- a mocking imitation of someone or something, usually light and good-humored; lampoon or parody; 2. a hoax; prank.
- to mock (something or someone) lightly and good-humoredly; kid; 4. to fool by a hoax; play a trick on, especially one intended to deceive; 5. to scoff at something lightly and good-humoredly; kid.
The Department of Justice has brought the first-ever indictment for spoofing. Contrary to the definitions above, spoofing is no joke.
Michael Coscia, former manager and owner of Panther Energy Trading LLC, has been indicted for spoofing and commodities fraud. The 12-count indictment alleges that Mr. Coscia used two custom-built trading programs to manipulate two futures markets in 2011.
His programs would supposedly fool other market participants into shifting prices in his favor.
For all that, Mr. Coscia now faces six counts of commodities fraud in violation of 18 U.S.C. § 1348 and six counts of “spoofing” in violation of 7 U.S.C. §§ 6c(a)(5)(C) and 13(a)(2).
Spoofing and Dodd-Frank
Spoofing is a relatively new type of securities violation. Because it can’t be done without the ability to engage in high frequency trading, the act itself has only been around as long as computers have been used to execute trades.
In order to profit from spoofing, a trader needs to perform several transactions and cancellations within milliseconds.
Inside this tiny window, a spoofer uses large, strategically-placed bids on one side of the market by either buy or sell enormous amounts of futures. Those bids shift the prices in the market, allowing the spoofer to make a second transaction that benefits from the distorted prices.
However, shortly after the spoofer has completed the second transaction, she cancels the first one. By repeating the process back and forth, an unscrupulous trader can make enormous profits in a very short period of time.
In 2010, Congress retooled the legislative framework that outlaws spoofing. The Dodd-Frank Wall Street Reform and Consumer Protection Act added an anti-spoofing provision to the Commodity Exchange Act. However, it has been used sparingly and Coscia’s prosecution is the first of its kind.
The Spoofing Statute
Section 6c of Title 7 includes a section for “disruptive practices.” It states that:
It shall be unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—
(A) violates bids or offers;
(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or
(C) 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).
Note: It seems odd to have a criminal statute that defines a crime by what is “commonly know to the trade.” Isn’t the point of a statute to provide a definition, not to refer to what is “commonly known” about certain conduct?
According to the indictment, Mr. Coscia first designed two different computer programs named Flash Trader and Quote Trader. Mr. Coscia allegedly employed a software engineer to develop the programs and gave him instructions on how the programs should perform under specific market conditions.
Using these two programs, the government maintains, Mr. Coscia manipulated 20 different futures markets in 2011. He allegedly spoofed gold, copper, soybean meal and soybean oil futures in the U.S. and in the U.K.
The indictment alleges that Mr. Coscia’s programs would enter a small trade order at one end of the market – for example, buying Euro FX futures – while simultaneously entering a massive trade order to sell Euro FX futures.
The government claims that the massive trade would mislead the market’s traders and shift the prices in that direction.
This price shift would allow Mr. Coscia to execute the small trade order and buy at a lower price than the market would normally have permitted. However, the programs were allegedly designed to cancel the massive market-disrupting trade orders before they could be filled.
In fact, the government’s indictment states, these massive trade orders would be immediately cancelled if traders tried to fill them, even if they would have benefitted from the shift in price.
The government suggests that the small amounts of profits made on each trade could quickly add up to enormous amounts. The indictment states that the entire spoofing process takes twenty-nine thousandths of a second from beginning to end.
By oscillating his program and switching sides on which his programs carried out the large fake trades and the small, real ones, Mr. Coscia allegedly made a handsome profit. The indictment states that he made nearly $1.6 million in only three months of fraudulent trading.
Administrative Action and Potential Sentencing
Mr. Coscia’s indictment follows administrative actions taken against him by the CFTC and the UK Financial Conduct Authority. Mr. Coscia has already been fined $3.7 million . However, in those administrative actions, Mr. Cosica did not admit or deny wrongdoing.
In the criminal action here, the government has charged Coscia with six counts of commodities fraud, each of which carries a maximum sentence of 25 years in prison and $250,000 fine, and six counts of spoofing, which carries a 10 year maximum sentence and a $1 million fine.
How Far Will the Statute Go?
It’s always interesting to see prosecutions based on a relatively new statute. Little case law will guide the court. The government will unquestionably push for a broad interpretation of the statute, to set helpful precedent for later cases.
Mr. Coscia may argue that, given that there have not been other prosecutions under the statute, there was little guidance for him to follow. (That argument, however, rarely works—the law is the law.)
We may also see increased cooperation between the CFTC—which has been flexing its enforcement powers as of late—and the DOJ. High-frequency trading is no doubt of increased interest to regulatory and criminal authorities, so this spoofing case will likely not be the last.