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Bates Research  |  11-06-15

Criminal Conviction in Spoofing Case

After hearing the case of Panther Energy Trading head Michael Coscia, it took jurors only one hour to return a criminal conviction, one that will have a lasting impact on market traders and especially on high frequency trading firms. As we have covered in this blog, regulators have been focused on the behavior of traders using algorithmic or automated platforms for some time, but this case creates a new, and potentially more ominous, angle for those charges to take.

At issue in this case was "spoofing," which is the practice of entering buy or sell orders into the market and then cancelling them before they can be executed, thereby distorting perceived supply and demand in a security. Spoofing itself wasn't outlawed until the passage of Dodd-Frank in 2010, and enforcement agencies have found it difficult to prove the intent element, i.e. that the trader always intended to cancel the order from the second it was placed.

The CFTC has been pursuing civil cases using the rule, and this case, brought by U.S. Attorney Zachary T. Fardon, was a landmark use in a criminal context. The normally difficult element of intent was established over the course of the trial by prosecution witnesses from two exchanges who illustrated the disparity between the rate of canceled orders for large transactions versus small ones. Presumably, the large ones (canceled more frequently) showed that Coscia did not intend to trade, unlike smaller orders that were canceled less often. A former computer programmer for Panther Energy also testified as to the intended market effect of various algorithms he created at Coscia's direction.

While the judge did not allow prosecutors to introduce this fact at trial, Panther Energy (and Coscia) had previously agreed to a $2.8 million civil settlement with the CFTC in 2013 over allegations of spoofing in commodity markets that included a one-year trading ban. Coscia's criminal case focused on just six transactions, all from 2011, and all in futures markets. His conviction on six counts each of commodities fraud and spoofing carry with them a maximum sentence of 25 years in prison and a $250,000 fine and 10 years in prison and a $1 million fine respectively. He will be sentenced in March 2016 by U.S. District Judge Harry Leinenweber.

According to trading consultant Leslie Sutphen (of Financial Markets Consulting in Chicago), “The trading industry is shocked at the verdict, it seems that the Justice Department will define spoofing as excessive cancellation. If that is the case, then everybody spoofs. This will have a profound and negative effect on liquidity."

On the other side of the table, CFTC Chairman Timothy Massad indicated that the agency planned on continuing its aggressive pursuit of spoofers, stating, "If they're entering a lot of orders without the intention to consummate, then they should go talk to their lawyers."

Two parties most likely to be impacted by this decision are 3Red Trading and Navinder Singh Sarao. Last month the CFTC brought charges related to spoofing against 3Red Trading, also in commodity futures (and 3Red has previous settlements with CME and ICE related to spoofing charges). Navinder Singh Sarao is the U.K. based trader who is currently fighting extradition to the U.S. where he faces charges related to spoofing activity that allegedly led to the Flash Crash in 2010.