BOURSE DE MONTRÉAL INC. Disciplinary Committee. -and- Timber Hill Canada Company Respondent

Transcription

1 BOURSE DE MONTRÉAL INC. Disciplinary Committee -and- Timber Hill Canada Company Respondent Chair: Me Stéphane Rousseau Mr Benoît Carignan Me Douglas Simsovic I. PROCEEDINGS 1. On August 1st, 2012, the Regulatory Division of the Bourse de Montréal ( the Bourse ) served a disciplinary complaint on Timber Hill Canada Company ( THC ) alleging a breach of the Rules of the Bourse. 2. More specifically, the complaint alleges that between October 4, 2011 and January 26, 2012, THC contravened article 3011 Surveillance and Compliance of the Rules of the Bourse, in that it did not establish and maintain a system to supervise the activities of each employee, reasonably designed to achieve compliance with the Rules of the Bourse, with regards to thirteen (13) transactions whose execution did not result in any change in the beneficial or economic ownership of the relevant derivative instruments. 3. A hearing of the Disciplinary Committee was held on March 26, 2012 in the Bourse s office. The Bourse was represented by in house counsel, Me Francis Larin, accompanied by Ms. Laurianne Carrière, investigator on the file. THC was represented by Me Jean-François Bernier, vice-president and chief compliance officer. 4. Members of the Committee each made a declaration that there was no cause of recusation. 1

2 II. FACTS 5. THC is an approved participant of the Bourse. THC is registered as an investment dealer in Québec with the Autorité des marchés financiers ( AMF ). 6. THC is an electronic market maker that conducts its trading almost exclusively through a proprietary automated system. It carries out algorithmically-driven market making in derivatives. As part of its activities, THC does not engage in any speculative buy and hold trading of particular securities. 7. In November 2011, the Regulatory Division of the Bourse conducted a review of the equity option contracts executed for the month of October The review sought to identify transactions whose execution did not result in any change in beneficial ownership, and which could potentially contravene article 6306 of the Rules of the Bourse. 8. Following the review, the investigation team of the Bourse analyzed transactions executed between October 2011 and January The investigation identified thirteen (13) transactions executed by THC (the Transactions ), which involved equity option contracts, and whose execution did not result in any change in the beneficial or economic ownership of the relevant derivative instruments. 9. All of the Transactions result from manual orders entered by Mr. George Lennon, a SAM authorized person approved by the Bourse since May 15, At THC, Mr. Lennon is referred to as a pilot, i.e. he supervises THC s automated trading operations, and enters manual trades where required. 10. In the case of the Transactions, the trader or pilot entered manual orders which in turn executed against orders submitted by THC, automatically, pursuant to its algorithm. The manual orders purported to maintain the risk profile of the portfolio at a time of unusual market volatility in those equity option contracts. 2

3 11. The pilot, Mr. Lennon, did not report the cross trades internally. As a result, the transactions were not reported by THC to the Bourse. 12. Further, the investigation revealed that THC did not have an audit trail and proof of supervision for the Transactions. 13. After investigation, the Bourse determined that the Transactions did not constitute manipulative or deceptive trades pursuant to article 6306 nor, in fact, did the Bourse conclude that the Transactions breached any Rule of the Bourse III. DECISION 14. The Committee is asked to decide if THC breached article 3011 Surveillance and Compliance of the Rules of the Bourse, in that it did not establish and maintain a system to supervise the activities of each employee, reasonably designed to achieve compliance with the Rules of the Bourse, with regards to thirteen (13) transactions whose execution did not result in any change in the beneficial or economic ownership of the relevant derivative instruments. 15. According to the Bourse, THC did not meet the requirements of article 3011 in the context of the Transactions. Specifically, the Bourse argues that article 3011 requires that THC establish written policies and procedures to ensure daily oversight of the manual trades that can result in cross trades. Such procedures, according to the Bourse may be necessary to ensure compliance with the Rules of the Bourse, regardless of whether the trades breach a Rule of the Bourse or not. According to the Bourse, it was not adequate or reasonable for THC to leave it to the pilot to supervise any cross trades that may result from manual transactions. 3

4 16. Thus, the Bourse alleges that THC s system of supervision did not meet the requirements of article Indeed, the Bourse argues, in all instances where a manual trade led to a cross trade in the period subject to the investigation, the manual trade went undetected. For the Bourse, to comply with article 3011, THC should have had a policy similar to the one it adopted on March 1 st, 2012, entitled Policies and Written Supervisory Written Procedures to Help Prevent and Detect Unlawful Wash Trades. 17. The Respondent argues that it did not contravene the requirements of article 3011 for several reasons. First, it alleges that article 3011 must be applied differently to a market-maker like THC engaged in algorithmically-driven trading. Since trades are automated, the likelihood of market manipulation is quasi-inexistent. And, the pilot has no incentive and very little opportunity for engaging in market manipulation. Second, article 3011 should not apply where there is no underlying breach of a Rule of the Bourse, as is the case here. Third, article 3011 should not be used to sanction a human error, as is the case here, since article 3011 is concerned with compliance with the Rules of the Bourse. Finally, and more generally, THC policies and procedures comply with article The Committee is of the view that article 3011 states a general rule that applies to each approved participant of the Bourse. When the Bourse alleges a breach of article 3011, the analysis focuses on whether there exists a supervisory system and whether the system is reasonably designed to achieve compliance with the Rules of the Bourse. In this respect, article 3011 establishes the minimum characteristics of the supervisory system at subsections A)i) to vii). That being said, the Committee expresses a reservation that an approved participant can be found to have breached article 3011when there is no underlying rule violation. 19. Notwithstanding the Committee s reservation articulated above, any analysis must be undertaken in light of the reasonableness criterion articulated at article The use of the expression reasonably designed indicates that the system, policies and procedures need not be perfect. Stated differently, a breach of a Rule of the Bourse does not automatically imply that the supervisory system fails to meet the requirements of article

5 20. Moreover, the Committee considers that the reasonableness of the supervisory system must be assessed in light of the circumstances of the approved participant, including its structure and activities, rather than in abstracto. 21. In light of the foregoing, the Committee must decide whether article 3011 required that THC establish and enforce written policies and procedures to ensure the daily oversight of the manual trades that can result in cross trades. 22. The Committee notes that the supervisory system of THC provided for a procedure to deal with cross trades. The procedure was embedded in THC s trading platform. Specifically, the procedure flagged the cross trades on the computer terminal, thereby allowing the trader to have the transactions cancelled by the Bourse. In other words, there was a supervisory mechanism with respect to cross trades. 23. The supervisory mechanism dealing with cross trades was not laid out in a written policy of THC. However, the Committee is of the view that article 3011 does not require that every aspect of an approved participant s supervisory system be stated in written policies and procedures. 24. Indeed, it is important to emphasize the overall goal of article 3011 which is to ensure that each approved participant have a supervisory system that is reasonably designed to achieve compliance with the Rules of the Bourse. A supervisory system is not limited to written policies and procedures. Indeed, the introduction to article 3011 does not refer to a written system to supervise. This means that to appreciate the reasonableness of an approved participant s system to supervise, it is necessary to go beyond written policies and procedures. 25. Now, sub-section 3011 A)i) does specify that the approved participant must adopt, maintain and enforce written policies and procedures that are reasonably designed to achieve compliance with the applicable legislation and regulation. However, an approved participant s written policies and procedures can meet the reasonableness test without dealing in writing with every supervisory issue. 5

6 26. For this reason, in this case, the Committee is of the view that the lack of a written policy to deal with cross trades is not per se a breach of article However, this conclusion does not end the analysis. The Committee must determine whether THC s supervisory system for dealing with cross trades, which included unwritten procedures, was reasonably designed to achieve compliance with the Rules of the Bourse, and particularly article The Committee is of the view that THC s supervisory system pertaining to cross trades did meet the reasonableness test at the time the events took place. THC s system provided for a supervision of cross trades through its trading platform that alerted the pilot when such trades occurred as a result of manual orders. This allowed the pilot to have the cross trades cancelled with the Bourse. 29. While it is true that THC s system involves a form of self-supervision by the pilot, the Committee considers that it is a reasonable system of supervision given the activities and structure of THC. In particular, the pilot s role is compatible with a supervisory role. The pilot is involved in the day-to-day operations and has the authority and capacity to resolve issues, i.e. cross-trades, quickly as they come up. Moreover, the pilot does not trade on the market, but intervenes in specific circumstances. Finally, the pilot has no financial incentive as an employee of THC to engage in market manipulation. 30. The Committee acknowledges that with respect to the Transactions the pilot failed to intervene to have the trades cancelled. The Committee also acknowledges that THC s system did not provide for an up-the-ladder reporting where cross-trades occurred. However, it is important to emphasize that the Committee is called upon to assess whether THC s supervisory system is reasonable. The reasonableness criterion of article 3011 does not require perfection. 31. To conclude, in the present case, the Disciplinary Committee finds that the Respondent s supervisory system was reasonably designed to achieve compliance with the Rules of the Bourse. 6

7 32. For the foregoing reasons, the Complaint of the Bourse is dismissed. Dated at Montreal, Province of Québec, this 17 th day of May (s) Stéphane Rousseau Stéphane Rousseau Chair of the Disciplinary Committee (s) Benoît Carignan BenoîtCarignan Member of the Disciplinary Committee (s) Douglas Simsovic Douglas Simsovic Member of the Disciplinary Committee 7