Last week, the judge that recently oversaw the trial of Michael Coscia in a US federal court in Chicago declined to grant Mr. Coscia’s motion for acquittal or a new trial. In November 2015, Mr. Coscia was convicted 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 subsequently filed his motion, claiming, among other things, that the prosecution misapplied the relevant standard for proving commodities fraud and that the law prohibiting spoofing is void for vagueness. The court rejected both arguments. Although Mr. Coscia argued that, to find commodities fraud, the prosecution had to show his actual orders were false or deceptive, the court held this was not the case. Instead, said the Court, the prosecution only had to show there was a fraudulent intent, a scheme or artifice to defraud, and a nexus to the commodities markets. According to the court, “[i]n the indictment and throughout the trial, the Government alleged that Coscia engaged in a scheme to defraud by intentionally misleading market participants about price and volume information in the commodities markets through sham quote orders. That theory fits the requirements of the statute.” The court also rejected Mr. Coscia’s claim that the law prohibiting spoofing is void for vagueness, claiming 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 further said that spoofing is a type of market manipulation, and “statutory prohibitions against specific forms of market manipulation are nothing new.” The court also rejected claims by Mr. Coscia that instructions given to the jury were faulty and that certain testimony given by the prosecution’s witnesses was false and prejudicial. (Click here for a further discussion of Mr. Coscia’s criminal conviction in the article, “Jury Convicts Michael Coscia of Commodities Fraud and Spoofing” in the November 8, 2015 edition of Bridging the Week.)
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 clear what is prohibited by this provision, as the court has written, 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 a trade 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 a market advisory addressing disruptive trading (click here to access) 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 (consider, for example, exchange-sanctioned iceberg orders). 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 is “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.
The jury hearing Mr. Coscia’s prosecution clearly believed there was sufficient evidence to find the defendant had engaged in spoofing, and the judge overseeing the trial has now ruled twice that Mr. Coscia was on sufficient notice that his specific trading activity constituted spoofing.
However, until the anti-spoofing law is further 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; and potentially cause some market participants to run afoul of the law for ordinary order placement activity. This is not right or fair, even if, as the court ruled in Mr. Coscia’s case, traders have “fair notice.”