On October 23, 2017, a Brooklyn federal jury found Mark Johnson, a foreign exchange trader, guilty of fraud for trading ahead of a $3.5 billion client order.¹ The verdict is a clear warning to foreign exchange traders that trading ahead of a client order, even for hedging purposes, can qualify as front-running and can result in criminal liability.

Traders oftentimes anticipatorily trade ahead of a pending transaction. One such strategy, pre hedging, is a common practice where a person takes a hedge position in anticipation of a future transaction. In contrast, front-running is a practice where a trader enters into a transaction to benefit from non-public information about a large, pending transaction that will impact the market price of a commodity or security. While the former practice is perfectly legal, the latter runs afoul of a broad swath of federal laws and regulations.

In 2011, Johnson received a client order to exchange the proceeds for a unit sale in dollars for pounds. Johnson had knowledge of the confidential order and bought pounds ahead of the client transaction. Johnson argued that he was "pre-hedging" the transaction, a standard foreign exchange market practice, rather than engaging in front-running. However, the prosecution presented emails and phone call records to the jury that undermined his defense. In these calls, Johnson speculated on how high the pound's value might rise before Cairn would "squeal."

This case demonstrates the importance of documenting the trading strategy behind every transaction, and refraining from discussing trading strategies on taped phone lines. There is a very fine line between pre-hedging and front-running that will depend upon the risk and reward of a given anticipatory transaction. With the risk of both civil monetary penalties and criminal liability, traders must exercise extreme caution when engaging in these transactions.

This criminal conviction sets the stage for the U.S. Commodity Futures Trading Commission to pursue similar cases on an enforcement basis with little to no risk.

Footnotes



¹U.S. v. Johnson, 16-cr-457 (E.D.N.Y. 2017).

This article is presented for informational purposes only and is not intended to constitute legal advice.