One thing that people like to say is that insider trading in commodities is just fine. It’s the point, even: the main people – if some politicians had their way, the only people – who trade in commodities are the people growing them, or digging them out of the ground, or whatever one does to make commodities on the one hand,1 and the people eating them or burning them or whatever one does with commodities on the other hand. All hedging real-world activity, no speculation. And if you’re a huge wheat grower, and all your wheat was involved in some sort of unexpected wheat accident, then you will probably want to go buy some wheat in the market (to close out your hedges or satisfy your contracted delivery requirements or bake your bread or whatever). And you’ll probably want to do that before prices go up when people realize that the supply of wheat is lower than expected. And you can do that. That’s fine. That’s hedging, more or less, not insider trading.
But that’s not the whole story. Trading in advance of your own inside information is okay, but trading in advance of someone else’s inside information is … sometimes problematic, depending on where you get that information from. For instance, operations people at commodities exchanges really shouldn’t be telling traders on those exchanges confidential information about other traders’ positions and trades. Like Billy Byrnes and Christopher Curtin allegedly did. It’s bad. Humongously bad even:
According to a CME NYMEX Managing Director responsible for the CME ClearPort Facilitation Desk (“Managing Director”), maintaining the confidentiality of the type of non public information that Byrnes and Curtin disclosed is the “lifeblood” of an Exchange such as CME NYMEX, prohibitions against disclosing such information to unauthorized persons are “the most important thing to the business in general” of an Exchange, and disclosing such information as Byrnes and Curtin did is “a humongous deal.”
Byrnes and Curtin worked at CME ClearPort, an electronic clearing system run by CME to support clearing of NYMEX trades. As far as I can tell they were in, like, tech support:2
Defendant Byrnes’ responsibilities as aCME NYMEX employee included ensuring that ClearPort registrants received timely and accurate assistance in resolving issues involving the use of the CME Clear Port platform, including the review, reconciliation and, where necessary, the correction of trades input into the ClearPort system.
So they could see everyone’s trades. And one enterprising broker – named, naturally enough, Broker X – figured out that tech support could be a gold mine for him to get inside information about who was trading what with whom. A pretty cheap gold mine:
[B]roker X and his employer provided Byrnes with meals, drinks, and entertainment on multiple occasions during the time Byrnes was providing material nonpublic information to broker X.3
This is what he got in exchange:
Broker X: Quick question. Cal 10 flat [i.e., options related to crude oil futures contracts] calls traded yesterday – one hundred a month – who was
it? W A Cal ten flat calls. Tell me what price, what brokers, who bought, who sold …
Byrnes: Cal ten flat calls … one hundred lots .. . 55 (inaudible) a month … January 10 through Dec 10. [States name of the buyer] buys, [states name of the seller] sells. [States name of the broker].
Broker X: Who bought?
Byrnes: [States name of the buyer]
Broker X: What’s his name again?
Byrnes: [States name of the individual trader at the buyer firm].
I dunno it all makes me sad, no? Byrnes was so eager to please, yet he got so little out of it. And Broker X so cynically exploited him: when they realized that talking about illegal stuff on recorded lines was not a great idea, Broker X told Byrnes:
Bring your cell phone tomorrow. We missed out on some massive trades on Friday and some stuff happened today … I guess you can’t help me now then. Bring your phone tomorrow we definitely want to know.
Broker X lived in a somewhat lawless world where obtaining inside information was sort of the point, though obtaining it from the CME was a no-no. If he was trying to pick off other traders in the market, and/or pitch them for brokerage business, information about what they were buying and selling, and at what sizes and prices, seems like it would be valuable. And he realized that a cheap easy way to obtain that valuable information was by, basically, plying bored exchange customer service representatives with steak dinners and strip club visits.4
The CFTC is suing Byrnes and Curtin in civil court, seeking monetary penalties and industry bans. Could be worse for them. They’re accused of violating Section 9(e)(1) of the Commodity Exchange Act,5 which says that it’s a felony for a commodity exchange employee “willfully and knowingly to disclose for any purpose inconsistent with the performance of such person’s official duties as an employee or member, any material nonpublic information obtained through special access related to the performance of such duties.”6 So they could be going to jail, as commodities brokers have in the past for this sort of front-running.
Wait, as commodities brokers have. Where is Broker X in all of this? Section 9(e)(2) of the CEA makes it also a felony for any person to trade on the basis of material nonpublic information obtained in violation of Section 9(e)(1): i.e., if Broker X made any use of Byrnes and Curtin’s information, he’s as guilty of a felony as they are. Guiltier, in some ways: while you can see why the CFTC would be interested in cracking down on exchanges that illegally disclose information, you’d think they’d also be interested in cracking down on the insider traders who exploited that information to actually make money, instead of the leakers whose only reward was the occasional dinner and male bonding session.
But Broker X wasn’t even named in the complaint. Seems sort of odd. Perhaps the CFTC is working up its case against Broker X, but that might be hard. They’ve got Byrnes and Curtin because just disclosing the information is illegal, regardless of whether anyone trades on it. Broker X only gets in trouble if he traded on it, which is harder to prove: it’s not like getting merger news in a stock, where you pretty much just buy the stock; knowing one trader’s position wouldn’t necessarily lead to a broker going out and taking the same (or an opposite) position with certainty. Maybe he hopped on their bandwagon, maybe he faded them, maybe he called them up looking for business. Broker X might be the guiltier party here morally, but he’s also much more likely to get off the hook than the customer service reps he exploited.
CFTC Sues CME Group, Alleging Trade-Data Leaks [WSJ]
CFTC Charges CME Group’s New York Mercantile Exchange and Two Former Employees with Disclosing Material Nonpublic Information about Customer Trades [CFTC]
Complaint: CFTC v. Byrnes et al. [CFTC]
1. Or “inventing them,” as is the case with Libor. Liborgate in the U.S., remember, is a CFTC operation, because interest rate derivatives are, in America, commodity derivatives, making interest rates commodities I suppose. Thus insider trading in interest rates is legal, sort of, if you don’t think too hard about it. Which I suppose means, as we’ve discussed a little before, that if you’re a rates trader and you call your Libor submitter and ask “hey are you submitting a high Libor today?” and he says yes, then you can trade on that information. You just can’t tell him to submit a high Libor.
2. Meh. Byrnes was a floor trader for 21 years, according to LinkedIn, then “ran the Customer services area for Clearport clearing for the CME.” So not literally a help desk guy. Still, seems like a boring job.
3. Same for Curtin later on (paragraph 55). Incidentally he’s sometimes “broker X” and sometimes “Broker X” in the complaint; the capital is, I think more appropriately villainous.
4. Or maybe “entertainment” was Philharmonic tickets, I dunno. Weird, actually: it’s never Philharmonic tickets.
5. Also known as section 9(f) of the Commodity Exchange Act. (See note 9-2 on page 97 here.) It’s riddled with typos.
6. Section 1.59(a)(5) of the CEA regulations defines “material information” to include “information relating to present or anticipated cash, futures, or option positions, trading strategies, the financial condition of members of self-regulatory organizations or members of linked exchanges or their customers or option customers.”