The Financial Industry Regulatory Authority filed a proposed rule amendment with the Securities and Exchange Commission that expressly prohibits a type of ongoing disruptive trading activity commonly described as layering and spoofing, and provides for a disciplinary process that enables FINRA to obtain a permanent injunction in its administrative process on an expedited basis. FINRA’s proposed rule does not reference the term spoofing. However, it makes wrongful a “frequent pattern” of conduct that involves a member placing multiple limit orders on one side of a market that changes the level of supply and demand of a security, followed by the same member placing one or more orders on the other side of the market that are executed followed by cancellation of the initially placed orders. This provision is different from an equivalent prohibition under the Commodity Exchange Act (click here to access CEA Section 4c(a)(5), 7 USC Sec 6c(a)(5)) that prohibits a single act of, by name – “spoofing.” In addition, the proposed FINRA rule prohibits a frequent pattern where a member narrows the inside national bid and offer of a security then places an order on the opposite side of the market that executes against another market participant that joined the new inside market established by the initial order. Under existing FINRA rule (click here to access FINRA Rule 5210), no member may publish or cause to published or circulated any notice that purports to quote the bid or asked price for any security unless such member believes that such quotation represents a bona fide bide or offer. As part of its submission, FINRA also requested approval for a new rule that allows for the entry of a permanent injunction against its newly identified form of disruptive trading on an expedited basis if a hearing panel finds by a preponderance of the evidence that alleged disruptive trading has occurred and will result in significant market disruption or other significant harm to investors unless immediately halted. Unless the SEC intervenes, FINRA proposes to implement the new rule on December 15 although SEC will accept comments on the new proposal through December 19.
Legal Weeds: Curiously, FINRA’s proposed rule prohibiting disruptive trading places no time frames on the prohibited activities. Although the pattern of problematic trading must be “frequent” it appears that any placing of limit orders on one side of the market where afterwards the level of supply and demand for the security changes – whether related or not – followed by placement and execution of an order on the other side of the market is prohibited where subsequently, at any time (e.g., microseconds, seconds, or minutes) the initial orders are cancelled. The described conduct may, in fact, be problematic, but it may also be legitimate. The key, in fact, is the speed these series of transactions occur as well as the intent of the orders placer. In November, three judges of the US Court of Appeals for the Seventh Circuit heard oral arguments on November 10 related to Michael Coscia’s efforts to set aside his November 2015 criminal conviction on 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. During his presentation, Mr. Coscia’s counsel principally argued that the provision of law prohibiting spoofing under which Mr. Coscia was prosecuted had not given him adequate notice of what trading activity was precisely prohibited. This was because the CEA solely prohibited spoofing without defining it and, prior to the time of Mr. Coscia’s alleged wrong conduct, the CFTC had provided no guidance regarding what constituted prohibited spoofing. (Click here for details in the article, “Federal District Court Approves Flash Crash Spoofer’s US $38 Million Settlement; Federal Appeals Court Appears Sympathetic to Michael Coscia’s Claim That Spoofing Prohibition Is Too Vague” in the November 20, 2016 edition of Bridging the Week.) FINRA, unlike Congress, is endeavoring to prohibit problematic conduct as opposed to a word that conveys many meanings.