Resolutions of criminal actions—including jury verdicts and pleas—highlighted developments in the financial services industry last week. Among these actions were Michael Coscia being convicted in a widely followed case involving the new Dodd-Frank provision of law prohibiting spoofing, and two former employees of the New York Federal Reserve Bank pleading guilty to criminal charges in connection with leaks of non-public information. Meanwhile, the Securities and Exchange Commission’s Director of Enforcement endeavored to calm chief compliance officers by saying that the agency was not out to get them despite a number of recent SEC enforcement actions against CCOs of investment advisers. As a result, the following matters are covered in this week’s edition of Bridging the Week:
After a seven-day trial in Chicago, Michael Coscia was convicted last week 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 had initially been indicted for such offenses in October 2014.
According to his indictment, during the relevant time, Mr. Coscia utilized two computer-driven algorithmic trading programs that repeatedly placed small buy or sell orders in a market, followed by the rapid placement and retraction of large orders—so called “quote orders”—on the opposite side of his small orders. He supposedly did this in order to deceive the market and help ensure the execution of his small orders at favorable prices.
After the initial small orders were executed, Mr. Coscia would reverse the process—placing new small orders on the opposite side of the market as his initial filled orders and large quote orders on the opposite side of the new small orders. He allegedly traded this way in order to ensure the fills of the new small orders and profits on the overall transaction.
This case marked the first indictment and conviction under the new anti-spoofing provision of relevant law that was added as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.
Previously, the Commodity Futures Trading Commission, the UK Financial Conduct Authority and the Chicago Mercantile Exchange had all brought enforcement proceedings in July 2013 against Mr. Coscia and his trading company Panther Energy Trading LLC, and entered into simultaneous settlements with Mr. Coscia and Panther related to the same conduct, assessing aggregate sanctions in excess of approximately US $3 million and various trading prohibitions. The CME also required disgorgement of US $1.3 million of trading profits. (Click here to access more information on these civil enforcement actions in the article “CFTC, UK FCA and CME File Charges and Settle With Proprietary Trading Company and Principal for Spoofing” in the July 22, 2013 edition of Between Bridges.)
The jury hearing Mr. Coscia’s criminal case took approximately one hour to render a decision. Sentencing is scheduled to occur on March 17, 2016. Mr. Coscia could face 25 years in prison and a US $250,000 fine for each count of commodities fraud, and 10 years in prison and a US $1 million fine for each count of spoofing.
Prior to his trial, Mr. Coscia filed a motion to dismiss his indictment as a matter of law, claiming that the federal law regarding spoofing was “hopelessly vague, and its criminal enforcement would violate [his] right to due process of law.” The Court rejected this motion. (Click here for further information regarding Mr. Coscia’s indictment in the article, “NJ-Based Trader Previously Sanctioned by UK FCA, CFTC and CME Indicted in Chicago for Same Spoofing Offenses” in the October 5, 2014 edition of Bridging the Week.)
My View: As I wrote at the time of Mr. Coscia’s indictment: “[w]hatever the merits of this action, a major policy concern is the chilling effect the knowledge of impending or likely criminal charges will have on persons eager to settle their exchange or government-driven civil enforcement matters and move on. Here, Mr. Coscia not only paid a substantial penalty for his actions, he disgorged most of his profits and agreed to trading prohibitions—thus substantially impacting his future livelihood. If the purposes of criminal sanctions are to act as a deterrent, punish individuals and encourage the rehabilitation of wrongdoers, it is not clear what the incremental benefit of imposing additional penalties in this criminal action may be. Moreover, it is also not clear how this effectively redundant legal proceeding (albeit a criminal action with the prospect of incarceration) … justifies the expenditure of limited tax dollars—other than to generate dramatic headlines. These musings are not to condone illicit conduct—which should be appropriately punished—but solely to ask: when is enough enough?” With Mr. Coscia’s verdict now rendered, what once was just a potentially chilling effect becomes downright cold.
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 abundantly clear what is prohibited by this provision, 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 an 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 its interpretation of its rule related to market disruption, goes even further by suggesting there is a difference between intent and hope when placing an order. According to CME, “[m]arket participants may enter stop orders as a means of minimizing potential losses with the hope that the order will not be triggered. However, it must be the intent of the market participant that the order will be executed if the specified condition is met.” (Click here to access CME Group Advisory, RA-1515-5.)
Potentially, every individual that a regulator might seek to prosecute for spoofing, will likely hope that some orders might not be executed, but is likely okay for the orders to be executed if they are — i.e., if the specified market conditions are met!
Moreover, in its Advisory, CME Group 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. 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’s “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.
Until the law is 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, as well as inadvertently to cause some market participants to run afoul of the law for ordinary order placement activity.
Compliance Weeds: In light of recent heightened attention by the Commodity Futures Trading Commission and exchanges to alleged market disruption activities by traders, it is worth recalling that the CFTC takes a broad view of a future commission merchant’s duty to supervise all commodity interest accounts “carried, operated, advised or introduced” by a registrant, while the CME Group has a rule that generally states that “[i]f a clearing member has actual or constructive notice of a violation of Exchange rules in connection with the use of Globex by a non-member for which it has authorized a direct connection and the clearing member fails to take appropriate action, the clearing member may be found to have committed an act detrimental to the interest or welfare of the Exchange.” ICE Futures U.S. has an equivalent rule. (Click here to access ICE Futures U.S. Rule 27.04(d).) FCMs should consider their potential obligations, if any, under these provisions to monitor for potential disruptive trading activities by clients, as well as how to respond when they may have red flags regarding such conduct.
Four criminal actions against individuals involved in the financial services industry were resolved in New York last week through, in one case, a jury verdict, and in the other cases, plea agreements.
Anthony Allen and Anthony Conti, residents of England, were found guilty by a jury in New York of manipulating the London InterBank Offered Rates for US dollar and Yen benchmark interest rates at various times from mid-2005 through 2011. Both individuals were previously traders for Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A. (Rabobank).
In October 2013, Rabobank itself entered into a deferred prosecution agreement with the US Department of Justice and agreed to pay sanctions of US $325 million as well as also settled civil charges with the Commodity Futures Trading Commission and the UK Financial Conduct Authority for violations related to its LIBOR submissions. The CFTC had charged that Rabobank, “through the acts of certain traders and managers located throughout the world, engaged in hundreds of manipulative acts that undermined the integrity of LIBOR and Euribor.” (Click here for additional details of the CFTC and FCA actions in the article, “CFTC and FCA Fine Rabobank over LIBOR” in the November 4, 2013 edition of Bridging the Week.)
Mr. Allen, in addition to being a trader for Rabobank, was also its global head of liquidity and finance and the manager of the bank’s money market desk in London. Sentencing is scheduled for March 10, 2016.
Separately, as expected, Rohit Bansal, a former employee of Goldman, Sachs & Co and the New York Federal Reserve Bank, and Jason Gross, a former employee of the New York Fed only, pled guilty to charges related to the unauthorized use of non-public confidential information by Mr. Bansal while employed by Goldman which he obtained from Mr. Gross. (Click here for details regarding this matter in the article, “Investment Bank Group Fined US $50 Million by NY State Agency for Actions of Malfeasant Employee” in the November 1, 2015 edition of Bridging the Week.) Mr. Bansal and Mr. Gross are scheduled to be sentenced in early March 2016.
Finally, Michael Oppenheim, a former employee of J.P. Morgan Securities LLC, pled guilty to embezzlement and securities fraud in connection with his theft of US $22 million from investors over a seven-year period. According to the US Attorneys Office in Manhattan, Mr. Oppenheim told his clients he would invest their money in low-risk municipal bonds and sent them fake account statements while using their funds for his personal purposes. Mr. Oppenheim is scheduled to be sentenced on February 15, 2016.
My View: Mr. Ceresney’s comments on potential CCO liability, as well as the comments of Andrew Donohue, chief of staff of the Securities and Exchange Commission, a few week’s ago, are valiant efforts to at least define the very few types of fact patterns that may prompt an SEC enforcement action against a CCO. However, SEC officials must make clear that, at a minimum, the agency will not proceed against CCOs for violations of rules that do not apply to them when the language of the rule is, at best, unclear, and, more objectively, seemingly not applicable at all. Under the relevant provision of the rule under which a number of CCOs recently have been charged, it is the responsibility of an investment adviser to “adopt and implement” written policies and procedures reasonably designed to prevent law and rule violations and to review such policies and procedures at least annually for effectiveness. It is the legal requirement of CCOs solely to administer such policies and procedures. (Click here to access the relevant SEC rule—SEC Rule 275.206(4)-7). As pointed out in the separate statement of former SEC Commissioner Daniel Gallagher to the recent settlement order of Eugene Mason, the CCO of SFX Financial Advisory Management Enterprises, SEC enforcement actions imposing obligations on CCOs not explicitly required by a rule send “a troubling message that CCOs should not take ownership of their firm’s compliance policies and procedures, lest they be held accountable for conduct that … is the responsibility of the adviser itself. Or worse, that CCOs should opt for less comprehensive policies and procedures with fewer specified compliance duties to avoid liability when the government plays Monday morning quarterback.” (Click here for further background and commentary on the SEC enforcement action involving SFX in the article “Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally,” in the June 21, 2015 edition of Bridging the Week.)
Compliance Weeds: Beginning October 12, CME Group introduced futures-style options. The principle difference between premium-style and futures-style options is that with premium-style options, premium is calculated at the original trade price and is recognized in a settlement cycle on the day the trade first clears, while with futures-style options, initial margin is assessed against both sides from the initiation of a trade—just like with ordinary futures contracts. As long as a premium-style options contract remains open, the current market value of the option is subtracted in the case of a long option and added in the case of a short option, to determine initial margin requirements. For a futures-style option, after the initial trade event, the option is daily marked to market and variation margin is paid or collected just like with a futures contract. The first futures style options contract on CME Group involved a futures-style option on NYMEX Brent Crude Oil futures. (Click here for further details on the clearing process for futures-style options on CME Group.)
And more briefly:
For more information, see:
Alleged Criminal Conduct Snares Multiple Ex-Financial Services and Regulator Defendants in New York:
Another Bank Fined for Sanctions Evasion:
Block Trade No-Action Extended for SEFs:
Canadian Regulators Also Float Crowdfunding Proposal:
CFTC Chairman Says Agency Working to Improve Swap Data Reporting:
Claims of Disruptive Trading, EFPs and Position Limit Violations Prompt Sanctions by CME Group:
CME Group Proposes Changes to Transfer Trade Rules and Issues Position Limit Guidance:
CPOs Are Reminded of Their Ps and Qs – and Rs Too – While CTAs Are Helped With Their PR Only:
ESMA Consults on Indirect Clearing:
FCA Consults on Implementation of Market Abuse Regulation:
Jury Convicts Michael Coscia of Commodities Fraud and Spoofing:
NFA Publishes a Regulatory Guide for Forex Transactions:
SEC Enforcement Director Tells CCOs Not to Worry as Another CCO Named in SEC Enforcement Action:
SEC Sues Individual for False Tweets to Manipulate Prices of Two Stocks:
2015 Enforcement Results Highlighted by CFTC:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of November 7, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.