On September 24, 2015 the CFTC issued an Order settling an enforcement action against TeraExchange, a provisionally registered swap execution facility (SEF). According to the Order, TeraExchange failed to enforce its rules prohibiting wash trading and pre-arranged trading. In fact, the Order found, TeraExchange affirmatively arranged for two market participants to enter into the SEF’s newly-listed Bitcoin swaps without intending to take on any price risk.
Orchestrated wash trades and prearranged trades
TeraExchange began offering a non-deliverable forward Bitcoin swap on September 12, 2014. As of October 7, 2014, TeraExchange had only two participants and, on that date, TeraExchange told traders from both participants that it would like to test the Bitcoin swap by doing a “round trip trade with the same price in, same price out, (i.e. no P/L [profit/loss] consequences).”
The next day, the two participants entered into two Bitcoin swaps six minutes apart from one another. These transactions were for the same notional amount and the same defined price, thereby offsetting one another. The Order concluded that the trades were wash trades and pre-arranged trades.
In the Order, the CFTC distinguished TeraExchange’s activity from pre-operational test trades (i.e., simulating trades to confirm that systems are capable of executing transactions) in that TeraExchange: (1) issued a press release announcing that the “first bitcoin derivative to be executed on a regulated exchange” had taken place, (2) stated to the CFTC’s Global Market Advisory Committee that trading in the Bitcoin swap had occurred and (3) submitted reports of the transactions to a swap data repository, which made the reports public. The CFTC concluded that, rather than testing the new product as TeraExchange claimed it was doing, TeraExchange intended to create the impression that actual trading had taken place in its Bitcoin swap product.
As a registered SEF, TeraExchange is required to “enact and enforce rules prohibiting certain types of trade practices on the SEF, including wash trading and prearranged trading.” TeraExchange had such rules, but the CFTC found that it failed to enforce them by arranging transactions that were intended to negate risk or price competition while creating the appearance of trading activity in the market.
Without admitting or denying the findings or conclusions in the Order, TeraExchange agreed to cease and desist from future violations. The settlement did not include a civil monetary penalty for TeraExchange, though. Commissioner Sharon Bowen dissented, arguing that the CFTC should have imposed a penalty on TeraExchange.
Notably, the Order comes just one week after the CFTC settled a separate enforcement case for unlawfully operating a Bitcoin options trading platform (called “Derivabit”) without registering as a SEF. There, too, the CFTC found liability but declined to impose a monetary penalty. Taken together, these two cases demonstrate that the CFTC: (1) is paying close attention to the SEF space, and (2) is not hesitant to assert jurisdiction over Bitcoin derivatives products. The agency’s forbearance in imposing penalties presumably can be explained by these being cases of first impression. As we noted in our blog post about Derivabit, though, future violators may not receive such leniency.