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Acquittal In CFTCs First Insider Trading Trial: Analysis And Takeaways – Commodities/Derivatives/Stock Exchanges



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On August 9, 2022, in CFTC v. EOX Holdings LLC, the
first insider trading trial in a Commodity Futures Trading
Commission (CFTC) enforcement action, a jury in the U.S. District
Court for the Southern District of Texas found in favor of the
defendants—a brokerage firm and a broker employed by the
firm—on insider trading claims related to block trades of
energy futures contracts. The jury, however, found in favor of the
CFTC on three counts alleging non-fraud commodities
violations.

Key Takeaways

  • The CFTC’s decision to proceed to trial against the
    defendants on the insider trading claims underscores the
    government’s focus on enforcing laws against insider trading.
    Recent months have seen a slate of insider trading enforcement
    actions brought by federal regulators, including the CFTC and the
    Securities and Exchange Commission, and criminal cases brought by
    the Department of Justice.

  • While EOX is the first insider trading charge that the
    CFTC has brought to trial, the CFTC has been increasingly active in
    this area since 2010 when the Dodd-Frank Act conferred on it the
    authority to bring commodities insider trading enforcement actions.
    Officials with the CFTC have publicly stated that insider trading
    in the commodities markets is an increasing focus of the CFTC’s enforcement
    regime.

  • In finding against the CFTC on the insider trading count, it
    appears that the jury may have determined that the CFTC failed to
    establish the following elements of an insider trading offense:
    first, that EOX and its broker owed a duty of trust and confidence
    to the customers on whose behalf the broker placed trades; and
    second, that the broker traded based on material nonpublic
    information in breach of a duty.

  • The jury’s finding against the CFTC on its insider trading
    count may cause the CFTC to reassess its insider trading theories,
    particularly as they apply to commodities brokers who place block
    trades for customers to whom they do not owe a fiduciary duty.
    Block trades nevertheless remain a focus of investigations by the
    CFTC and a developing area of insider trading law.

  • Although the verdict comes as a setback to the CFTC, the
    continued robust enforcement by the CFTC of the laws against
    insider trading in commodities—including energy futures and
    cryptocurrencies—is expected.

Factual Background

As a broker in EOX’s Houston office, the defendant broker
executed block trades in energy futures contracts on behalf of EOX
customers. Block trades are transactions that meet or exceed an
exchange-determined minimum threshold quantity of futures or
options contracts, are privately negotiated, and are executed
outside public electronic markets. As defendants argued at trial,
the broker, who connects two interested customers, is on both sides
of a block trade transaction, and thus must share a customer’s
block trade information with the counterparty in order to complete
the transaction.

The broker entered an agreement with a particular customer
(“Customer A”) in which Customer A granted the broker the
authority to place trades at the broker’s discretion on behalf
of Customer A. This arrangement was a departure from EOX’s
written policy against brokers exercising discretion over a
customer account. Under this agreement, the CFTC alleged, the
broker structured and executed block trades for Customer A’s
benefit by improperly using order information that the broker had
obtained from other EOX customers who sought to place block
trades.

Procedural Background

In 2018, the CFTC brought an enforcement action against EOX
and the broker for violations of the Commodity Exchange Act
(Section 6(c)(1)) and CFTC Regulation 180.1(a), alleging that the
defendants had used or disclosed customer trade information
improperly to benefit Customer A. The CFTC alleged that the broker
both traded based on and tipped material nonpublic customer
information to Customer A to curry favor with Customer A. In doing
so, the CFTC asserted, the broker violated the duties of trust and
confidence that he owed to other EOX customers, whose information
the broker shared with Customer A. The CFTC also alleged additional
counts of non-fraud commodities violations: one count against both
EOX and the broker for disclosing to Customer A orders placed by
other customers and for taking the other side of orders placed by
those customers without the customers’ consent; and two counts
against EOX for recordkeeping and supervision violations.

The Trial and Jury Verdict

After a seven-day trial, a jury found for the defendants on the
insider trading claims and for the CFTC on the non-fraud claims.
Based on the jury’s verdict on the insider trading claims, it
appears that the jury may have credited the defendants’
principal arguments at trial that they (1) did not owe duties of
trust and confidentiality to customers as to block trade order
information and (2) did not misappropriate material nonpublic
information, and thus found that the CFTC failed to prove two
required elements of insider trading.

As for the question of a duty of trust and confidentiality, the
defendants argued that the broker acts as an agent to both sides of
a privately negotiated block trade. The broker, according to the
defendants, necessarily must use his or her knowledge of a
customer’s order to structure the transaction and share that
information with the counterparty to complete the transaction.
Thus, as the defendants argued, the broker did not owe duties of
trust and confidentiality to customers placing block trades, and
customers could not have reasonably expected that the broker would
keep their trade information confidential.

The defendants similarly asserted that they did not
misappropriate material nonpublic information. The defendants
maintained that the customer order information that the broker was
alleged to have traded on and shared with Customer A was not
confidential given his role as an agent to both parties in the
block trade.

According to the defendants, the CFTC could not point to any
rule, agreement, or understanding that defined a duty of trust and
confidentiality or provided that the customer order information at
issue was material nonpublic information.

On August 25, 2022, the defendants moved for judgment as a
matter of law and a new trial as to the non-fraud count alleging
improper disclosure of customer information, on which the jury
found in favor of the CFTC. The defendants have also indicated they
will likely appeal.

Julia Koch contributed to the writing of this alert

Because of the generality of this update, the information
provided herein may not be applicable in all situations and should
not be acted upon without specific legal advice based on particular
situations.

© Morrison & Foerster LLP. All rights reserved

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