The government’s pursuit of alleged “spoofing” continues to garner headlines with the criminal authorities recently securing a conviction in the prosecution of Michael Coscia for alleged spoofing on the Chicago Mercantile Exchange (“CME”) as well as an order requiring the extradition of a UK resident, Navinder Sarao, to face a combination of criminal and civil charges in the United States for alleged spoofing in the S&P 500 E-mini futures contract.
In a recent conference focusing on enforcement trends in the financial markets, the head of the Securities & Financial Fraud Unit of the Department of Justice (“DOJ”) expressed his view that spoofing is widespread in the commodities and derivatives markets, likely leading to an uptick in spoofing cases going forward. Clearly, with the new anti-spoofing authority that was given to the Commodity Futures Trading Commission (“CFTC”) as part of the Dodd-Frank Act, and the DOJ’s recent interest, we agree with this assessment.
In addition to this continued, aggressive pursuit of alleged spoofing, recent events suggest that regulators are broadening the net of what may constitute spoofing and looking further afield to determine who may be engaging in it. With this expanded reach, regulators are deploying additional techniques to deter market participants from engaging in such conduct. On April 28, 2016, the Financial Industry Regulatory Authority (“FINRA”) made available to member firms its first monthly cross-market equities supervision report cards. According to FINRA, the new report cards are sent to firms where FINRA has identified potential spoofing or layering by: (1) the firm; or (2) entities to which the firm provides market access. The report cards are designed to help firms “identify and halt spoofing and layering activity.”
While noting that most firms have compliance functions that attempt to detect spoofing and other potentially problematic trading activity, in its announcement FINRA noted that “bad actors look to mask their activity by trading across multiple markets or firms . . .” Therefore, FINRA emphasized that the report cards leverage FINRA’s “cross-market data” and “sophisticated automated surveillance technology to flag suspicious trading patterns so that firms can add that data to their own surveillance and supervisory processes and take appropriate action to address the activity even before FINRA can complete a formal investigation.”
We believe there are several, important takeaways from the FINRA “reports cards,” each of which may apply equally to the markets for equities, commodities and related derivatives:
- Where are the regulators looking. To this point, the publicly disclosed spoofing investigations and resulting enforcement actions have focused on alleged spoofing confined to a single product traded on one market or exchange. The FINRA announcement suggests that regulators (at least on the equities side) now are reviewing suspicious trading patterns across It is easy to envision regulators applying a similar approach to the commodities markets, particularly where commodities regulators remain fixated on alleged uneconomic trading in one market to impact prices in another, related market. This is particularly true where futures contracts trading on multiple markets share a direct economic link – e.g., the NYMEX and ICE WTI crude oil contracts.
- Who is looking. To date, many of the publicized spoofing investigations have been spearheaded by criminal authorities and civil enforcement agencies like the DOJ, CFTC and SEC, as well as by exchange surveillance staff. The FINRA report cards make clear that other self-regulatory organizations are also invested in the pursuit of alleged spoofing and they are able to marshal significant resources and market data to inform their review. Moreover, because a significant amount of market activity now occurs across multiple jurisdictions, non-U.S. regulators likely will add another dimension to the mosaic of oversight.
- What do the regulators expect from market participants. For many market participants, surveilling for alleged spoofing is difficult, time consuming, and expensive. Perhaps mindful of these limitations, regulators seemingly have focused less attention on potential supervisory failures that may have contributed to the occurrence of alleged spoofing activity. Again, the FINRA report cards suggest that change may be on the horizon. As FINRA made clear, the purpose in giving members access to FINRA’s “sophisticated automated surveillance technology” is to augment the members’ own surveillance and supervisory processes so that members can “take appropriate action to address the activity even before FINRA can complete a formal investigation.” FINRA is giving its members additional tools to combat allege spoofing. It is reasonable to assume that FINRA expects its members to use those tools. Failure to do so likely could lead to charges of supervisory failures. These developments eventually may define the industry’s best practice, leading to similar expectations in the commodities markets.
In light of recent regulatory announcements, firms (particularly intermediaries) should consider reviewing their surveillance systems to determine whether they are capable of detecting suspicious cross-market trading patterns, including activity that occurs outside the United States.