{"id":15496,"date":"2015-05-22T17:14:52","date_gmt":"2015-05-22T22:14:52","guid":{"rendered":"http:\/\/news.medill.northwestern.edu\/chicago\/?p=15496"},"modified":"2015-05-27T16:47:19","modified_gmt":"2015-05-27T21:47:19","slug":"high-profile-spoofing-cases-put-traders-on-edge","status":"publish","type":"post","link":"https:\/\/news.medill.northwestern.edu\/chicago\/high-profile-spoofing-cases-put-traders-on-edge\/","title":{"rendered":"High profile ‘spoofing’ cases put traders on edge"},"content":{"rendered":"

By Lucy Ren<\/a><\/p>\n

Traders are on notice and looking for ways to avoid even the appearance of being market manipulators as prosecutors and regulators crack down on spoofing, an illegal practice that was blamed in part for setting off a \u201cflash crash\u201d in 2010.<\/p>\n

Spoofing involves pushing a market price in one direction by entering large numbers of orders, then quickly canceling them. This tricks other investors into buying or selling at artificially high or low prices.<\/p>\n

<\/p>\n

Spoofing crackdown<\/h3>\n

Last month\u2019s arrest of London trader Navinder Singh Sarao, whose spoofing allegedly contributed<\/a> to the 2010 \u201cflash crash,\u201d follows last year\u2019s fraud and spoofing charges against Chicago trader Michael Coscia. Some in the industry say there may be more cases to come.<\/p>\n

\u201cIt appears as though this may be just the beginning of a strategic and coordinated effort to crack down on spoofing,\u201d said David Widerhorn, the CEO and founder of David Widerhorn Consulting LLC, a Chicago-based technology consulting firm that develops market surveillance software.<\/p>\n

Sarao faces multiple criminal charges in the U.S. for having \u201cknowingly engaged in trading, practice, and conduct\u201d of the character of spoofing, according to the complaint filed last month.<\/p>\n

It alleges that his spoofing helped cause the 2010 \u201cflash crash\u201d in which U.S. stock prices sharply plummeted and then rebounded within minutes. Sarao remains in a U.K. jail and is fighting extradition to the U.S.<\/p>\n

Coscia, owner of Panther Energy Trading LLC, faces several counts of fraud and spoofing<\/a> for allegedly entering large-volume orders that he had no intention of completing, and immediately canceling them before they could be filled.<\/p>\n

His was the first criminal spoofing case after lawmakers added an anti-spoofing provision to the Dodd-Frank Act in 2010.<\/p>\n

Traders under the microscope<\/strong><\/h3>\n

Dennis Dick, a proprietary trader and head of markets structure at Bright Trading LLC, worries that the increasing public and regulatory attention to spoofing puts traders in a grey area.<\/p>\n

Faced with rapidly evolving trading tactics, traders at Dick\u2019s company are now \u201cvery careful in canceling their orders\u201d for fear of being mistaken for spoofers.<\/p>\n

\u201cThere is always risk that they might prosecute someone innocent, too, especially those traders who change their minds frequently,\u201d he said.<\/p>\n

\"High<\/a>
High frequency trading amounts to roughly 50 percent of daily stock market trading volume, according to a study done by the Tabb Group. (Justrader\/Wikimedia Commons<\/a>)<\/figcaption><\/figure>\n

Dick said traders at his firm have shifted their strategies towards longer time horizons, focusing on relationship-based trading that relies heavily on analysis rather than speed.<\/p>\n

Ultimately, the outcome of any spoofing investigation hinges on the market manipulator\u2019s intention.<\/p>\n

\u201cTrading strategies involve canceling orders, so to separate what\u2019s illegal from what\u2019s simply sharp trading, prosecutors have to prove what\u2019s in the mind of those traders,\u201d said Clifford Histed, partner at K&L Gates LLP and former federal enforcement lawyer with the CFTC.<\/p>\n

Among the many market participants harmed by disruptive trading practices like spoofing, high frequency traders are often hit the hardest. Dick said that\u2019s because their algorithms are programmed to read orders and respond to them within milliseconds.<\/p>\n

HFT vs. spoofers<\/h3>\n

In March, a Chicago-based high frequency trading firm became the first in its industry to blow the whistle publicly.<\/p>\n

HTG Capital Partners LLC filed a federal lawsuit <\/a>against an unnamed defendant for repeatedly conducting spoofing trades in 2013 and 2014. In the lawsuit, HTG claims to have lost $500,000 from the disruptive pattern of trades.<\/p>\n

\u201cI think we lost a lot more than half a million from that spoofer,\u201d HTG\u2019s CEO Christopher Hehmeyer said in an interview, \u201cmainly because HTG had to spend thousands of hours to write programs to detect it.\u201d Hehmeyer also serves as the chairman of the National Futures Association, a self-regulatory organization for the U.S. futures industry.<\/p>\n

Approximately six months before HTG filed its lawsuit, Allston Trading LLC, also a Chicago-based high frequency trading firm, was identified by anonymous sources as the counterparty to HTG\u2019s transaction in an arbitration case, according to a Bloomberg news report published in August.<\/p>\n

Allston stated in an email response to Medill: \u201cWe have conducted ourselves with the highest standards of excellence and integrity.\u201d<\/p>\n

Hehmeyer believes that spoofing is becoming less of a problem after the CME Group Inc. tightened prohibition of spoofing last fall in its Rule 575<\/a>, titled \u201cDisruptive Practices Prohibited.\u201d Under the new rule, the CME identifies \u201crecklessness\u201d as a sufficient level of intent to find a violation.<\/p>\n

Regulators are putting pressure on the exchanges where spoofers place their trades.<\/p>\n

Tim Massad, chairman of the U.S. Commodity Futures Trading Commission, told a Senate subcommittee<\/a> last week that his agency has asked the CME, where Sarao\u2019s trades were sent, to strengthen its efforts to combat spoofing.<\/p>\n

In response, CME Chairman Terry Duffy told the subcommittee<\/a> that the exchange has devoted \u201csubstantial resources\u201d to oversee the markets, including employing \u201cover 200 financial regulatory, IT, and surveillance professionals to monitor its markets and detect financial misconduct before it occurs.\u201d<\/p>\n

The whistleblower program under the Dodd-Frank Act could also encourage individuals to help regulators detect fraud and other trading misconduct, Massad said.<\/p>\n

[field name=”spoof”]<\/p>\n

The future of spoofing detection<\/h3>\n

Not surprisingly, businesses designed to detect spoofing and other disruptive trading tactics are growing.<\/p>\n

Widerhorn\u2019s firm developed a market surveillance system called Neurensic that uses artificial intelligence technology to analyze order activities of trading firms and exchanges, as well as government inquiries and criminal cases.<\/p>\n

Widerhorn said the number of the firm\u2019s customers has grown to be in the \u201cdouble digits\u201d after the Dodd-Frank anti-spoofing provision and the CME Rule 575 were written.<\/p>\n

The system identifies \u201cclusters\u201d of activities which it believes to be related to a particular intent. With these clusters, the system can protect traders by telling them whether their clusters of trades have a strong likelihood of attracting future regulatory attention.<\/p>\n

Similarly, the product allows regulators and exchanges to detect trading activity that may be reckless or ill-intended.<\/p>\n

Widerhorn said the system is designed to \u201cbring clarity to an issue that affects all industry participants by defining a fair and cohesive industry standard for classifying behavior intent.\u201d<\/p>\n

He said spoofing is a still-expanding practice that could be even more widespread than people believe, citing as evidence the fact that his customer base is growing \u201cextremely rapidly.\u201d<\/p>\n

\u201cThere is clearly more scrutiny over traders now,\u201d said Histed, the former CFTC lawyer, noting the tightening rules by the exchanges and the CFTC rules. \u201cBut the task is always for the prosecutors to keep up with the criminals. They innovate and the detectives chase after them.\u201d<\/p>\n

Photo at top: The CME’s trading platform is where spoofing took place on May 6, 2010 and allegedly contributed to the “flash crash.” (Lucy Ren\/Medill)<\/div>\n","protected":false},"excerpt":{"rendered":"

By Lucy Ren Traders are on notice and looking for ways to avoid even the appearance of being market manipulators as prosecutors and regulators crack down on spoofing, an illegal practice that was blamed in part for setting off a \u201cflash crash\u201d in 2010. Spoofing involves pushing a market price in one direction by entering […]<\/p>\n","protected":false},"author":29,"featured_media":15526,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[27,436],"tags":[],"class_list":["post-15496","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-business","category-spring-2015"],"yoast_head":"\nHigh profile 'spoofing' cases put traders on edge - Medill Reports Chicago<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/news.medill.northwestern.edu\/chicago\/high-profile-spoofing-cases-put-traders-on-edge\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"High profile 'spoofing' cases put traders on edge - Medill Reports Chicago\" \/>\n<meta property=\"og:description\" content=\"By Lucy Ren Traders are on notice and looking for ways to avoid even the appearance of being market manipulators as prosecutors and regulators crack down on spoofing, an illegal practice that was blamed in part for setting off a \u201cflash crash\u201d in 2010. 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