On July 13, 2016, an Illinois federal judge sentenced Michael Coscia, a New Jersey commodities trader, to three years in prison under a law prohibiting "spoofing," which was added to the Commodity Exchange Act ("CEA") by the 2010 Dodd-Frank Act. The sentencing followed a jury trial, the result of which was Coscia's conviction on six counts of spoofing and six counts of commodities fraud in November 2015. The presiding judge had previously rejected Coscia's challenge of the spoofing law, including arguments that the statute was unconstitutionally vague.
Coscia was the first person prosecuted under the law, and his October 2014 indictment came as a shock to the futures industry. Coscia's indictment alleged that he "devised, implemented, and executed a high-frequency trading strategy in which he entered large-volume orders that he intended to immediately cancel before they could be filled by other traders." The indictment also alleged that Coscia "create[d] a false impression regarding the number of contracts available in the market;" designed computer systems to carry out his scheme and realized a profit of approximately $1.5 million.1
The indictment followed Coscia's settlement of civil allegations related to the same conduct with US and UK regulators, through which he paid $3.1 million in fines, agreed to the disgorgement of profits and accepted a one year trading suspension. In a press release issued contemporaneously with the announcement of the settlement, the then-director of the Division of Enforcement of the Commodity Futures Trading Commission ("CFTC") stated that "[w]hile forms of algorithmic trading are of course lawful, using a computer program that is written to spoof the market is illegal and will not be tolerated."
The CEA's anti-spoofing provision prohibits placing a buy or sell order with the intent to cancel the order before execution. Generally, spoofing occurs when a trader places an order on one side of the book (for example, a buy order), and then places several orders on the other side of the book (i.e., sell orders) at different prices to give the impression of depth and demand in the marketplace. The strategy is designed to induce other orders that will be executed against the original order at a higher price than the trader would have otherwise obtained without the layered orders, which are subsequently cancelled before execution.
In May 2013 (more than two years after the trading activity for which Coscia was prosecuted), the CFTC published its final interpretive guidance on spoofing. The guidance includes four specific examples of spoofing:
- Submitting or cancelling bids or offers to overload the quotation system of a registered entity;
- Submitting or cancelling bids or offers to delay another person's execution of trades;
- Submitting or cancelling multiple bids or offers to create an appearance of false market depth; and
- Submitting or cancelling bids or offers with intent to create artificial price movements upwards or downwards.
78 Fed. Reg. 31890 (May 28, 2013).
The CFTC's guidance also indicated that cancelled orders would not be considered spoofing if the orders were initially submitted "as part of a legitimate good-faith attempt to consummate a trade," and that factors relevant to distinguishing legitimate trading from spoofing included "the market context, the person's pattern of trading activity (including fill characteristics) and other relevant facts and circumstances." (Id.)
The success of the Coscia prosecution was a validation of the CFTC Division of Enforcement's pronouncement that it will pursue an active policy of criminal referrals for violations of the CEA generally, and disruptive market practices specifically. It can only serve to embolden the U.S. Attorney's Office for the Northern District of Illinois in Chicago, which has assembled a team specifically to prosecute violations of the CEA. Traders and firms, regardless of whether they use algorithmic trading, must exercise particular care to ensure that their trading strategies are not branded as disruptive and do not fall under the critical gaze of the CFTC, and ultimately federal prosecutors.
1 United States v. Michael Coscia, 14-cr-551 (N.D. Ill. Oct. 1, 2014)
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