the exchange.
• Correction. It goes without saying that market participants should move promptly to remediate upon detection of noncompliant conduct, but there are failures to supervise cases in which the respondent either ignored or failed diligently to respond to exchange notifications that should have prompted corrective action. Remedial measures may include enhanced training and internal disciplinary action, as well as modifications to automated systems and programs. Evidence that the remediation was effective (i.e., prevented recurrences) is helpful.

CME failure to supervise actions often highlights missteps involving automated trading systems and strategies, and a market participant’s failure to (i) perform testing in advance of deployment (prevention); (ii) monitor diligently (detection); or (iii) take immediate corrective action when the systems or strategies turn disruptive to the market.

The MRAN FAQ includes guidance addressed specifically to intermediaries, including CME clearing members. Notably, the MRAN reminds firms that handle customer orders or clear customer contracts of their obligation to monitor CME disciplinary matters for trading suspensions or bans, since such firms will be expected to enforce the terms of such exchange orders against current customers (including where the customer accesses execution or clearing service through an omnibus account).

The CME MRAN and FAQ is available here.