the exercise of futures&derivativeslawdeltastrategygroup.com/wp-content/uploads/2016/07/... ·...

THE EXERCISE OFANTI-SPOOFINGAUTHORITY IN U.S.FUTURES MARKETS:POLICY ANDCOMPLIANCECONSEQUENCES

By James A. Overdahl and Kwon Y.ParkDelta Strategy Group1, Washington, DCJames A. Overdahl is a Partner at DeltaStrategy Group (DSG), and previouslyserved as the Chief Economist at theCFTC (2002-2007) and the SEC (2007-2010). He has co-edited and co-authored,with Robert Kolb, four books in multipleeditions including Financial Derivatives:Pricing and Risk Management and Fu-tures, Options, and Swaps. Kwon Y. Parkis counsel and consultant at DSG. We ac-knowledge the help of Kevin K. Batteh, aPartner at Delta Strategy Group and theGeneral Counsel to the Commodity Mar-kets Council.

IntroductionThe purpose of this article is to describe

changes in Federal law aimed at the prac-tice of “spoo!ng” in U.S. futures markets.Spoo!ng is commonly understood to be aform of market abuse where a person (the“spoofer”) intentionally attempts to causechanges in the futures price by creating amisleading perception of supply and de-mand for futures contracts in the orderbook of the futures exchange. Althoughno precise de!nition exists, spoo!ng isunderstood to work by misleading other

traders and enticing them to react to largeorders (or a series of layered orders)2

submitted by the spoofer, but where theorders are never intended to be executed.Once the futures price has moved in thedirection desired by the spoofer, the ordersare immediately cancelled, and smallerpreviously-placed resting limit orders areexecuted to the bene!t of the spoofer.Through such conduct, a spoofer, if suc-cessful, increases the odds of his restinglimit orders being executed and can earn apro!t by unwinding the transactions usingthe same process in reverse. In this article,we will a) provide a general overview ofthe government’s approach to regulatingspoo!ng, b) examine recent enforcementcases, and c) discuss criticisms and conse-quences arising from regulatory actionsand enforcement cases related to spoo!ng.

Anti-Spoo!ng Authority

Dodd-Frank and TheCommodity Exchange ActThe prohibition of spoo!ng in futures

markets stems from the Dodd-Frank WallStreet Reform and Consumer ProtectionAct3 (the “Dodd-Frank Act”). Section 747of the Dodd-Frank Act amends section4c(a) of the Commodity Exchange Act’s(“CEA”) prohibited transactions provisionby adding a new section entitled “Disrup-tive Practices.” The amended section4c(a)(5) makes it unlawful for any personto engage in certain disruptive tradingpractices, including conduct that “is of thecharacter of, or is commonly known to the

Reprinted with permission from Futures and Derivatives Law Report, Vol-ume 36, Issue 5, K2016 Thomson Reuters. Further reproduction withoutpermission of the publisher is prohibited. For additional information aboutthis publication, please visit www.legalsolutions.thomsonreuters.com.

REP

ORT

TheJ

ournalon

theLaw

ofInv

estment&

Risk

Managem

entProducts

Futures&

DerivativesLaw

May 2016 ▪ Volume 36 ▪ Issue 5

trade as, ‘spoo!ng’ (bidding or o"ering with theintent to cancel the bid or o"er beforeexecution).”4

Prior to the enactment of the Dodd-Frank Act,government authorities relied on provisions inSections 6(c) and 9(a)(2) of the CEA to capturedisruptive trading practices such as spoo!ng.These provisions prohibited manipulative ordeceptive trading conduct in general terms with-out explicitly mentioning spoo!ng by name. Itwas not until the enactment of the Dodd-FrankAct that the term spoo!ng was speci!cally enu-merated as a prohibited trading practice.

A possible motivation for the inclusion ofspeci!c prohibited trading conduct (such asspoo!ng) in the Dodd-Frank Act may be the dif-!culty the Commodity Futures Trading Commis-sion (“CFTC”) faced in trying to prove manipula-tion under its existing authority. Former CFTCCommissioner Bart Chilton supported this viewproclaiming “currently, we have a nearly impos-sible manipulation standard, winning only onecase in 35 years.”5 With respect to spoo!ng, theCFTC’s enhanced enforcement authority coin-cided with changes in trading and surveillancetechnology that allowed regulatory authorities toscrutinize the entire life cycle of buy and sellorders to detect suspicious conduct.

Even with enhanced enforcement authorityand the application of additional surveillancetools to detect spoo!ng conduct, spoo!ng casescan be di#cult to develop for at least fourreasons. First, spoo!ng may not be a widespreadpractice. Nobody knows for sure how widespreadspoo!ng really is.6 Second, spoo!ng cases willnecessarily involve hard-to-detect conduct. Thisis because for spoo!ng to successfully mislead

other market participants it must not be obvious.Attempted spoo!ng that is easily detected byother market participants is unlikely to work.Third, spoo!ng cases involve the processing ofvast amounts of data concerning order submis-sions, order modi!cations and cancellations, andorder executions.7 Finally, interpreting the datarequires reliance on !nancial market experts tohelp distinguish lawful market conduct fromunlawful spoo!ng conduct.

Although this article focuses on anti-spoo!ngprohibitions in the U.S. futures markets, it isimportant to note that similar authorities exist inother markets and jurisdictions. Spoo!ng allega-tions have been made in U.S. securities marketsby securities market regulators.8 The Director ofEnforcement at the Securities and ExchangeCommission (“SEC”) stated in a November 2015speech that “[the SEC] will continue to focus onlayering and spoo!ng.”9 Spoo!ng allegationshave also been made by the New York AttorneyGeneral in relation to trading in the foreignexchange market.10 Media outlets report that inNovember 2015, the New York Attorney Gen-eral subpoenaed records from interdealer brokerssuspected of spoo!ng violations.11 The U.S.Department of Justice (“DOJ”) has pursued crim-inal cases against spoo!ng conduct.12 In addition,spoo!ng allegations have been made in jurisdic-tions outside of the United States.13 Finally, indi-vidual !rms can bring private actions under thelaw.14 Regulators and market participants alikeexpect the number of spoo!ng cases to increasein 2016.

CFTC Interpretive Guidance

A few months after the passage of the Dodd-Frank Act, the CFTC published an Advanced No-

Futures and Derivatives Law ReportMay 2016 | Volume 36 | Issue 5

2 K 2016 Thomson Reuters

tice of Proposed Rulemaking (“ANPR”),15 solic-ited public comments, and held a roundtable tode!ne the term “spoo!ng” and its qualifyingconduct. However, due to the di#culty in de!n-ing the term “spoo!ng” among other reasons, theCFTC terminated its rulemaking e"orts, and inits place, !nalized interpretive guidance with re-spect to disruptive trading practices.16 The guid-ance stressed that a person must intend to cancela bid or o"er before execution to engage in“spoo!ng.”17 Recklessness is not enough for aviolation of this provision, and instead, a tradermust act with some degree of intent beyondrecklessness.18 The CFTC also a#rmed that itwill not consider orders, modi!cations, or cancel-lations to be “spoo!ng” if they were submitted aspart of a legitimate, good-faith attempt to con-summate a trade.19 For a criminal violation,prosecutors have the burden to prove that thespoofer “knowingly” intended to engage inspoo!ng conduct.20

The CFTC guidance states that a violation doesnot require a pattern of activity because even asingle instance of trading activity can amount toa violation.21 The CFTC indicated that it willevaluate the market context, examining the per-son’s pattern of trading activity (including !llcharacteristics of orders), and other relevant factsand circumstances.22

Additionally, the CFTC provided guidance asto what activity is subject to the prohibition ofspoo!ng. Section 4c(a)(5)(C) covers bid and of-fer activity on all registered entities—includingdesignated contract markets (“DCMs”) and swapexecution facilities (“SEFs”)—and includes allbids and o"ers in pre-open periods or duringexchange-controlled trading halts.23 The ap-plicability of this provision is not restricted to

trading platforms and venues only having orderbook functionality. Rather, “spoo!ng” may oc-cur on any trading platform or venue where amarket participant has the ability to either sendexecutable bids and o"ers to market participantsor transact against resting orders.24 Non-executable market communications such as re-quests for quotes and other authorized pre-tradecommunications do not qualify as “spoo!ng.”25

The CFTC guidance also provided four “non-exclusive” examples of “spoo!ng” behavior,including: 1) submitting or cancelling bids or of-fers to overload the quotation system of a regis-tered entity (sometimes referred to as “quotestu#ng”); 2) submitting or cancelling bids or of-fers to delay another person’s execution of trades;3) submitting or cancelling multiple bids or of-fers to create an appearance of false marketdepth; and 4) submitting or canceling bids or of-fers with intent to create arti!cial price move-ments upwards or downwards.26

Rules of Self-RegulatoryOrganizations

The CME Group (“CME”) and ICE FuturesU.S. (“ICE”), as self-regulatory organizations(“SROs”), have also developed their own ruleswith respect to spoo!ng. Although spoo!ng hasalways been prohibited at the SRO level undergeneral conduct rules, the new rules speci!callyaddress spoo!ng conduct. CME Rule 575(A)states that “no person shall enter or cause to beentered an order with the intent, at the time of or-der entry, to cancel the order before execution orto modify the order to avoid execution.”27 TheCME rule also identi!es conduct that would notbe considered spoo!ng such as 1) an “order,entered with the intent to execute a bona !detransaction, that is subsequently modi!ed or

Futures and Derivatives Law Report May 2016 | Volume 36 | Issue 5

3K 2016 Thomson Reuters

cancelled due to a perceived change in circum-stances”; 2) an “unintentional, accidental, or ‘fat-!nger’ order”; and 3) a bona !de stop-lossorder.28 The CME Rule 575 Market RegulationAdvisory Notice states that the execution oforders and the amount of time an order is exposedto the market are not safe harbors.29 Unlike theCFTC’s view that recklessness is not a su#cientlevel of intent to constitute spoo!ng, the CMEviews recklessness as a su#cient level of intentfor a spoo!ng violation.30

In 2015, ICE amended Rule 4.02 to addressdisruptive trading practices in a manner that isvery similar to the CME’s rule.31 Although therule does not address “spoo!ng” by name, Rule4.02 prohibits any person from “knowingly enter-ing any bid or o"er for the purpose of making amarket price which does not re$ect the true stateof the market, or knowingly entering, or causingto be entered, bids or o"ers other than in goodfaith for the purpose of executing bona !de

transactions.”32 Unlike the rule text, the FAQ ac-

companying the ICE Rule does address “spoof-ing” by name and also identi!es conduct thatwould not be considered spoo!ng.

Recent Cases Involving Instances ofAlleged Spoo!ng

CFTC Enforcement ProceedingsSince the passage of the Dodd-Frank Act,

prosecuting spoo!ng conduct in futures marketshas become a top priority for the CFTC. TheCFTC has brought !ve cases related to spoo!ngconduct.33 Aitan Goelman, CFTC Director ofEnforcement, stated that “spoo!ng seriouslythreatens the integrity and stability of futuresmarkets because it discourages legitimate marketparticipants from trading”34 and that “the CFTCis committed to prosecuting this conduct and isactively cooperating with regulators around theworld in this endeavor.”35 Table A summarizesinformation regarding the !ve cases brought bythe CFTC.

Table A: CFTC Spoo!ng Cases

CFTC Case Date ofCharges

Dodd-FrankAuthority

Current Status CFTC CivilMonetaryPenalty

CFTC Dis-gorgement

Eric Mon-cada36

December 4,2012

No37 Settled onOctober 1,

201438

$1.56 Million None

MichaelCoscia andPanther Trad-ing LLC39

July 22, 2013 Yes Settled onJuly 22,

201340

$1.4 Million $1.4 Million

NavinderSarao41

April 21,2015

Yes Pending Pending Pending



CFTC Case Date ofCharges

Dodd-FrankAuthority

Current Status CFTC CivilMonetaryPenalty

CFTC Dis-gorgement

Heet Kharaand NasimSalim42

May 5, 2015 Yes Settled onApril 5, 2016.

The settle-ment order

also imposedpermanent

trading andregistration

bans on Kharaand Salim43

$1.38 Million(Khara)

$1.31 Million(Salim)

None

Igor Oys-tacher44

October 19,2015

Yes Pending Pending Pending

SRO Disciplinary ProceedingsIn 2015, the CME Group brought 16 cases re-

lated to spoo!ng before the CME Business Con-duct Committee, which was a substantial increaseover the number of spoo!ng cases considered in2014.45 Table B below summarizes those 16cases. As can be seen, none of the CME actionsrelied upon speci!c anti-spoo!ng authority pur-suant to the CME’s Rule 575 Advisory Notice.This highlights that the CME, similar to theCFTC, can rely on more general enforcementauthority with respect to conduct that may re-semble spoo!ng. Table B also includes and sum-marizes the CME proceedings for the !ve spoof-ing cases that also had parallel CFTC proceedings(as described in Table A). Observations showthat the CME’s disciplinary actions preceded theCFTC proceedings for Moncada and Oystacher,while the proceeding against Coscia was settledsimultaneously. Khara and Salim were suspendedfrom trading before the CFTC !led and settled itscharges, but the !nal CME disciplinary action ispending. Navinder Sarao is also awaiting a !nalresolution of CME disciplinary proceedings. Fur-ther, the Table illustrates that trading bans rangedfrom 10 days to six months (for bans falling short

of a permanent suspension), and monetary penal-ties ranged from $25,000 to $600,000.

In 2015, ICE also brought disciplinary pro-ceedings using general enforcement authority re-lated to conduct that may resemble spoo!ng, butin 2016, started to commence charges under itsamended Rule 4.02 disruptive trading practicesauthority.46 For example, on April 1, 2016, ICEsettled charges against Alan Rabinowitz for atrade practice violation under Rule 4.02(l).47 ICEMarket Regulation Sta" determined that Rabi-nowitz “engaged in a pattern of trading activityin the Co"ee ‘C’ (‘KC’) Futures market betweenMarch 2015 and May 2015 where numerous or-der book imbalances were created wherein heentered a small order relative to market condi-tions to buy or sell at the best price on one side ofthe market and a large order to sell or buy on theopposite side of the market,” and he was “able tobene!t from the price of KC futures he put on tohedge KC options positions that he held by ap-proximately $8,081.95.”48 Rabinowitz neitheradmitted nor denied the Rule 4.02 violations andpaid a monetary penalty of $81,928.75 and adisgorgement amount of $8,081.25.49 The settle-ment notice explained that ICE took an alterna-



tive method to calculate the disgorgementamount, by taking the di"erence between the bestbid/o"er prior to the entry of the large order byRabinowitz and the !ll price he received for thesmall order.50 He was also suspended from trad-ing on any ICE market for 10 days.51 These recent

trends should alert market participants that thenumber of SRO disciplinary proceedings willlikely increase in the near future.

Table B: CME Spoo!ng Cases

Case E"ectiveDate of

Disciplin-ary Action

CME RuleViola-tion(s)

Exchange CurrentStatus

CME Fine TradingBan / Rem-

edies

Eric Mon-cada52

May 2,2011

Rule 534WashTrades Pro-hibited;Rule 539Prear-ranged,Pre-Negotiatedand Non-Competi-tive TradesProhibited53

CBOT Settled $25,000 N/A

PantherEnergyTradingLLC54

July 22,2013

Rule 432GeneralO"enses

CBOT Settled $600,00055 $1,312,947.02in Dis-gorge-ment56

MichaelCoscia57

July 22,2013

Rule 432;Rule 576Identi!ca-tion ofGlobexTerminalOperators

CME Settled $200,00058 $1,312,947.02in Dis-gorge-

ment59 / 6Months

NavinderSarao60

Pending Pending Multiple Pending Pending Pending

HeetKhara61 andNasim Sa-lim62

Pending Rule 413SummaryAccessDenial Ac-tions

COMEX Pending Pending 60 DayAccessDenial

from AllCME Mar-

kets63

Igor Oys-tacher64

November28, 2014

Rule 432 COMEX Settled $150,00065 1 Month

RobertLeeds 66

January 20,2015

Rule 432 NYMEX Settled $40,000 15 Days



Case E"ectiveDate of

Disciplin-ary Action

CME RuleViola-tion(s)

Exchange CurrentStatus

CME Fine TradingBan / Rem-

edies

JonathanBrims67

January 22,2015

Rule 432 CBOT Settled $50,000 10 Days

StephenGola68

January 22,2015


MichelSimonian69

March 20,2015

Rule 432 COMEX Settled $35,000 15 Days

HimanshuKalra70

June 1,2015


StephenDuggan71

June 5,2015

Rule 432 CBOT Settled 2 Years

SimonPosen72

June 18,2015

Rule 432 COMEX Settled $75,00073 5 Weeks

RaphaelKurlansik74

June 18,2015


JamesGroth75

July 20,2015


Peter DiS-taulo76

July 24,2015


WilliamSilva77

August 21,2015

Rule 432 CME Settled $75,00078 2 Weeks

Banco BTGPactualS.A.79

August 21,2015

Rule 43280 NYMEX Settled $50,000 N/A

MichaelFranko81

August 21,2015


Bruno Cor-deiro82

October 2,2015


NitinGupta83

October 12,2015

Rule 432 COMEX Settled $100,000 PermanentSuspension

MatthewGarber84

November6, 2015


Criminal ProceedingsThe !rst and only criminal spoo!ng case to

date involves Michael Coscia, who faced accusa-tions from four di"erent authorities with respectto his alleged spoo!ng conduct.85 AlthoughCoscia settled actions brought by the CME andthe CFTC simultaneously on July 22, 2013, andthe U.K. Financial Conduct Authority (“FCA”),he still faced criminal prosecution by DOJ.86

Over a year after the case was settled by theCFTC and the CME, criminal authorities chargedCoscia with both “spoo!ng” and commodities

fraud.87 DOJ’s decision to pursue criminal actionfor a case already settled in the previous year bymarket regulators represents an uncommon and

unusual course of action.88 They alleged thatCoscia, a 28-year veteran commodities futurestrader, developed and implemented a high-



frequency trading strategy that allowed him toenter and cancel large volume orders allegedlyfor the purpose of moving prices in the market sothat he could purchase (at a lower price) or sell(at a higher price) contracts for his bene!t.89 Toaccomplish this, Coscia hired a computer pro-grammer to design a computer program thatwould apply this strategy in 17 CME operatedmarkets and three ICE operated markets.90 Theindictment claimed that Coscia realized up to$1.5 million in pro!ts.91

In response to the criminal complaint, onDecember 15, 2014, Coscia !led a motion todismiss the indictment asserting that the anti-spoo!ng provision in the Dodd-Frank Act was“unconstitutionally vague, and the government’se"ort to hold [him] criminally responsible . . .fails as a matter of law.”92 Coscia’s defenserested, in part, on the fact that the CFTC was un-able to !nalize a rule outlining what might con-stitute “spoo!ng” and that there was concernexpressed by industry participants that it washard to de!ne spoo!ng. He argued that the anti-spoo!ng provision “prohibits a wide range oftrading activity without o"ering any reasonablyascertainable standard for separating legitimatetrading from illegitimate spoo!ng.”93 With re-spect to the commodity fraud charge, Cosciaargued that the commodity fraud counts arelegally invalid because: 1) the underlying spoof-ing counts upon which they are based are vague;2) Coscia did not make a#rmative or impliedmisrepresentations to market participants (hesimply placed bids and o"ers); and 3) the fraudstatute is vague as applied to his conduct becausehe had no notice that his conduct might consti-tute a violation of the fraud statute.94

On April 16, 2015, the U.S. District Court for

the Northern District of Illinois ruled on Coscia’smotion to dismiss the case.95 When considering amotion to dismiss, the Court must assume that allof the government’s factual allegations are trueand consider only the legal su#ciency of thegovernment’s case. The Court explained thatwhen accepting as true Coscia’s conduct (as al-leged by the Government) for purposes of themotion, the Government su#ciently alleged aviolation of “spoo!ng” because it claimed that heengaged in: “bidding or o"ering with the intentto cancel the bid or o"er before execution.”96

Also, the Court said that the intent to cancelrequirement was signi!cant because “when thegovernment must prove intent and knowledge,these requirements do much to destroy any forcein the argument that application of the statutewould be so unfair that it must be held invalid.”97

The Court distinguished Coscia’s conduct, whichallegedly involved entry of a large number oforders with the intent to immediately cancel,from lawful activity involving a “!ll or kill” or-der or a partial !ll order.98 In the “!ll or kill” or-der or a partial !ll order scenario, a trader placesan order knowing the order or some part of theorder might be cancelled, but with the intent toconsummate a trade.99 The Court responded toother arguments made by Coscia, but denied hismotion to dismiss the indictment.100

The case ultimately went to trial, and on No-vember 3, 2015, Coscia was convicted on 6counts of spoo!ng and 6 counts of commoditiesfraud.101 Coscia’s sentencing hearing was origi-nally scheduled for March 17, 2016, but has beenpostponed inde!nitely. He faces up to 25 years inprison and a $250,000 !ne for each count of com-modities fraud, and ten years in prison and a $1million !ne for each count of spoo!ng.102 Somecommentators expect Coscia to appeal his con-



viction by arguing that the spoo!ng statute isunconstitutionally vague, as he did in his unsuc-cessful attempt to dismiss the claim prior totrial.103

Private ActionsRecently, it has been reported that some mar-

ket participants have actively scrutinized order$ow in an attempt to detect whether spoo!ng orother suspicious conduct is being used againsttheir own trading algorithms.104 The results ofsuch private surveillance, when shared withregulatory authorities, help enhance the ability ofregulators to detect and deter spoo!ng conduct.For example, Bloomberg has reported that hedgefund operator Citadel has !led a request with theCFTC for whistleblower status for uncoveringalleged spoo!ng conduct on futures exchangesbeginning in 2013. Bloomberg also reports that aformer trader at HTG Capital Markets, had also!led as a whistleblower with the CFTC concern-ing similar allegations of spoo!ng conduct.105

Such private surveillance can also be used tosupport private legal actions.106 Also, the use ofprivate resources to police markets points out thatthe victims of spoo!ng are market participantstrading either on their own behalf or on the behalfof their customers. Spoo!ng can impose losseson these traders either by luring them into money-losing trades or causing them to refrain frompro!table trades in an attempt to avoid interac-tions with suspected spoofers.

Using public data for private surveillance candetect suspicious conduct, but cannot identify theparties involved in the conduct because futurestrading is anonymous. Identi!cation of the trad-ing !rms behind the suspicious conduct can onlybe made by the relevant SRO (or the CFTC using

SRO data). Such information is considered highlycon!dential and can only be obtained by a courtorder. In one instance, HTG Capital Partners,LLC (“HTG”), sued the CME to obtain the iden-tities of the trading !rms suspected of spoo!ngconduct in dealing with HTG. On September 29,2015, U.S. District Judge Edmond Chang ruledthat the CME must reveal the identities of thetrading !rms associated with the suspected activ-ity under seal, to be seen only by the judge. Fur-ther, Judge Chang ordered the CME to provideHTG’s lawyers with a table that masked theidentities of the trading !rms using a numberinstead of a name. The CME had argued that theyshould not be compelled to reveal the names oftrade counterparties.107

An Aside on Damages Resulting fromSpoo!ng Conduct

In the cases seen to date, there is little evidencethat either gain-based or harm-based approachesto penalties have been applied to punish and de-ter spoo!ng conduct. Regulators have alleged ingeneral terms that spoo!ng conduct damagesmarket integrity and stability. Some commenta-tors have made preliminary attempts to addressthe issue of quantifying the gain or harm result-ing from spoo!ng conduct. For example, CraigPirrong, Professor of Finance at the University ofHouston, has pointed out that the damage causedby spoo!ng is likely to be small when comparedto other types of market abuse.108 He observesthat spoo!ng cannot cause the price to divergepersistently from where it otherwise would be,such as would be the case with other forms ofmanipulative conduct.109 Pirrong argues that theharm from spoo!ng is likely to be limited topeople induced to trade when they otherwisewould not.110



For these traders, their losses will approxi-mately equal the spoofer’s gains, which may beno larger than the bid-ask spread. Since the tradermay have hit the spoofer’s bid or o"er even inthe absence of spoo!ng, he contends that only afraction of those with whom the spoofer tradesare damaged.111 Pirrong has also argued that theimpact of spoo!ng conduct may be limited be-cause the victims of spoo!ng tend to be sophisti-cated traders who quickly realize that they havebeen victimized and take prompt action to protectthemselves from further damage.112 Further, hesuggests that damages would be hard to estimatebecause it is virtually impossible to identify whotraded because of the spoo!ng, and who pulled aquote and gave up an opportunity to trade becauseof the fear of encountering spoo!ng conduct.113

Therefore, the number of market participantsimpacted by spoo!ng conduct would be di#cultto determine.

Criticisms and Consequences ofSpoo!ng Regulation and Enforcement

Criticisms

Critics of the Dodd-Frank Act’s prohibition ofspoo!ng argue that the term is vague and mayinhibit lawful and desirable trading activity thatmay have a similar appearance to prohibitedactivity. The vagueness concern has been preva-lent since the passage of the Dodd-Frank Act.During the CFTC public roundtable on disrup-tive trading practices, Gregory Mocek, formerCFTC Director of Enforcement, speaking onbehalf of the Commodity Markets Council,shared his concerns on the vagueness of thestatute.114 Mocek warned that “vagueness is go-ing to chill legitimate trading,” and “vagueness isalso going to impede the ability of the Enforce-ment Division to bring cases.”115 He further

opined that a court will !nd that the statute isunconstitutionally vague because there is nocommon understanding of the meaning of theterms, no clear meaning to be derived from thestatute, no prior judicial construction, no avail-able treatise, and no commonly used industryterm within the statute available to conduct ap-propriate analysis of certain statutory terms bythe courts.116

In response to the CFTC ANPR, the CME, thelargest futures exchange in the world, also sub-mitted comments regarding the statute’svagueness. The CME explained that “in order toe"ectively implement Section 747, the Commis-sion must !rst promulgate rules that give marketparticipants appropriate notice of the speci!ctrading practices which run afoul of Section747,” and “as written, Section 747 is vague andsusceptible to constitutional challenge becausedue process precludes the government frompenalizing a private party for violating a rulewithout !rst providing adequate notice that hiscontemplated conduct is forbidden by the rule.”117

This concern has become even more pro-nounced since the conviction of Michael Cosciafor commodities fraud and spoo!ng. “The con-duct that is being prohibited just seems very hardto de!ne,”118 says Stephen Obie, former actingdirector of the CFTC’s Division of Enforcement.“The CFTC does a disservice when it fails tohave bright-line rules, particularly when tradingactivity is being criminalized.”119 Without a clearbright-line rule determined through the CFTC’spolicy-making procedures, market participantsface a moving compliance target where the divid-ing line between lawful and unlawful conduct isdetermined as the result of enforcement actions.Market participants worry about not having



explicitly de!ned safe harbors and instead hav-ing CFTC enforcement proceedings serve as asubstitute means for shaping the Commission’spolicy around this type of conduct.120

Consequences for ComplianceOfficers

As spoo!ng has become a priority for marketregulators, preventing spoo!ng has also becomea priority for compliance o#cers at trading !rmswho !nd themselves responsible for preventingthis type of conduct. However, compliance of-!cers may encounter di#culties in this endeavoras spoo!ng is not precisely de!ned and cannot beeasily distinguished from lawful trading activitythat may be bene!cial to market quality. In spiteof the CFTC interpretive guidance, althoughhelpful in generally describing conduct that maybe considered spoo!ng, it o"ers little practicalguidance for compliance o#cers, who are leftwith no bright-line separating lawful conductfrom prohibited spoo!ng conduct.

Consequences for MarketParticipants

One lawful and bene!cial activity that couldbe inhibited by aggressive enforcement of spoof-ing conduct is market making. This is due to thedi"erence in “intent” between prohibited conductand lawful conduct under the new rules. AsBloomberg View Columnist Matthew Levine hasobserved.” . . the same actions—putting in an or-der, cancelling it, and trading the other way—arelegal or illegal depending on what was going onin [the trader’s] mind in the relevant half-second.”121 Market makers are professional trad-ers who bridge the gaps between natural buyersand sellers of futures contracts who may not bein the marketplace at exactly the same time. For

these professional traders, the ability to quicklyrevise quotes (that is, to cancel and replace bidsand o"ers) in response to market information isan essential risk management tool. It is this riskmanagement ability that enables these traders too"er narrower bid-ask spreads, provide liquidity,and quote for larger trade sizes. Nonetheless, thefear of being accused of spoo!ng may lead to lessaggressive quoting, when a lawful market makerbecomes reluctant to revise orders for fear ofregulatory scrutiny and/or enforcement. Theunintended consequence of spoo!ng regulationmay be wider bid-ask spreads resulting in lessliquidity and higher costs for market users.

Conclusion

The frequency with which spoo!ng conducthas been alleged and prosecuted has increasedsteadily since the Dodd-Frank Act explicitlyprohibited this type of conduct in 2010. Thisincrease is expected to continue as market regula-tors focus on detecting and deterring spoo!ngconduct. In addition to the frequency of allega-tions, the severity of the penalties resulting fromthe prosecution of spoo!ng conduct, includingsigni!cant criminal penalties, have made compli-ance a high priority at trading !rms.

The high pro!le of spoo!ng allegations hasalso generated public policy concerns with re-spect to the consequences, both intended andunintended, of how spoo!ng prohibitions areenforced. In this article, we describe the govern-ment’s approach to regulating spoo!ng, examinerecent enforcement cases, and discuss criticismsarising from these regulatory and enforcementactions. We describe the concerns of marketparticipants who seek a clearly-de!ned safeharbor, determined through the CFTC’s policy-making procedures. These participants worry that



without a bright-line rule distinguishing theboundary between lawful and unlawful conductthat the boundary will be determined on a case-by-case basis through enforcement actions. Fi-nally, we describe the di#culty authorities facein prosecuting cases such as distinguishing be-tween prohibited spoo!ng conduct and lawfulconduct such as market making.

RAM

ENDNOTES:

1Delta Strategy Group is a full-service con-sulting !rm that works closely with Congress,the CFTC, the SEC and other regulatory agen-cies to provide clients with innovative solutionsto their regulatory concerns. DSG has decades ofcombined government service and o"ers a wealthof expertise in the regulation of commodityfutures, capital markets, over-the-counter deriva-tives and exchanges, energy issues, and agricul-ture appropriations policy. DSG represents cli-ents including exchanges, energy andagribusiness companies, trade groups, !nancialservices !rms, investment funds, and Fortune 500companies in connection with key regulatoryreforms and landmark !nancial legislation (http://deltastrategygroup.com).

2Layering is a form of spoo!ng where ordersare placed at a series of prices (or layers) in theorder book to give a misleading impression ofmarket depth.

3Pub. L. 111-203, 124 Stat. 1376 (2010).47 U.S.C. § 6c(a)(5).5See, e.g., The Waiting, Statement by Com-

missioner Bart Chilton Regarding Anti-Fraudand Anti-Manipulation Final Rules, (July 7,2011), http://www.cftc.gov/PressRoom/SpeechesTestimony/chiltonstatement070711.

6Matthew Leising, Spoo!ng Went Main-stream in 2015, BloombergBusiness, (Dec. 21,2015), http://www.bloomberg.com/news/articles/2015-12-22/nabbing-the-rogue-algo-inside-th

e-year-spoo!ng-went-mainstream.7Matthew Leising, Mira Rojanasakul, and

Adam Pearce, How To Catch a Spoofer, (Sept. 4,2015), http://www.bloomberg.com/graphics/2015-spoo!ng/.

8See SEC Announces Charges for Spoo!ngand Order Mismarking, (Dec. 3, 2015), https://www.sec.gov/news/pressrelease/2015-273.html.

9See, e.g., Market Structure Enforcement:Looking Back and Forward, (Nov. 2, 2015), http://www.sec.gov/news/speech/ceresney-speech-sifma-ny-regional-seminar.html.

10Keri Geiger, Currency Spoo!ng Is Said ToBe New York’s Latest Target, (Nov. 23, 2015), http://www.bloomberg.com/news/articles/2015-11-23/currency-spoo!ng-is-said-to-be-new-york-s-latest-target.

11Laura Matthews, Current Spoo!ng ProbeCould Spell Trouble for Forex Options, Risk.net,(Jan. 7, 2016), http://www.risk.net/risk/news/2440938/currency-spoo!ng-probe-could-spell-trouble-for-forex-options.

12U.S. v. Coscia, Case No. 14 CR 551(N.D.Ill. Dec. 15, 2014), Dkt. No. 28.

13For a description of spoo!ng enforcementby the British Financial Conduct Authority(FCA) and how FCA authority di"ers from U.S.authority, see David Yeres, Robert Houck, Benja-min Berringer and Carlos Conceicao and OliverPegden, “Spoo!ng: The First Criminal Convic-tion Comes in the U.S.—Perspectives from theU.S.and UK, Futures and Derivatives Law Re-port, Vol. 36, issue 1 (Jan. 2016), pg. 1-11.

14See HTG Capital Partners LLC v. Doe(s),15-cv-02129, (N.D. Ill. Mar. 10, 2015).

1576 FR 14943.1678 FR 31890.17Id. at 31896.18Id.19Id.207 U.S.C. § 13(a)(2).2178 FR 31896.22Id.



237 U.S.C. § 6c(a)(5).2478 FR 31896.25Id.26Id.27Found at http://www.cmegroup.com/tools-i

nformation/lookups/advisories/market-regulation/!les/RA1405-5.pdf.

28Id.29Id.30Id.31Found at https://www.theice.com/publicdo

cs/futures%us/exchange%notices/IFUS%Disruptive%Practices%Notice.pdf.

32Id.33See In the Matter of Panther Energy Trad-

ing LLC and Michael J. Coscia, CFTC DocketNo. 13-26 (July 22, 2013); CFTC v. Heet Kharaet al., 15-cv-03497, (S.D.N.Y. May 5, 2015);CFTC v. Nav Sarao Futures Ltd. PLC et al., 15-cv-03398, (N.D.Ill. Apr. 17, 2015); CFTC v. IgorB. Oystacher et al., 15-cv-09196, (N.D.Ill. Oct.19, 2015); and CFTC v. Eric Moncada, et al., 12-cv-8791, (S.D.N.Y. Dec. 4, 2012).

34See supra note 36.35Michael Mackenzie and Phillip Sta"ord,

Why US Regulators Target Spoo!ng, FinancialTimes, (Oct. 21, 2015), http://www.ft.com/intl/cms/s/0/cbf0aeaa-76"-11e5-933d-efcdc3c11c89.html#axzz3wIqFlJhO.

36 See CFTC Files Complaint in FederalCourt Against Eric Moncada, BES Capital LLC,and Serdika LLC Alleging Attempted Manipula-tion of Wheat Futures Contract Prices, FictitiousSales, and Non-Competitive Transactions, (Dec.4, 2012), http://www.cftc.gov/PressRoom/PressReleases/pr6441-12.

37 Eric Moncada was charged by the CFTCin 2012 under the CFTC’s pre-Dodd Frank anti-manipulation authority for conduct allegedlysimilar to spoo!ng. Speci!cally, the CFTC al-leged that the conduct constituted a “manipula-tive scheme.”

38 See Federal Court Orders Eric Moncada to

Pay $1.56 Million Penalty for Attempting to Ma-nipulate the Wheat Futures Market, (Oct. 1,2014), http://www.cftc.gov/PressRoom/PressReleases/pr7026-14.

39 In the Matter of Panther Energy TradingLLC, CFTC Dkt. No. 12-26 (July 22, 2013).

40 Id.41 See CFTC Charges U.K. Resident Navin-

der Singh Sarao and His Company Nav SaraoFutures Limited PLC with Price Manipulationand Spoo!ng, (Apr. 21, 2015), http://www.cftc.gov/PressRoom/PressReleases/pr7156-15.

42 See CFTC Charges United Arab EmiratesResidents Heet Khara and Nasim Salim withSpoo!ng in the Gold and Silver Futures Markets,(May 5, 2015), http://www.cftc.gov/PressRoom/PressReleases/pr7171-15.

43 See Federal Court Orders UAE ResidentsHeet Khara and Nasim Salim to Pay CombinedCivil Monetary Penalties of $2.69 Million forSpoo!ng in the Gold and Silver Futures Markets,(April 5, 2016), http://www.cftc.gov/PressRoom/PressReleases/pr7353-16.

44 See CFTC Charges Chicago Trader Igor B.Oystacher and His Proprietary Trading Company,3 Red Trading LLC, with Spoo!ng and Employ-ment of a Manipulative and Deceptive DeviceWhile Trading E-Mini S&P 500, Copper, CrudeOil, Natural Gas, and VIX Futures Contracts,(Oct. 19, 2015), http://www.cftc.gov/PressRoom/PressReleases/pr7264-15.

45Leising, supra note 5.46ICE has not speci!ed which of their general

conduct disciplinary proceedings involve conductthat resembles spoo!ng. Therefore, we cannotprovide a table similar to Table B for the CMEcases.

47See ICE Futures U.S., Disciplinary NoticeSettlement of Charges Against Alan Rabinowitz,CASE Number 2015-025 (April 1, 2016).

48Id.49Id.50Id.



51Id.52 See CME Group, Notice of Disciplinary

Action Against Eric Moncada, File No. CBOT09-04100-BC (May 2, 2011).

53 The CME Group charged Moncada for ruleviolations unrelated to spoo!ng conduct.

54 See CME Group, Notice of DisciplinaryAction Against Panther Energy Trading, LLC,File No. CBOT 11-8581-BC (July 22, 2013).

55 Of the $600,000, $191,100 was allotted toCBOT.

56 Panther Energy Trading, LLC and Cosciawere held jointly and severally liable for$1,312,947.01 in disgorgement, and of thatamount, $393,884.11 was allotted to CBOT.

57 See CME Group, Notice of DisciplinaryAction Against Michael Coscia, File No. CME11-8581-BC (July 22, 2013).

58 Of the $200,000, $76,760 was allotted toCME.

59 Panther Energy Trading, LLC and Cosciawere held jointly and severally liable for$1,312,947.01 in disgorgement, and of thatamount, $525,178.81 was allotted to CME.

60 See CME Group, CME Group Statement,Chicago, Illinois (Apr. 22, 2015), http://cmegroup.mediaroom.com/2015-04-22-CME-Group-Statement. The CME Group issued a pressrelease in response to the CFTC charges againstNavinder Sarao.

61 See CME Group, Notice of Summary Ac-cess Denial Action Against Heet Khara, File No.COMEX 15-0103-SA-2 (Apr. 30, 2015).

62 See CME Group, Notice of Summary Ac-cess Denial Action Against Nasim Salim, FileNo. COMEX 15-0103-SA-1 (Apr. 30, 2015).

63 Pursuant to Rule 413, this access denialmay be extended for an additional period of timeif the Chief Regulatory O#ce or his delegatesprovide written notice.

64 See CME Group, Notice of DisciplinaryAction Against Igor Oystacher, File No. COMEX11-08380-BC (Nov. 28, 2014).

65 Of the $150,000, $50,000 was allotted to

COMEX.66 See CME Group, Notice of Disciplinary

Action Against Robert Leeds, File No. NYMEX12-8886-BC (Jan. 20, 2015).

67 See CME Group, Notice of DisciplinaryAction Against Jonathan Brims, File No. CBOT12-8860-BC (Jan. 22, 2015).

68 See CME Group, Notice of DisciplinaryAction Against Stephen Gola, File No. CBOT12-8860-BC (Jan. 22, 2015).

69 See CME Group, Notice of DisciplinaryAction Against Michel Simonian, File No.COMEX 13-9598 (Mar. 20, 2015).

70 See CME Group, Notice of DisciplinaryAction Against Himanshu Kalra, File No.COMEX 12-9004-BC (June 1, 2015).

71 See CME Group, Notice of DisciplinaryAction Against Stephen Duggan, File No. CBOT12-9134-BC (June 5, 2015).

72 See CME Group, Notice of DisciplinaryAction Against Simon Posen, File No. COMEX13-9258-BC (June 18, 2015).

73 Of the $75,000, $45,000 was allotted toCOMEX.

74 See CME Group, Notice of DisciplinaryAction Against Raphael Kurlansik, File No.NYMEX 14-9952 (June 18, 2015).

75 See CME Group, Notice of DisciplinaryAction Against James Groth, File No. CBOT 11-8463 (July 20, 2015).

76 See CME Group, Notice of DisciplinaryAction Against Peter Distaulo, File No. CBOT12-9106-BC (July 24, 2015).

77 See CME Group, Notice of DisciplinaryAction Against William Silva, File No. CME 13-9387-BC (Aug. 21, 2015).

78 Of the 75,000, $25,000 was allotted toCME and $50,000 was allotted to NYMEX.

79 See CME Group, Notice of DisciplinaryAction Against Banco BTG Pactual S.A., FileNo. NYMEX 14-9783-BC (Aug. 21, 2015).

80 Banco BTG Pactual S.A. settled chargesfor failure to supervise Bruno Cordeiro.



81 See CME Group, Notice of DisciplinaryAction Against Michael Franko, File No.COMEX 13-9651-BC (Aug.21, 2015).

82 See CME Group, Notice of DisciplinaryAction Against Bruno Cordeiro, File No.NYMEX 14-9783-BC (Oct. 2, 2015).

83 See CME Group, Notice of DisciplinaryAction Against Nitin Gupta, File No. COMEX13-9391-BC (Oct. 12, 2015).

84 See CME Group, Notice of DisciplinaryAction Against Matthew Garner, File No. CBOT12-8862-BC (Nov. 6, 2015).

85See CFTC Orders Panther Energy TradingLLC and its Principal Michael J. Coscia to Pay$2.8 Million and Bans Them from Trading forOne Year, for Spoo!ng in Numerous Commod-ity Futures Contracts, (July 22, 2013), http://www.cftc.gov/PressRoom/PressReleases/pr6649-13.

86Found at https://www.fca.org.uk/static/documents/!nal-notices/coscia.pdf.

87U.S. v. Coscia, Case No. 14 CR 551(N.D.Ill. Dec. 15, 2014), Dkt. No. 28.

88Gregory Mocek and Jonathan Flynn,‘Spoo!ng” - A New, Amorphous Crime with Do-mestic & International Implications for Traders,Commodities Now, (Feb. 2016), http://www.cadwalader.com/uploads/books/ecef383400c1b1041b556aee35dae608.pdf.

89U.S. v. Coscia, Case No. 14 CR 551(N.D.Ill. Apr. 16, 2015), Dkt. No. 31.

90Id. at 1.91Id. at 2.92U.S. v. Coscia, Dkt. No. 28 at 2.93Id. at 15.94Id.95U.S. v. Coscia, Dkt. No. 31.96Id. at 12.97Id. at 11.98Id.99Id. at 6.100Id. at 16.101See High-Frequency Trader Convicted of

Disrupting Commodity Futures Market in First

Federal Prosecution of “Spoo!ng,” (Nov. 3,2015), http://www.justice.gov/usao-ndil/pr/high-frequency-trader-convicted-disrupting-commodity-futures-market-!rst-federal.

102Id.103Peter Henning, Conviction O"ers Guide to

Future ‘Spoo!ng’ Cases, The New York Times,(Nov.9, 2015), http://www.nytimes.com/2015/11/10/business/dealbook/conviction-o"ers-guide-to-future-spoo!ng-cases.html.

104Pirrong, supra note 89.105See Matthew Leising and Janan Hannah,

“Can a $24 Billion Hedge Fund Blow theWhistle? Citadel Thinks So,” Bloomberg (April29, 2016), http://www.bloomberg.com/news/articles/2016-04-29/can-a-24-billion-hedge-fund-blow-the-whistle-citadel-thinks-so.

106Leising, supra note 6.107See HTG Capital Partners, LLC v. Doe(s),

No. 15-cv-02129 (N.D.Ill. Sept. 22, 2015), Dkt.No. 30.

108See Craig Pirrong, I’m Not Spoo!ng YouAbout Judicial Overkill, Streetwise Professor,(Nov. 4, 2015), http://streetwiseprofessor.com/?p=9678.

109Id.110Id.111Id.112See Craig Pirrong, Spoof Me Once, Shame

on You: Spoof Me Twice, Shame on Me, Street-wise Professor, Dec. 29, 2015, http://streetwiseprofessor.com/?p=9762.

113Id.114See Sta" Roundtable on Disruptive Trad-

ing Practices, Dec. 2, 2010, tr. at 170.115Id.116Id. at 171-72.117See CME Comment Letter on Antidisrup-

tive Practices Authority, (Jan. 3, 2011) at 2.118Roberto Barros, CFTC Spoo!ng Crack-

down Poses Compliance Challenges, Risk.net,(Nov. 23, 2015), http://www.risk.net/energy-ris



k/feature/2434944/cftc-spoo!ng-crackdown-poses-compliance-challenges.

119Id.120See Futures Industry Association (“FIA”)

Comment Letter on Antidisruptive Practices

Authority, (Dec. 23, 2010) at 3.121Matt Levine, Regulators Bring a Strange

Spoo!ng Case, BloombergView, (Oct. 21, 2015),http://www.bloombergview.com/articles/2015-10-21/regulators-bring-a-strange-spoo!ng-case.



the exercise of futures&derivativeslawdeltastrategygroup.com/wp-content/uploads/2016/07/... ·...

Documents