U.S. derivatives regulator prepares for courtroom showdowns

WASHINGTON, July 28 Mon Jul 28, 2014 1:00am EDT

WASHINGTON, July 28 (Reuters) - The U.S. federal agency regulating derivatives has fought just three trials since 2011, all against small-time fraudsters in Florida. Now it is poised to take on a series of formidable opponents in the biggest courtroom tests yet of its efforts to crack down on market wrongdoing.

A loss in the courtroom would be a setback for the Commodity Futures Trading Commission as it tries to catch up with its sister agencies, the Securities and Exchange Commission and the Federal Energy Regulatory Commission, which have already adopted more aggressive tactics toward reining in Wall Street excesses.

CFTC lawyers are preparing to confront Brian Hunter, who oversaw the energy desk of hedge fund Amaranth when it collapsed in 2006, in a federal court in Manhattan on Oct. 6. Hunter, accused of attempted manipulation, has sought to dismiss the case, arguing the court has no jurisdiction and that the CFTC does not have enough evidence against him.

On Nov. 3, Royal Bank of Canada is due to go on trial for what the CFTC alleges was an unlawful trading scheme to realize tax benefits. RBC has called the allegations against it "absurd," and said its trading was permissible.

Two weeks later, it will be the turn of futures trader Eric Moncada, who is accused of manipulating wheat prices. Moncada argues that he had good reasons for placing and canceling large orders and did not profit from them.

The regulator is also preparing for the possible trial of Jon Corzine, the former New Jersey Governor and MF Global chief. The CFTC has accused him of failing to supervise employees who, it says, raided customer funds to prop up the failing brokerage. A court date has not yet been set for the trial and a settlement could be reached before then.

Corzine's legal counsel says the CFTC lawsuit is based on "meritless allegations" and that he will be vindicated in court.

The stakes are high for the CFTC, which is slowly shedding its image as a small-time regulator responsible for keeping agriculture and energy futures markets in check. After the 2008-2009 financial crisis, it was put in charge of helping oversee the $710 trillion global market for swaps, a type of derivative.

Derivatives are financial products widely used on Wall Street to hedge risk but also to engage in risky speculation.

The cases represent a daunting task for an agency with a relatively puny budget, a thin track record in court, and big-name opponents like Corzine, who has enlisted Andrew Levander from law firm Dechert LLP, one of New York's most successful white-collar defense lawyers.

The SEC has fought a dozen or more trials each year since 2011 - in comparison to the CFTC's three - and has completed 25 so far in its fiscal year 2014.

"The Commission has to be really shrewd, and serious, and make sure its best people are on the highest-profile cases," Mark Wetjen, a Democratic CFTC Commissioner, told Reuters.

Wetjen, who headed the agency for five months earlier this year, has complained that the CFTC can barely afford the highly paid expert witnesses needed to win over a jury at trial.

"TAKE IT OR LITIGATE"

The loss of any of these high-profile cases would be a blow to new CFTC head Tim Massad, and the enforcement chief he has brought in, Aitan Goelman, a former federal prosecutor best known for convicting two of the bombers for the 1995 bombing of a federal office building in Oklahoma.

The case against Hunter is particularly important for the CFTC, which has used it as a formal argument to introduce one of its most contested rules, which caps the overall position in futures any one trader can hold.

The CFTC first showed signs of getting tougher under Goelman's predecessor, David Meister, also a former federal prosecutor. After his appointment in 2010, Meister told staff there would be no more haggling with defendants wanting to avoid trial. It would be "take it or litigate."

He then crafted a series of headline-grabbing deals with large banks over the manipulation of the Libor benchmark, which yielded billions of dollars in fines for the U.S. taxpayer.

Proving manipulation has become easier for the CFTC because the 2010 Dodd-Frank consumer protection law dropped the need for it to show that the behavior was intentional. In future cases, all it has to show is that the behavior was reckless.

There are no signs that Goelman - a veteran litigation lawyer at the law firm Zuckerman Spaeder LLP - will deviate from Meister's tough stance. Goelman declined to be interviewed.

STRETCHED BUDGET

Goelman has 149 people at his disposal, most of whom are lawyers, according to the CFTC. The SEC's enforcement group, by comparison, employs 1,200 people.

"The CFTC has been engaging in efforts to add bench strength to its team of trial lawyers, to ensure that it is able to take cases to trial successfully if the cases do not get resolved by settlement," said Lawrence Zweifach, a litigation lawyer at law firm Gibson Dunn in New York.

The CFTC declined to comment on its legal hires.

What counts is not how many lawyers the CFTC has, but how much experience they have in the courtroom, argues William Rosch, a retired attorney who helped a defendant beat a case against the CFTC in 2010.

"They don't need 100 lawyers who have never tried a lawsuit. They need about four or five guys or women who have tried lots of lawsuits," he said.

The CFTC's effort to litigate cases is constrained by its relatively small budget - it has earmarked $46 million for its enforcement division in the fiscal year 2014. That's about a tenth of the SEC enforcement division's budget.

The budget constraints may, for example, rule out the option of holding an expensive mock trial, which the SEC has on occasion used to prepare for trials.

It is also not clear how many expert witnesses the CFTC will be able to afford to use in the trials, but a source familiar with the agency's operations said some would be hired.

Expert witnesses - typically academics or partners at consulting firms - are crucial in helping to persuade a jury and a judge of wrongdoing in derivatives trading, which involve highly complex financial instruments few outsiders easily understand.

But they come at a price. The SEC, for instance, offered a contract with a ceiling of more than $128,000 to just one witness at a high-profile trial in 2013. In another case that same year, the SEC was billed more than $1.3 million by an accounting expert witness, according to records obtained by Reuters. (Reporting by Douwe Miedema and Sarah Lynch, additional reporting by Nate Raymond in New York and Aruna Viswanatha in Washington; Editing by Karey Van Hall and Ross Colvin)

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