Spoofing Is a Silly Name for Serious Market Rigging: QuickTake

In September 2020, JPMorgan Chase & Co. admitted wrongdoing and agreed to pay more than $920 million to resolve U.S. authorities’ claims of market manipulation in the bank’s trading of metals futures and Treasury securities over an eight-year period, the largest sanction ever tied to the illegal practice known as spoofing. Criminal charges had been filed in 2019 against several of the bank’s employees, including former head of the precious metals desk, Michael Nowak. In that case, the Justice Department used racketeering laws more commonly used in mafia and drug gang prosecutions, alleging the precious metals desk effectively became a criminal enterprise for eight years. In August, Bank of Nova Scotia agreed to pay $127.4 million to settle U.S. allegations that the company engaged in spoofing of gold and silver futures contracts, and made false statements to the government. In 2017, Citigroup was fined $25 million for manipulating the U.S. Treasury futures market. In 2016, a British futures trader, Navinder Sarao, pleaded guilty to spoofing charges in U.S. federal court in Chicago after losing an extradition battle; in January 2020 he was sentenced to a year of home detention after providing what the judge called “extraordinary cooperation” to prosecutors. Sarao had been arrested in suburban London after U.S. authorities said his activities had contributed to the flash crash of May 2010, when almost $1 trillion was temporarily wiped out in the U.S. stock market.

“It shall be unlawful for any person to engage in any trading, practice, or conduct … that is of the character of, or is commonly known to the trade as, ‘spoofing’” –Dodd-Frank Act Section 747

Traders have always used bluffs to gauge where prices are heading. What’s changed is that they no longer stand face to face, buying and selling with hand signals on trading floors. Now they watch numbers on a screen. When trading was done in a pit, bad behavior was easier to identify and avoid. In the electronic age, computer programs can flood markets with fake orders. For example, Sarao was accused of changing or moving futures contracts more than 20 million times on the day of the flash crash, while the rest of the market combined totaled fewer than 19 million actions. Rooting out spoofing is paramount for regulators and exchange operators to convince investors that markets are fair. In the U.S. stock market, the Securities and Exchange Commission has had the authority to punish spoofing as a civil violation since the 1930s. To help police futures markets, which are overseen by the Commodity Futures Trading Commission, the Dodd-Frank Act defined spoofing and made it illegal in 2010.

Government regulators and operators of exchanges are outgunned by sophisticated and well-financed manipulators. CME spends $45 million a year to police traders, yet has been criticized by the CFTC for not doing enough to catch spoofers. CME says it has improved its software and suspended two traders it accused of spoofing gold and silver markets. CFTC officials have argued that the agency should have access to real-time order and messaging data to better detect spoofing. That would be a big change, since it has always relied on CME to police its own market. Traders argue that the definition of spoofing remains too vague, making it hard to distinguish it from legitimate order cancellations. (It’s perfectly legal for a trader to change her mind.) Prosecutions of spoofing have to show that traders intended in advance to cancel their orders. In a 2014 case, for example, prosecutors said the trader’s intent was shown by computer programs written to cancel orders automatically. Some argue that the main victims of fake orders placed and withdrawn within milliseconds are high-frequency traders who have been blamed for a variety of market woes themselves, and many doubt that Sarao could have done more than contribute to the flash crash. Sarao gave his perspective in 2015, when he shouted to a London courtroom, “I’ve not done anything wrong apart from being good at my job!”

Read More: Spoofing Is a Silly Name for Serious Market Rigging: QuickTake

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