After a seven-day trial in Chicago, Michael Coscia was convicted last week of six counts of commodities fraud and six counts of spoofing in connection with his trading activities on CME Group exchanges and ICE Futures Europe from August through October 2011. Mr. Coscia had initially been indicted for such offenses in October 2014.

According to his indictment, during the relevant time, Mr. Coscia utilized two computer-driven algorithmic trading programs that repeatedly placed small buy or sell orders in a market, followed by the rapid placement and retraction of large orders—so called “quote orders”—on the opposite side of his small orders. He supposedly did this in order to deceive the market and help ensure the execution of his small orders at favorable prices.

After the initial small orders were executed, Mr. Coscia would reverse the process—placing new small orders on the opposite side of the market as his initial filled orders and large quote orders on the opposite side of the new small orders. He allegedly traded this way in order to ensure the fills of the new small orders and profits on the overall transaction.

This case marked the first indictment and conviction under the new anti-spoofing provision of relevant law that was added as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.

Previously, the Commodity Futures Trading Commission, the UK Financial Conduct Authority and the Chicago Mercantile Exchange had all brought enforcement proceedings in July 2013 against Mr. Coscia and his trading company Panther Energy Trading LLC, and entered into simultaneous settlements with Mr. Coscia and Panther related to the same conduct, assessing aggregate sanctions in excess of approximately US $3 million and various trading prohibitions. The CME also required disgorgement of US $1.3 million of trading profits. (Click here to access more information on these civil enforcement actions in the article “CFTC, UK FCA and CME File Charges and Settle With Proprietary Trading Company and Principal for Spoofing” in the July 22, 2013 edition of Between Bridges.)

The jury hearing Mr. Coscia’s criminal case took approximately one hour to render a decision. Sentencing is scheduled to occur on March 17, 2016. Mr. Coscia could face 25 years in prison and a US $250,000 fine for each count of commodities fraud, and 10 years in prison and a US $1 million fine for each count of spoofing.

Prior to his trial, Mr. Coscia filed a motion to dismiss his indictment as a matter of law, claiming that the federal law regarding spoofing was “hopelessly vague, and its criminal enforcement would violate [his] right to due process of law.” The Court rejected this motion. (Click here for further information regarding Mr. Coscia’s indictment in the article, “NJ-Based Trader Previously Sanctioned by UK FCA, CFTC and CME Indicted in Chicago for Same Spoofing Offenses” in the October 5, 2014 edition of Bridging the Week.)

My View: As I wrote at the time of Mr. Coscia’s indictment: “[w]hatever the merits of this action, a major policy concern is the chilling effect the knowledge of impending or likely criminal charges will have on persons eager to settle their exchange or government-driven civil enforcement matters and move on. Here, Mr. Coscia not only paid a substantial penalty for his actions, he disgorged most of his profits and agreed to trading prohibitions—thus substantially impacting his future livelihood. If the purposes of criminal sanctions are to act as a deterrent, punish individuals and encourage the rehabilitation of wrongdoers, it is not clear what the incremental benefit of imposing additional penalties in this criminal action may be. Moreover, it is also not clear how this effectively redundant legal proceeding (albeit a criminal action with the prospect of incarceration) … justifies the expenditure of limited tax dollars—other than to generate dramatic headlines. These musings are not to condone illicit conduct—which should be appropriately punished—but solely to ask: when is enough enough?” With Mr. Coscia’s verdict now rendered, what once was just a potentially chilling effect becomes downright cold.

Legal Weeds: The relevant provision of law under which Mr. Coscia was prosecuted prohibits trading activity that “is, is of the character of, or is commonly known to the trade as, 'spoofing' (bidding or offering with the intent to cancel the bid or offer before execution).”  It may be abundantly clear what is prohibited by this provision, but by its broad sweep, the provision technically makes illegal relatively ordinary trading conduct that no one – not even the Commodity Futures Trading Commission or any exchange – would likely consider nefarious.

For example, when a trader places a stop loss order, he or she does not intend for the order to be executed, because, presumably that would mean the market is trending in a direction opposite his or her expectation. However, he or she will accept an execution if the conditions of the stop loss order are realized.  The CFTC, in its May 28, 2013 Antidisruptive Practices Authority guidance (click here to access) seems to acknowledge this dichotomy. According to the CFTC, “a spoofing violation will not occur when the person’s intent when cancelling a bid or offer before execution was to cancel such bid or offer as part of a legitimate, good-faith attempt to consummate a trade. Thus the Commission interprets the statute to mean that a legitimate, good-faith cancellation or modification of orders (e.g., partially filled orders or properly placed stop-loss orders) would not violate [the relevant statutory provision].”

CME Group, in its interpretation of its rule related to market disruption, goes even further by suggesting there is a difference between intent and hope when placing an order. According to CME, “[m]arket participants may enter stop orders as a means of minimizing potential losses with the hope that the order will not be triggered. However, it must be the intent of the market participant that the order will be executed if the specified condition is met.” (Click here to access CME Group Advisory, RA-1515-5.)

Potentially, every individual that a regulator might seek to prosecute for spoofing, will likely hope that some orders might not be executed, but is likely okay for the orders to be executed if they are — i.e., if the specified market conditions are met!

Moreover, in its Advisory, CME Group also provides a number of other examples where the intent of a trader is not necessarily to have all his or her orders executed at the time of order placement, but the consequence is not deemed impermissible spoofing — e.g., placing a quantity larger than a market participant expects to trade in electronic markets subject to a pro-rata matching algorithm and placing orders at various price levels throughout an order book solely to gain queue position, and subsequently cancelling those orders as markets change.

Unfortunately, the statute prohibiting spoofing simply has it wrong. There is nothing automatically problematic about all spoofing as now defined under applicable law. Deception, to some except, is part of smart trading. No trader knowingly reveals all his or her strategy or intent as part of an order placement. As CME Group wrote in a comment letter to the CFTC about what should be deemed illegal spoofing, it is not the intent to cancel orders before execution that is necessarily problematic, it’s “the intent to enter non bona fide orders for the purpose of misleading market participants and exploiting that deception for the spoofing entity’s benefit” (emphasis added; click here to access CME letter to CFTC dated January 3, 2011). Spoofing is simply the big circle in the applicable Venn diagram; what should be prohibited is solely a smaller circle within the larger one – a subset.

Until the law is clarified to reflect what truly is problematic, it will embrace both legitimate and illegitimate activity, potentially scare away bona fide trading, and have a deleterious impact on market liquidity, as well as inadvertently to cause some market participants to run afoul of the law for ordinary order placement activity.

Compliance Weeds: In light of recent heightened attention by the Commodity Futures Trading Commission and exchanges to alleged market disruption activities by traders, it is worth recalling that the CFTC takes a broad view of a future commission merchant’s duty to supervise all commodity interest accounts “carried, operated, advised or introduced” by a registrant, while the CME Group has a rule that generally states that “[i]f a clearing member has actual or constructive notice of a violation of Exchange rules in connection with the use of Globex by a non-member for which it has authorized a direct connection and the clearing member fails to take appropriate action, the clearing member may be found to have committed an act detrimental to the interest or welfare of the Exchange.” ICE Futures U.S. has an equivalent rule. (Click here to access ICE Futures U.S. Rule 27.04(d).) FCMs should consider their potential obligations, if any, under these provisions to monitor for potential disruptive trading activities by clients, as well as how to respond when they may have red flags regarding such conduct.