This article was first published on Thomson Reuters Regulatory Intelligence on 18 December 2015.

On 4 December 2015, the Sanctions Committee of the Autorité des Marchés Financiers (the “AMF”) has sentenced the High Frequency Trading (“HFT”) company Virtu Financial Europe (“Virtu”) and the French market operator Euronext Paris (“Euronext”), to the highest fines ever imposed in HFT manipulation case, imposing a €5M fine on each company.

HFT deviations have been increasingly targeted over the past years

HFT practice has revealed to foster market manipulation behaviours. This is the assessment of several Regulating Authorities[1] which have increased their controls and sanctions against HFT companies over the last years.

Yet, the sheer volume of data generated by HFT and the speed of the operations can make it especially challenging for Regulating Authorities to investigate and evidence the commission of “price manipulation”. So far, only a few HFT companies have been effectively convicted on this ground.

  • On 12 May 2011, the Dutch HFT firm Kraay Trading was sentenced to pay a €10,000 fine by the AMF for voluntarily manipulating the prices of five listed securities by using an algorithm designed to place multiple orders, which were then immediately cancelled. The AMF underlined that many orders were placed in order to produce artificial price fluctuations and benefit from this tendency to purchase or buy securities at the best price.  
  • On 16 October 2014, the US based HFT firm Athena Capital Research, has agreed to pay aUS$1M fine to settle charges brought by the Securities Exchange Commission based on the use of an algorithm designed to engage in a practice known as “marking the close”[2].
  • In 2013, the US based High Frequency Trader, Michael Coscia, was successively fined in the UK by the Financial Conduct Authority and in the US by the Commodities and Future Trading Commission and by the Chicago Mercantile Exchange for a total of US$3.7M, for using an algorithm designed to instigate an abusive strategy known as “layering” or “spoofing”[3]. Michael Coscia is also currently subject to the first-ever criminal prosecution conducted by the US Department of Justice on the basis of the Anti-Spoofing provision of the Commodity Exchange Act.

An extensive application of price manipulation by the AMF

The latest decision of the AMF Sanctions Committee, dated 4 December 2015, significantly broadens the scope of price manipulation to sanction HFT practises.

Under French law (article 631-1, 1°, a, and 631-2, 6°of the AMF General Regulations) price manipulation “consists of: 1° transactions or orders to trade that: a) give or are likely to give false or misleading signals as to the supply of, demand for, or price of financial instruments, or the price or value of commercial contracts” and can be deduced from: “the impact of orders given on the best bid or offer prices in the financial instrument or commercial contract, or more generally on the representation of the order book available to market participants, that are removed before they are executed”.

Virtu is a member of the Euronext market as well as four other regulated markets[4]. Between 21 July 2009 and 2 September 2009, Virtu designed an algorithm intended to: (i) identify on the five markets the highest purchase order of a relevant security, then (ii) place slightly lower purchase orders on the four other markets, (iii) as soon as one of its purchase orders was settled on one of the four markets, (iv) Virtu immediately cancelled its three remaining orders and (v) sold the security to the buyer who placed the identified highest purchase order, therefore generating a profit between the purchase price and the selling price. During the considered period of time, Virtu would have realised a global benefit of €782,000 on 27 different securities. 

In convicting Virtu, the AMF highlights that the market book order “did not accurately reflect the reality of the orders effectively placed on the market” and considers that “the multiplication of the orders cancelled prior to their execution […] had generated a confusion on the reality of the offer and demand on the relevant securities, therefore meeting the conditions for price manipulation”. Hence, according to the AMF, the conditions under which Virtu operated on the market generated misleading information on the value of the securities at stake.

The AMF also found that the scale and extremely fast scope of the interventions secured Virtu a dominant position on the markets.

The decision is based on a comparative study between the amount of orders placed by Virtu on the market on 27 relevant securities on 32 market days, and the amount of orders placed by other members on the same securities, at the same time. The AMF concluded that Virtu had placed 110.1 million of orders, which corresponded to 65.6% of the total orders on the market, which only resulted in 2% of the transactions executed on the market. In comparison, at the same time, the second highest member on the market, had placed 10.4 million of orders - so 11 times less that Virtu - for a volume of executed transactions 4 times higher than Virtu.

Contrary to the preceding decision against Kraay Trading, in which the AMF found that the HFT company was deliberately influencing the market price, Virtu was merely taking advantage of the real market prices in order to execute transactions at the best price. The price manipulation was only an indirect consequence from Virtu’s large and extremely fast interventions on the markets.

The first conviction of a market operator for breach of neutrality

This is the first time that the French authorities have sanctioned Euronext. The market operator has been convicted for breach of integrity and neutrality of the market and equality of treatment between Euronext members.

The AMF considered that Euronext allowed an unlimited and unjustified exemption to Virtu, and could not provide any “convincing explanation as to the reasons of the difference of treatment between Virtu and the other market members”.

Indeed, Euronext allowed Virtu to exceed its ratio of 100 to 1 between the number of orders placed and the number of executed transactions on one security, without imposing any financial penalty.

The unprecedented severity of the AMF sanctions

The fines imposed on Virtu and Euronext by the AMF are extremely harsh and unprecedented, particularly when compared to the previous conviction of Kraay Trading which only resulted in a €10,000 fine.

The AMF College – the prosecution body - had only called for a fine of €4M on Euronext and €5M on Virtu. It is extremely rare in practice for the Sanctions Committee to turn out as being more severe than the College, who voluntarily always sets the bar high. 

Besides, the fine imposed on Virtu far exceeds the profits generated by the use of Virtu’s algorithm, which amounted to €782,000 according to the AMF.

Impact of the decision

This decision might draw a turning point in the sanction of price manipulation by the AMF and heavily impact the exercise of HFT practices. Many trading companies operate on the markets pursuing similar strategies, using sophisticated algorithms, although their order book might not be as “massive” as Virtu’s. 

One difficulty is that the practice of cancelling placed orders is not in itself prohibited by the Regulator and commonly spreads through HFT.

Therefore, unless the AMF defines a clear threshold beyond which this practice is considered to constitute price manipulation, the door remains open to a discretionary and broad sanction of HFT practice.

The decision is widely criticised by the commentators and the media for its “unprecedented severity” and unexpected nature. Euronext itself had denounced a “particularly disputable, completely disproportionate and archaic” decision.

So far, Euronext has announced its intention to lodge an appeal against the decision. This might be an opportunity for the Regulating body of the AMF to set clear standards for the prosecution of price manipulation.