For professional traders in financial markets, the potential consequences of “spoofing” are not funny.
Variants of spoofing, the strategy of entering and quickly cancelling securities or futures orders to trick others into making trades, have long been punishable by fines – usually in the thousands of dollars.
Last week the potential consequences escalated sharply when a high-frequency trader was indicted by a grand jury over alleged spoofing and fraud. If convicted, he faces 25 years in prison.
The first criminal case against spoofing has unsettled traders around Chicago, a hub for proprietary firms that use sophisticated algorithms to outwit one another. The US attorney in Chicago who brought the charges, Zachary Fardon, earlier this year formed a new unit to focus on securities and commodities fraud – a strong signal in a city where federal prosecutors are known for bringing gang and public corruption cases.
“This is a watershed moment in the futures industry,” says Michael Creadon, chief executive of Traditum, a Chicago trading group. “There’s never been an indictment for what’s essentially order entry.”
Congress explicitly outlawed spoofing with the Dodd-Frank financial reform law of 2010. But under other names, the practice was previously banned by exchanges. CME Group, the largest US futures exchange operator, recently told a traders’ organisation that disciplinary actions for disruptive trading date as far back as 2002.
Nor is spoofing limited to automated trading. Last week the Commodity Futures Trading Commission obtained a $1.56m civil fine against a trader named Eric Moncada for attempting to manipulate wheat futures prices. In a court filing, CFTC lawyers said Mr Moncada manually placed and cancelled orders in a “practice commonly referred to as ‘spoofing’”. He has not, however, been charged with any crime.
Mr Fardon brought the criminal spoofing case against a trader named Michael Coscia. According to the indictment, Mr Coscia designed computer programmes named “Flash Trader” and “Quote Trader” to place orders in markets such as gold and currency futures “that he intended to immediately cancel before they could be filled,” moving the market in a direction favourable to him and generating $1.6m in profit.
What surprises some traders and lawyers about the indictment is that Mr Coscia already settled related civil charges with the CFTC and the UK’s Financial Conduct Authority in 2013, without admitting or denying wrongdoing. He paid millions of dollars in fines.
Dan Waldman, head of the derivatives practice at law firm Arnold & Porter, says: “Criminal indictments for trading activity are rare. So [Coscia’s indictment] sends a pretty strong signal.”
Richard Reibman, a lawyer for Mr Coscia, declined to comment on the case. The defendant is scheduled to be arraigned on the criminal charges next week.
In the past three years, CME’s regulation wing has brought more than 40 exchange disciplinary actions for spoofing, misleading, or intentionally or recklessly disruptive conduct, it told the traders’ organisation.
In one case CME cited as an example of spoofing, trader James Chiu was fined $155,000 after being found to have violated exchange rules in part by entering orders in stock index futures, “most of which he did not affirmatively want to be filled”, then cancelling them less than a second later, according to a disciplinary notice.
Regulatory records show Mr Chiu was employed by the large Chicago firm Jump Trading at the time of the alleged violation in 2010. He could not be reached. Jump, which was not named in the case, declined to comment.
Some market participants say the line between spoofing and legitimate trading is blurred and that any victims of spoofing are other speedy traders, not ordinary investors. CME sought to clarify what was disallowed by issuing a new anti-spoofing rule last month.
Drew Shields, director of product management and marketing at software maker Trading Technologies, says spoofing is “a bush-league move” that most elite high-frequency firms do not engage in.
“What’s interesting is that we’re finally seeing the potential of jail time for someone who wrote an algo that broke the rules,” adds Mr Shields, who was chief technology officer at Chicago-based proprietary firm Infinium Capital Management.
The head of one high-frequency firm says the new indictment is “a very loud shot heard by everybody”, causing traders to review how they place orders.
“This case is a big deal because it alleges the type of manipulative conduct that regulators and investigators have been most concerned about in this space,” says Lorin Reisner, a former federal prosecutor and deputy director of enforcement at the US Securities and Exchange Commission.
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