December 8, 2015

The Tip of the Spoofing Iceberg

Early in November, after a highly anticipated week-long trial, a jury of twelve found CME futures trader, Michael Coscia, 53, guilty of six counts of commodities fraud and six counts of spoofing in Illinois Federal Court. The outcome of the case serves as a warning to other market participants as this may be only the tip of the iceberg for spoofing prosecutions in the future.

Coscia was the first person ever indicted, and now the first person convicted, for using a market manipulation scheme commonly known as “spoofing.” Spoofing occurs when a market participant rapidly places a significantly large number of orders that are deliberately canceled before execution to create the illusion of demand in the market.  In October 2014, the Department of Justice accused Coscia of participating in a spoofing scheme intended to defraud other CME market participants. Coscia was also accused of committing commodities fraud through the use of computer programming that automatically canceled contract orders to prevent other market participants from filling them. The DOJ pointed to a series of transactions initiated by Coscia that occurred between August 2011 and October 2011 in violation of Title 18 U.S.C § 1348, and Title 7 U.S.C. §§ 6c(a)(5)(C) and 13(a)(2). The indictment alleged that Coscia used the spoofing tactic to improperly make approximately $1.4 million within a three-month period.

Spoofing and Relevant Regulations

Since the passage of Dodd-Frank in 2010, authorities and regulators have made concerted efforts to eradicate market manipulation methods, such as spoofing, that have gained prominence due to the advanced capabilities of computers and the rapid shift to electronic and high-frequency trading. Although authorities and exchanges have long prohibited commodities fraud and spoofing, Dodd-Frank explicitly criminalized both methods in 2010. Market participants found guilty of criminal spoofing under Section 4c(a)(5) of the Commodity Exchange Act (CEA) as amended by Section 747 of Dodd-Frank, face prison sentences of up to 10 years and fines up to $1M. However, market participants found guilty of commodities fraud under section 18 U.S.C. §1348 of the criminal code face a maximum prison sentence of 25 years with $250,000 in fines.  Government prosecutors charged Coscia with commodities fraud under the criminal code in addition to criminal spoofing charges under the CEA. Hence, Coscia’s conviction set a new stage for spoofing prosecutions because it, in effect, links the two crimes and more than doubles the potential maximum imprisonment term for criminal spoofing.

In recent years, Section 4c(a)(5) of the CEA, commonly referred to as the anti-spoofing provision, has received quite a bit of attention from market participants and regulators attempting to establish clarity and decrease uncertainty about the definition of spoofing. In December of 2010, the CFTC hosted a Roundtable discussion on Disruptive Trading Practices and sought comments from a panel of market professionals and CFTC staff on the anti-spoofing provision. The provision received much criticism for being too vague, and market participants expressed concern that the provision would have a negative impact on the market because the term “spoofing” had no settled meaning and could potentially penalize legitimate transactions, a sentiment echoed by Coscia in his defense. Coscia argued in his motion to dismiss that “in its zeal to enforce this provision for the very first time, the government has overlooked that the ‘anti-spoofing’ provision is hopelessly vague,” and “prohibits a wide range of trading activity without offering a reasonably ascertainable standard for separating the permissible from the impermissible.”

In response to the roundtable comments, the CFTC issued a Final Interpretive Guidance and Policy Statement in May of 2013. As defined therein, spoofing is the act of entering a bid or offer with the intent to cancel that bid or offer before execution. The CFTC added that spoofing violations are not limited to patterns of activity; rather, even a single instance of trading activity conducted with the prohibited intent can be viewed as a violation of the anti-spoofing provision of the CEA. The Interpretive Guidance went on to clarify that “a spoofing violation will not occur when the person’s intent when cancelling a bid or offer before execution was to cancel such bid or offer as part of a legitimate, good-faith attempt to consummate a trade.”

Although the Final Interpretive Guidance clarified the appropriate interpretation of the statutory definition of spoofing, it was issued more than 18 months after Coscia had concluded trading. Coscia contended in his motion to dismiss that the anti-spoofing provision was unconstitutionally vague because at the time of the trades in question “there was no binding guidance available that might have assisted [him] in attempting to distinguish legitimate trading from impermissible spoofing.” The Court did not agree, and denied Coscia’s motion to dismiss the indictment in last April. The case then proceeded to trial where Coscia took the stand in his own defense. After five hours of closing remarks, and about an hour of deliberation, the eight men and four women of the jury, did not agree with Coscia’s arguments and found him guilty on all twelve counts. Coscia is now awaiting sentencing, and the CME Group is now consulting with legal professionals on their views of the first spoofing conviction in U.S. history.

Coscia’s conviction could be devastating news for British trader, Navinder Sarao, 36. Sarao has been accused of causing the May 2010 “flash crash,” and was charged under the same statute as Coscia. If prosecutors succeed in extraditing Sarao from the U.K., he could be the second defendant to stand trial for spoofing, and to be subjected to the newly coupled spoofing and commodities fraud penalties.

On a similar note, shortly after the ruling in Coscia’s case, the SEC filed securities fraud charges against Scottish trader, James Alan Craig of Dunragit, Scotland, for allegedly posting two false tweets that caused a sharp drop in prices of shares for two companies and a trading halt in one. “As alleged in our complaint, Craig’s fraudulent tweets disrupted the markets for two public companies and caused significant financial losses for their investors,” said Jina L. Choi, Director of the SEC’s San Francisco Regional Office. That same day, the U.S. Attorney’s Office in the Northern District of California filed criminal charges against Craig. The SEC has charged Craig with committing securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 and with violating rule 10b-5.

Craig’s criminal charges have yet to be released, but stand as further evidence, along with Coscia’s conviction and Sarao’s indictment, that DOJ authorities and regulators are breaking new ground and working together to crack down on deceptive and manipulative trading practices throughout the securities and commodities trading industry.

Article by Diona Rogers

 

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