DD Support Board and Research Team

[TechKim]

Is the First Criminal Conviction for “Spoofing” a Sign of Things to Come?
By Robert Rabinowitz on November 10th, 2015 Posted in Broker-Deale

http://www.bizlawtoday.com/2015/11/is-the-first-criminal-conviction-for-spoofing-a-sign-of-things-to-come/r, Dodd-Frank, Securities

Last week marked the first criminal conviction of a commodities trader for “spoofing” since the implementation of the anti-spoofing provisions in the Dodd-Frank Act of 2010. The case at issue relates to a prior regulatory settlement in July 2013 among a former commodities trader, his firm, and the Commodity Futures Trading Commission (“CFTC”).

In that case the CFTC charged former trader Michael J. Coscia and his firm, Panther Energy Trading, LLC, with engaging in the disruptive practice of “spoofing” by utilizing a computer algorithm that was designed to illegally place and quickly cancel bids and offers on futures contracts. The CFTC found that Mr. Coscia conducted this unlawful activity across a broad spectrum of commodities from August through October 2011. The settlement required Mr. Coscia and his firm to pay a monetary penalty of $1.4 million and to disgorge an additional $1.4 million in trading profits, and banned Mr. Coscia and his firm from trading in any CFTC-registered entity for one year.

It is unlikely that Mr. Coscia would have agreed to this settlement if he had known what would happen next. In September 2014, the U.S. Attorney for the Northern District of Illinois handed down a twelve-count criminal indictment against Mr. Coscia accusing him of commodity fraud and spoofing for the same activities that led to the CFTC settlement.

The fraud involved posting and then immediately canceling bids and offers for the purchase and sale of various commodities via a high-frequency trading platform. High-frequency trading is a form of computerized trading that uses complex algorithms for decision making and the placement of orders. It employs sophisticated technology designed to enable a trader to communicate with electronic markets as quickly as possible (usually in time measured in 1/1000th of a second, also known as a “millisecond”) and involves the entry of high volumes of quotes, orders, and in the case of Mr. Coscia’s scheme, cancellations of orders.

The indictment charged that Mr. Coscia devised, implemented, and executed a high-frequency trading strategy in which he entered large volume orders that he intended to immediately cancel before they could be filled by other commodity traders. He did this to create the false impression that the number of available contracts for purchase was larger that it actually was, in order to fraudulently induce other market participants to react to the deceptive market information that he created. The strategy moved the market in a direction favorable to him, enabling him to purchase contracts at prices lower than, or sell contracts at prices higher than, the prices available in the market before he entered and canceled his large volume orders.

Is this simply a case of old-fashioned market manipulation using the newest technology, or is this the new trend of traders using highly sophisticated technology and computer algorithms to do what traders have always done—look for a competitive edge in the market place? A federal jury resoundingly answered the question on November 3rd, when after just one hour of deliberation, it convicted Mr. Coscia on all counts. His conviction marked the first of its kind since the implementation of anti-spoofing provisions in the Dodd-Frank Act of 2010. With the Federal government recently losing several high-profile insider trader cases, this conviction served to bolster a much desired crackdown on perceived Wall Street excesses.

But for compliance officers and supervisors in trading firms, this is an unwelcome development that will add yet another layer of regulatory scrutiny of their oversight and review of traders’ activities. In the wake of this decision, traders and other market participants will have to more carefully document and explain their reasons for placing trades and, where appropriate, canceling trades that haven’t been filled.