As New York attorney general, Eric Schneiderman, investigates
alleged spoofing activity in the FX markets, legal experts indicate that it is
unclear how the rules regarding this behaviour will be enforced.
The issue of spoofing has become a controversial topic in
the financial markets, especially since Michael Coscia, a principal at Panther
Energy Trading, was found guilty of six counts of commodities fraud and six
counts of spoofing in 2013.
Christian Kemnitz, co-head of the financial services
litigation practice at law firm Katten Muchin Rosenman (KMR), points out that
this case raised questions regarding when US authorities would decide to
prosecute individuals for spoofing activity.
“The challenges made in this case were whether the
definition of spoofing was specific enough to avoid constitutional scrutiny,”
he says, “and the answer is the regulators evaluate on an ‘as apply’ basis.”
More recently, a US Federal grand jury indicted London-based
day trader, Navinder Sarao, on charges of market manipulation. In both cases,
prosecutors allege that the individuals used automated trading strategies to
“spoof” the markets by generating trades and then quickly cancelling them in
order to impact the price of certain financial instruments.
A source at the New York attorney general’s office confirmed
that it is investigating possible cases of spoofing on electronic platforms in emerging market FX options. They
also said that last week, subpoenas for records were issued to the brokerage
firms TFS-Icap, BGC Partners, GFI Group and Tullett Prebon in connection with
Spokespeople for the brokerages either declined to comment
or did not respond to requests for comment regarding the investigation.
But with different US regulatory agencies now looking at
spoofing in the context of market abuse and disruptive behaviour, it is not
clear how the existing rules regarding spoofing will be enforced.
“I think that people understand what the spoofing rules say,
I think the question is how they will be enforced. That’s the issue,” says Gary
DeWaal, special counsel in the financial services practice at KMR.
He adds: “Spoofing is just a general terminology. In the
Commodity Exchange Act there’s a specific definition of spoofing while the SEC
is apparently proposing its own rules regarding disruptive trading. My guess is
that the New York state authorities will rely on one of their own laws. The
problem is that all of the authorities are defining spoofing slightly
For example, under the Commodity Exchange Act spoofing is
defined as “bidding or offering with the intent to cancel the bid or offer
before execution”. However, a stop-loss order could conform to this definition
as traders do not intend to hit the order and in fact, given that stop-losses
are usually put in place to limit losses or hold gains because the market is
trending against that trader, they are hoping that it doesn’t get executed.
This is one reason why the CME Group, in its rules regarding
spoofing, talks not only about the intent to cancel orders, but also “intent
to mislead other market participants”.
Under the US laws, intent can be proved
by circumstantial evidence. In the Coscia case, the evidence given was
instructions to the programmer who developed the algorithm that was used to
Defining and enforcing rules around
spoofing is further complicated by the fact that this type of trading activity
has been present in financial markets trading for a long time, it is only with
the advent of algorithmic trading that serious concerns are being raised about
“The type of trading activity that is
considered spoofing has been around since the dawn of time,” says DeWaal.
“Before electronic trading, if you were handling the order of a large
commercial entity, in order to get it executed without disrupting the market
you would absolutely do some bidding and asking because you wanted to make sure
that the floor didn’t take advantage of a large order. That was considered to
be good brokering.
“Now that kind of trading itself is
considered as disrupting the market, the only difference is that the trades are
placed a lot faster and the audit trails are better.”
Indeed, Coscia was convicted
under a statute that was part of the Dodd-Frank Act that only came into force
in 2010. It should be noted though that as a state official, Schneiderman
operates under a different legal authority.