Two former JPMorgan traders in the United States were recently sentenced to jail, one for two years and the other for one year, for what has been referred to as a “prolific” spoofing case in the commodities market, echoing many aspects of the landmark Panther Energy Trading spoofing case from 2013. Spoofing has been an ongoing focus of regulators, with two recent instances, one in Australia and another in Israel, illustrating its global scope. We have also seen the regulatory focus broaden, with cases involving voice-brokered interest rate swaps (i.e., HSBC being fined 45M USD in 2023) and the EU Agency for the Cooperation of Energy Regulators (ACER) publishing guidance on spoofing in wholesale energy markets, such as gas and electricity. There is even a new Hungarian Energy and Public Utility Regulatory Authority (MEKH) market manipulation case involving fictitious orders in natural gas. Spoofing has also been a persistent concern in crypto-asset markets, with the EU addressing the behavior in the recently passed MiCA legislation.
Spoofing covers a broad set of market manipulation techniques that involve entering non-genuine orders (spoof orders) to create a misleading impression of the supply and demand of that asset. Usually, the goal is to attract orders into the market at the false price level to be profited from by the manipulator. In its modern form, it is often associated with layering and algorithmic trading (also known as “algos”), where algorithmic trading tools are used to build the complex layers of false orders and, in nano-seconds, adjust them so they don’t trade. However, algos are more likely to be manipulated than be the manipulator. As trading becomes increasingly automated in all asset classes, manipulators use spoofing techniques to create the market conditions that attract the automated algorithms. As a classic manipulation technique, spoofing has found a new form in our modern trading world.
Landmark case
One would be remiss to discuss spoofing without covering the relatively well-known Panther Energy Trading case involving the U.S. Commodity Futures Trading Commission (CFTC) and the U.K. Financial Conduct Authority (FCA). In 2011, Michael Coscia, the owner of Panther Trading, which was a High-Frequency Trading (HFT) firm, would first place a relatively small sell order in the market and then, through a tool the company had developed, place a series of increasingly higher priced, and large volume buy orders into the market. Though these large buy orders did not trade, they gave the impression of buy pressure on the market, eventually attracting others to trade against the original sell order, which sat at the new perceived market price. Coscia would then quickly cancel the buy orders and flip the strategy, placing a small buy order in the market at a lower price and placing increasingly better large sell orders to push the price down. While each part of his cycle would last only 300 milliseconds, the scheme netted Coscia 1.4M USD in three months. It also earned Coscia three years of jail time and 4.5M USD of total fines.
Though novel at the time, the Panther Energy Trading case is now seen as a classic example of spoofing. Since then, we’ve seen multiple variations of this theme. In 2022, the Securities and Exchange Commission (SEC) settled a case against Aleksandr Mildrud, a Canadian citizen who recruited online traders, primarily from China and Korea, whom he taught and then directed to perform spoofing on U.S. stocks manually. He instructed each recruit to use multiple accounts, separate them into “dirty” and “clean” accounts, trade in small quantities, spread their activity across various stocks, and keep their price manipulation small, typically pennies per trade. He even went so far as to instruct his recruits to use different computers with different IP addresses. The scheme was lucrative, with one of the trading groups generating profits of one million dollars per month. The Mildrud example showcases some of the measures that manipulators take to hide their activities.
Trillion-dollar flash crash
Spoofing has also been tied to financial market instability. London futures trader Navinder Sarao was charged with spoofing activity that contributed to the trillion-dollar flash crash in 2010. Sarao used what prosecutors called a dynamic layering technique, which involved placing huge sell orders, from 35 to 85 times the average market size, across multiple price steps. In this market, the ten best prices on each side are visible, and he placed his orders at levels 4 to 8; his trading program would constantly adjust the orders to be within that range, ensuring they didn’t trade. Sarao supplemented this by flashing huge orders, 285 times the average, into the book, impacting the overall order book imbalance. Using this technique, Sarao profited by buying at depressed prices and selling when prices recovered. Though it was determined that his activities did not cause the flash crash, there is a case to be made that the dynamic layering activities contributed to creating false order book imbalances ahead of the crash. Irrespective, the incident linked spoofing to market instability in many people’s minds, fostering the perception that it is a pervasive source of unfairness in the financial system.
Challenges in court
While there has been a continuous wave of cases in the past decade, the definition of spoofing and its prosecution have often proved challenging. Two interesting cases, one from Norway and one in Connecticut, show these difficulties. In the Connecticut case from 2018, Andre Flotron, a former UBS trader, was found not guilty of manipulating the precious metals futures markets through spoofing. This was the first acquittal in a U.S. criminal case involving spoofing. In a criminal case, there can be difficulty proving the intent of the orders because traders do cancel orders frequently for legitimate reasons. It appears the defense focused on this aspect, pushed against “prosecution by statistics” and accused prosecutors of cherry-picking trades.
In the Norwegian case, Svend Egil Larsen and Peder Veiby were handed a suspended prison sentence for market manipulation, which they successfully appealed in 2012. The Norwegian traders had discovered an automated market maker system was using very simplistic logic to adjust its quotes in illiquid securities. By placing small orders at slightly improved prices, the traders could cause the market maker system to move its prices as well; using this, they would place fake orders to improve the price and trade against the better prices. In the determination, the court decided that the men had acted in full transparency and considered an expert opinion, which argued the moves were accepted practice in the market. The small monetary value of the profits and the defense’s focus on a single system flaw being impacted (versus the market as a whole) also potentially contributed to the court’s decision. Both cases show the difficulty in determining the difference between legitimate and illegitimate activity.
Impact on the Industry
These cases have all had a lasting impact on the industry for three distinct reasons. Firstly, they fed into the fears of a public already wary of algorithmic and HFT trading, prompting regulators to tighten or extend existing rules and pay greater attention to this type of behavior. Secondly, they demonstrated the potential for new forms of market abuse as markets were modernizing, as well as their potential contribution to market instability. Thirdly, they shone a spotlight on the entire family of order-level manipulations. Factors that explain why they remain highly relevant today.
Regulatory Updates
21 November: The Australian Securities and Investments Commission (ASIC) announced its enforcement priorities for 2024, which include focusing on member services failures and misconduct related to the erosion of superannuation balances in the superannuation industry. Additionally, ASIC will prioritize technology and operational resilience for market operators and participants to maintain market integrity.
20 November: The Financial Services Regulatory Authority (FSRA) of Abu Dhabi Global Market (ADGM) published its 2024 Business Plan, outlining regulatory priorities and emphasizing the fight against financial crime. The FSRA intends to focus on innovation, efficient and safe markets, growth through sound regulation and cooperation, and building the future.
16 November: The Monetary Authority of Singapore (MAS) granted in-principle approval to three entities that “substantially comply” with its regulatory framework to issue stablecoins. MAS also revealed three initiatives to ensure the safe and innovative use of digital money in Singapore. The three initiatives include a blueprint outlining the infrastructure required for a digital Singapore dollar, expanding digital money trials, and a plan to issue a “live” central bank digital currency (CBDC) for wholesale settlement. The MAS also published the Orchid Blueprint, which details the necessary technology infrastructure to facilitate digital money transactions in the future.
16 November: The Canadian Securities Administrators (CSA) and the Canadian Investment Regulatory Organization (CIRO) published a summary of responses and comments to CSA/IIROC Staff Notice 23-329 Short Selling in Canada. In December 2022, the CSA and the Investment Industry Regulatory Organization of Canada (a predecessor organization to CIRO) sought input on the current regulatory framework surrounding short selling in Canada.
15 November: Chinese regulators instructed securities firms to stop expanding their over-the-counter derivatives operations involving individual stocks, including total return swaps and options, limiting a profitable business for the brokerage industry and dealing a blow to hedge funds. The move is part of the China Securities Regulatory Commission’s revised risk-control measures, which aim to support the economy while tightening regulations on riskier businesses like OTC derivatives.
14 November: The U.S. Securities and Exchange Commission (SEC) filed a total of 784 enforcement actions in the fiscal year 2023, including 501 original actions. These enforcement actions represent a 2% and 8% increase, respectively, from the previous fiscal year. The SEC also pursued 162 “follow-on” administrative proceedings and took action against 121 issuers for delinquent filings. These actions targeted various violations across the securities industry, from fraud and cybersecurity threats to enforcement of recordkeeping requirements and investor protection measures.
10 November: The U.K. will lead one of the first global committees to combat offshore crypto tax evasion and, alongside 48 jurisdictions, announced its intention to implement the Organization for Economic Co-operation and Development’s latest tax transparency standard, the Crypto-Asset Reporting Framework (CARF), to help combat criminals using crypto assets to avoid billions in missing tax.
9 November: The Swiss Financial Market Supervisory Authority (FINMA) published its 2023 Risk Monitor, identifying nine significant risks for the financial sector. Two new risks have been identified: liquidity and funding, as well as outsourcing business activities. These risks include ongoing macroeconomic uncertainties driven by geopolitical tensions, regional conflicts, high inflation, rising interest rates, energy costs, and recent banking sector stress. Each Risk Monitor explores one selected trend with the potential to impact the Swiss financial market over the long term; FINMA views the use of artificial intelligence as such a trend.
7 November: The CFTC released its enforcement results for fiscal year 2023, highlighting a record number of digital asset cases and actions to uphold regulatory obligations. The CFTC filed 96 enforcement actions in diverse markets, resulting in over $4.3 billion in penalties, restitution, and disgorgement, demonstrating their commitment to market integrity and customer protection.
6 November: The Bank of England (BoE) aims to expand its regulatory oversight to include stablecoins that have the potential to disrupt the financial sector.
2 November: The SEC adopted Regulation SE to establish a regulatory framework for the registration and regulation of security-based swap execution facilities (SBSEFs). This new regulation aligns closely with the CFTC’s rules for swap execution facilities, aiming to increase transparency and integrity in the security-based swap market.
31 October: The European Securities and Markets Authority (ESMA) published the latest quarterly liquidity assessment of bonds and the data for the quarterly systematic internalizer calculations for various financial instruments. The liquidity assessment includes 1,148 liquid bonds subject to transparency requirements, while the data for systematic internalizer calculations covers equity, bonds, and derivatives.
30 October: The U.K. government finalized its proposals for crypto asset regulation, aiming to bring crypto asset activities under the regulatory perimeter for financial services for the first time. These proposals reflect the government’s commitment to creating a regulatory environment that fosters innovation while ensuring financial stability and clear regulatory standards for the safe use of new technologies.
30 October: The MAS partnered with the Financial Services Agency of Japan (FSA), FINMA, and the United Kingdom’s Financial Conduct Authority (FCA) to advance digital asset pilots in fixed income, foreign exchange, and asset management products. The establishment of the Project Guardian policymaker group aims to promote cross-border collaboration, discuss legal and policy treatment of digital assets, and develop common standards for digital asset networks.
27 October: The CFTC and the French Autorité des marchés financiers (AMF) signed a Memorandum of Understanding (MOU) to enhance cooperation and information exchange in the supervision of regulated firms operating on a cross-border basis between the U.S. and France. The MOU establishes a framework for cooperation, including sharing information and conducting examinations of French swap dealers registered with the CFTC.
24 October: The EU formally agreed on new rules that would allow tax authorities to share data on individuals’ crypto holdings, rules which were first proposed last year to curb the practice of concealing crypto holdings overseas. These new rules, known as the Eighth Directive on Administrative Cooperation (DAC8), extend existing reporting requirements to cover a variety of digital assets, from stablecoins to non-fungible tokens (NFTs) and decentralized finance (DeFi) tokens.
23 October: The Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) tightened regulations on retail clients trading digital assets due to increased inquiries about distributing these products to investors. The new rules state that virtual asset-related products should only be offered to professional investors, with intermediaries required to assess clients’ knowledge of investing in virtual assets before transacting on their behalf.
Enforcement Actions & Fines
The SEC charged Payward Inc. and Payward Ventures Inc., also known as Kraken, with operating Kraken’s crypto trading platform as an unregistered securities exchange, broker, dealer, and clearing agency. The SEC alleges that Kraken unlawfully facilitated the buying and selling of crypto asset securities, intertwining the functions of an exchange, broker, dealer, and clearing agency without proper registration, depriving investors of necessary protections, and presenting risks to customers.
A London hedge-fund manager was convicted in the U.S. of fraud for manipulating the U.S. dollar to South African rand foreign exchange market in a case related to options barrier chasing and defending. The former chief investment officer of Glen Point Capital was found guilty of commodities fraud but acquitted of a separate conspiracy charge. He was the counterparty on a $20 million option pegged to a “barrier” exchange rate between the U.S. dollar and the South African rand.
The SEC filed a motion for summary judgment in its ongoing legal battle against Do Kwon and Terraform Labs. The SEC argues that the evidence against them is so compelling that a trial is unnecessary, alleging a fraudulent scheme that led to a $45 billion market loss through unregistered transactions and misleading investors.
The Dubai Financial Services Authority (DFSA) fined FFA Private Bank (Dubai) Limited (FFA) $373,842 (AED 1,373,122) for inadequate systems and controls to identify, assess, and report trading exhibiting suspicions of market abuse. This action follows a prohibition on FFA from receiving orders from specific clients, which was lifted after addressing weaknesses in systems and controls, concluding the DFSA’s investigation.
The SEC announced fraud charges against four New York, U.S. individuals for a multi-year “free riding” scheme that resulted in over $2 million in illicit profits. The SEC alleges that the defendants opened brokerage accounts (the victim accounts) that provided the defendants an instant deposit credit once the defendants initiated a transfer of funds to those accounts from related bank accounts, but before the fund transfer was completed. The complaint alleges that, through this scheme in which the defendants controlled both sides of the transactions, they were able to generate guaranteed profits at the victim accounts’ brokerage firm’s expense. The defendants allegedly conducted the fraudulent scheme during the relevant period through at least 600 brokerage accounts.
The SEC charged software company SolarWinds Corporation and its chief information security officer (CISO) with fraud and internal control failures related to cybersecurity risks and vulnerabilities. The SEC alleges that SolarWinds and its CISO misled investors by overstating cybersecurity practices and understating risks, leading to a drop in the company’s stock price. The complaint seeks permanent injunctive relief, disgorgement, civil penalties, and an officer and director bar against the CISO.
The SEC fined BlackRock Advisors LLC, an investment adviser, $2.5 million for inaccurately describing investments in a publicly traded fund it advised. BlackRock failed to accurately describe its significant investments in Aviron Group LLC, a company involved in film development, in its reports to investors. BlackRock consented to the SEC’s order and agreed to a cease-and-desist order, a censure, and a penalty.
The SEC charged SafeMoon LLC, its creator, SafeMoon US LLC, and the companies’ executives for perpetrating a fraudulent scheme through the unregistered sale of the crypto asset security SafeMoon. The defendants promised massive profits but instead caused significant losses and misappropriated investor funds for personal use, resulting in billions in market capitalization being wiped out.
The SEC charged the president and chief compliance officer of Prophecy Asset Management LP for his involvement in a multi-year fraud that concealed losses of hundreds of millions of dollars from investors. According to the SEC’s complaint, the individual led investors to believe that their investments were protected from loss; however, most of the funds’ capital went to one sub-adviser, who incurred massive trading losses that far exceeded the cash collateral he had contributed. The individual caused the funds to invest in highly illiquid investments, resulting in substantial losses. The individual concealed these losses by fabricating documents and engaging in a series of sham transactions to cover up the actual financial condition of the funds.
Featured Content
Tech Tuesday: Gatekeepers of the Securities Markets
Latest articles
This data feed is not available at this time.
Data is currently not available