The Financial Industry Regulatory Authority said that it issued its first cross-market equities report cards aimed at helping member firms identify potential spoofing and layering activity by the firm itself or by entities for which the firm provides market access. According to Richard Ketchum, FINRA’s chairman and chief executive officer, “[w]e expect that the firms will use the data to enhance their own surveillance and move swiftly to cut off potential market manipulation.” FINRA had announced its plans to issue the report cards in January 2016. (Click here for further information in the article, “FINRA Will Grade Members on Culture, Supervision and Liquidity Management; BDs Not Managing Spoofing Likely to Get Bad Scores” in the January 10, 2016 edition of Bridging the Week.)

Legal Weeds: Just a few weeks ago, the federal judge that presided over Michael Coscia’s criminal trial for alleged spoofing rejected Mr. Coscia’s motion to set aside the jury verdict against him. Mr. Coscia had claimed, among other things, that the federal statute outlawing spoofing under which he was prosecuted was void for vagueness. The court dismissed this argument, saying that Mr. Coscia had “fair notice” of what constituted unlawful spoofing at the time of his alleged wrongful conduct. The court claimed that spoofing only occurs “when there is intent to defraud by placing illusory offers (or put another way, by placing offers with the intent to cancel them before execution).” The court’s parenthetical language is consistent with the plain definition of spoofing under the applicable federal law (click here to access Commodity Exchange Act §4c(a)(5), 7 US Code §6c(a)(5)). However, in the press release announcing its new report cards, FINRA defined spoofing as “entering orders to entice other participants to join on the same side of the market at a price at which they would not ordinarily trade, and then trading against the other market participants’ orders.” For FINRA, placing and cancelling orders alone does not appear sufficient to constitute a violation. The language of the federal statute under which Mr. Coscia was prosecuted may be clear — but it is not clear that it provides “fair notice” of what constitutes spoofing, as the definition of spoofing is not consistent among regulators. (Click here for further information on the federal court decision failing to set aside Mr. Coscia’s conviction in the article, “Federal Court Declines to Set Aside Coscia Spoofing Conviction” in the April 10, 2016 edition of Bridging the Week.)

My View: Hopefully, the cross-market equities report cards members received last week from the Financial Industry Regulatory Authority regarding potential layering or spoofing activity occurring at their organizations were of very high quality. It is apparent from the press release announcing the first report cards that FINRA expects members to evaluate most if not all situations flagged by it. However, the problem with any compliance report is precisely defining the parameters of the purported bad conduct to avoid the generation of too many false positives. This involves an iterative process that typically takes time and a fair amount of resources. Hopefully, the first and subsequent report cards will not overload FINRA member firms with reports of potentially problematic transactions that contain a large number of false positives and distract them from using existing resources to more effectively review ongoing conduct.