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From Securities Regulation Daily, October 3, 2014

High-frequency trader indicted in first federal criminal prosecution of “spoofing”

By Lene Powell, J.D.

In the first federal criminal prosecution of an anti-manipulation provision added by the Dodd-Frank Act, a commodities trader has been indicted for six counts of commodities fraud and six counts of “spoofing”, a strategy sometimes used in high-frequency trading. The indictment follows 2013 civil fines by the CFTC and U.K. Financial Conduct Authority (FCA) against the trader for the same conduct (U.S. v. Coscia, October 1, 2014).

“Traders and investors deserve a level playing field, and when the field is tilted by market manipulators, regardless of their speed or sophistication, we will prosecute criminal violations to help ensure fairness and restore market integrity,” said Zachary T. Fardon, United States Attorney for the Northern District of Illinois.

Spoofing. Michael Coscia is the manager and sole owner of Panther Energy Trading, a high-frequency trading firm based in New Jersey. Coscia has been registered with the CFTC as a floor trader since 1988.

In high frequency trading, computer algorithms make trading decisions and place orders in milliseconds (1/1000 of a second), entering a high volume of orders, quotes, or cancellations of orders. “Spoofing” is a particular strategy in which an algorithm places orders in order to create the appearance of market demand and quickly cancels them before execution. The algorithm first places a relatively small order to sell, which it does intend to execute, then quickly follows it with successively larger buy orders, which it intends to cancel. After the sell order is filled, it cancels the buy orders, rapidly repeating the reverse sequence, with a small buy order followed by several large sell orders. The whole process is repeated many times, earning a small profit each time.

Spoofing is specifically illegal as a manipulative practice under Sec. 4c(a)(5)(C) of the Commodity Exchange Act, as added by the Dodd-Frank Act. Last year, Coscia was fined by the CFTC and FCA for engaging in spoofing over several months in 2011 in the commodity futures markets. The CFTC ordered Panther Energy and Coscia to pay a $1.4 million civil monetary penalty and disgorge $1.4 million in trading profits, and banned Panther and Coscia from trading on any CFTC-registered entity for one year. The FCA fined Coscia about $900,000.

Indictment. Like the CFTC and FCA actions, the criminal indictment alleges that Coscia engaged in spoofing in 2011 in several commodity futures markets, including Euro FX, gold, soybean, and other markets.

Coscia designed two computer programs, Flash Trader and Quote Trader, to implement a spoofing strategy, and had a computer programmer create the programs. Coscia used the programs in 17 different CME Group markets and three markets on the ICE Futures Europe exchange. The programs looked for certain market conditions favorable to the strategy, including price stability, low volume at the best prices, and a narrow bid-ask spread. The programs sometimes placed a “ping order” of one contract to test the market and ensure that the strategy would work well.

In one example, the program followed this sequence in the Euro FX market on September 1, 2011:

  • Entered a buy order for 14 contracts at the price of 14288, lower than any offer in the market;

  • 11 milliseconds later, entered three large sell orders: (1) 91 contracts at 14291; (2) 99 contracts at 14290; (3) 61 contracts at 14289. Market prices fell.

  • 7 milliseconds later, the buy order was filled.

  • 6 milliseconds later, the program cancelled the sell orders.

  • 5 milliseconds after the last large sell order was canceled, entered a sell order for 14289, higher than any bid on the market.

  • 22 milliseconds later, entered four large buy orders: (1) 88 contracts at 14284; (2) 88 contracts at 14286; (3) 88 contracts at 14287; (4) 61 contracts at 14288.

  • 9 milliseconds later, the buy order was filled.

By entering large orders it intended to cancel at the time it placed them, and caused to be canceled before other traders could fill them, the program made a profit by buying 14 contracts at 14288 and selling them at 14289 less than one second later. In total, Coscia allegedly made about $1.5 million from his spoofing activities.

Prison time and fines sought.Coscia was indicted for six counts of commodities fraud and six counts of spoofing. Each count of commodities fraud carries a maximum sentence of 25 years in prison and a $250,000 fine, and each count of spoofing carries a maximum penalty of 10 years in prison and a $1 million fine. Coscia will be arraigned on a future date in the U.S. District Court in Chicago.

The case is No. 14 CR 551.

MainStory: TopStory FraudManipulation CommodityFutures Enforcement

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