CFTC Fines Trader $100,000 For Misappropriation of Material, Non-Public Information

In a recent case involving a claim of misappropriation of material, non-public information, a trader was fined by the CFTC in the amount of $100,000 and ordered to pay $216,955 in restitution for losses suffered by his employer as the result of energy trades placed in his personal accounts and an account of his employer.  From September to November 2013, the trader prearranged 34 trades between his employer’s account and his personal accounts which caused the employer’s account to buy at higher prices and sell at lower prices.  Moreover, on at least 12 other occasions, the trader placed trades in his personal accounts ahead of orders placed by him in his employer’s account to the employer’s detriment.

Among other violations of the CEA and CFTC Rules, the CFTC also found the trader violated Section 6(c)(1) of the CEA and CFTC Rule 180.1, both of which augment the CFTC’s existing authority to prohibit fraud and manipulation in the markets.  In the case at hand, the trader was found to have violated both Section 6(c)(1) and CFTC Rule 180.1 by trading on the basis of material nonpublic information in breach of a pre-existing duty to his employer.  The CFTC held that as an employee, the trader knew material, non-public information regarding the trading intentions of his employer, including various details of the intended trades.  The CFTC also found that the trader held a position of trust and confidence with his employer and owed a duty to his employer not to misuse proprietary or confidential information for his own personal benefit.  In a related matter arising out of the same facts and circumstances, the CME Group ordered the trader to pay a separate $100,000 fine, restitution to his employer, and barred him from direct or indirect access to CME Group markets for 5 years.

CFTC Proposes Regulation AT Governing Automated Trading and the Registration of Certain Market Participants

The CFTC has proposed a new rule - so-called Regulation AT - that specifically addresses automated, or algorithmic, trading and requires registration for market participants that (i) engage in proprietary “Algorithmic Trading,” (ii) have direct electronic access to a designated contract market (i.e., an exchange) (an “Exchange”), and (iii) that are not already registered.  Algorithmic Trading is defined as the trading in any commodity interest where: (i) one or more computer algorithm or system determines whether to initiate, modify, or cancel an order, or otherwise makes determinations with respect to an order, including various aspects such as timing, place and sequence, and (ii) such order is electronically submitted for processing on, or subject to the rules of, an Exchange. 

Under the proposed rule, an “AT Person” is any person registered or required to be registered as a futures commission merchant (“FCM”), floor broker, swap dealer (“SD”), major swap participant (“MSP”), commodity pool operator (“CPO”), commodity trading advisor (“CTA”), or introducing broker (“IB”) that engages in Algorithmic Trading on, or subject to the rules of, an Exchange.  The term “high frequency trading” is not defined or otherwise used in Reg. AT.  Ultimately, these broad definitions portend to encapsulate a large number of market participants.

Regulation AT would also require AT Persons to implement risk controls, standards for development, testing and monitoring Algorithmic Trading Systems (“ATSs”) and to submit annual compliance reports to Exchanges.  Clearing FCMs will also need to implement risk controls for orders originating from AT Persons and submit annual compliance reports to Exchanges.  Exchanges will also need to implement certain risk controls and other compliance procedures, but will also need to make certain disclosures and adopt certain controls regarding their market maker and incentive programs.

Regulation AT will be subject to a comment period and presumably will undergo revisions as a result of comments and the rulemaking process.  However, one controversial aspect that has already become an issue is the CFTC’s proposed access to the source code of ATSs.  Pursuant to proposed CFTC Rule 1.81(a), each AT Person is required to maintain “a source code repository to manage source code access, persistence, copies of all code used in the production environment, and changes to such code.”  CFTC Rule 1.81(a) also requires each AT Person to make the source code repository available for inspection by the CFTC.

CFTC Chairman Massad has previously indicated that the focus of Regulation AT would be on proprietary traders with direct access to exchanges.  While acknowledging that automated trading has brought many benefits to the marketplace, he has also noted that the markets have evolved significantly since the days when most trading occurred on the floors of the exchanges. In support of regulating automated trading, Chairman Massad has previously noted that automated trading accounts for over 50% of trading on U.S. financial markets as a whole, and 60-80% of trading on U.S. futures markets.  Comments on the proposed Regulation AT are due within 90 days of publication in the Federal Register.

The Department of Justice Obtains its First Criminal Conviction in a Spoofing Matter

The CFTC, the Department of Justice (“DOJ”) and the exchanges continue to pursue cases alleging disruptive trading practices, and the number of criminal and civil enforcement matters will presumably continue to increase following the DOJ’s criminal conviction of Michael Coscia on “spoofing” allegations and other violations of the CEA.

In November 2015, following a seven day trial, Mr. Coscia was convicted by a jury of six counts of commodities fraud and six counts of spoofing.  During its case in chief, the prosecution presented witnesses from CME Group’s market regulation department, ICE’s department of market oversight, a risk manager from a large chicken producer, traders from Citadel, Teza Technologies, HTG Capital Partners and D.E. Shaw, an FBI agent and, perhaps most importantly, Mr. Coscia’s former computer programmer.  While most of the witnesses testified as to the effects of Mr. Coscia’s trading strategies, the computer programmer was able to testify regarding how the trading strategies were formulated and instructions he received from Mr. Coscia, including instructions on how to program the algorithms to cancel orders.  In a seminal part of the trial, Mr. Coscia testified in his own defense for over two hours.  Mr. Coscia’s testimony was also supported by two expert witnesses.

The jury deliberated for only one hour before finding Mr. Coscia guilty on all counts.  As a result of his conviction, Mr. Coscia faces 25 years on each commodities fraud count and 10 years on each spoofing count.  He will be sentenced in March 2016 absent an appeal.

Following the conviction in the Coscia matter, the DOJ continues to prepare its case in the Sarao matter.  In its complaint, the DOJ alleges that Sarao’s trading in E-Mini S&P 500 futures contracts contributed to the Flash Crash which occurred on May 6, 2010.  Specifically, the DOJ alleges that Sarao placed and cancelled large orders without the intent to have them executed and further “layered” his orders to drive prices downward.  Sarao is currently fighting extradition to the U.S. 

In addition, the CFTC and the exchanges continue to pursue civil enforcement actions arising out of disruptive trading practices and manipulation.  To date, the CFTC and the exchanges have filed more than 20 actions this year as a result of such conduct.