Spoofing

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"Spoofing" is a practice in which traders attempt to give an artificial impression of market conditions by entering and quickly canceling large buy or sell orders onto an exchange, in an attempt to manipulate prices. Though the tactic has long been used by some traders, regulators have begun clamping down on the practice. The 2010 Dodd-Frank Act specifically forbids spoofing.[1]

Spoofing Example

A trader engaging in spoofing places limit orders outside the current bid and ask levels in order to change the reported price to other market participants. The trader can then place trades with market makers based on that artificial change in the price, subsequently removing the spoofing orders before they can be executed.

For example, a trader wishes to sell shares of Chococorp. Shares of the company are currently bid at $10.00 with an ask price of $10.20, so a market order to sell his shares would receive a sale price of $10.00. The trader places an order to buy a few hundred shares at $10.10, still some distance from the current ask price to keep it from being executed.

The $10.10 bid is reported as the National Best Bid and Offer best bid price. The trader then issues a sell order to a market maker for several thousand shares of Chococorp at $10.10. Since the best reported price is at $10.10, the market maker fills the sell order at that price. The trader then cancels the buy at $10.10, having received a higher price on the sale of his stock by using orders he had no intention of filling.[2]

Some analysts say that spoofing has the potential to undermine confidence in the markets because it can distort prices and lead investors to feel tricked. Some firms have developed software to red-flag suspected spoofing.[3] However, spoofing can be hard to define because there are many legitimate reasons to cancel orders.

Regulation and Enforcement

The 2010 Dodd-Frank law outlawed spoofing, but left it to regulators such as the CFTC and SEC to write specific rules. The CFTC issued staff guidance on disruptive trade practices in May 2013.

In 2014, the U.S. Attorney’s office in Chicago brought the first criminal case against an alleged spoofer, Michael Coscia. In November 2015, Coscia was convicted on six counts of commodities fraud, and in July 2016 he was sentenced to three years in prison.[4] The Securities and Exchange Commission and CFTC have brought several civil spoofing cases since 2012, but Coscia was the first person prosecuted under the CFTC's 2013 guidelines.[5]

The CME Group in August of 2014 submitted a rule to the CFTC, rule 575, which addressed the issue of spoofing.[6] Intercontinental Exchange submitted similar rule clarifications in January 2015.

In April 2015, UK authorities charged Navinder Singh Sarao with wire fraud, manipulation and commodities fraud, using illegal trading strategies such as spoofing and claiming his firm, Nav Sarao Futures Limited PLC, contributed to the May 2010 "Flash Crash."[7] He was also charged by the U.S. Commodity Futures Trading Commission with unlawfully manipulating, attempting to manipulate, and spoofing in the E-mini S&P 500 futures contracts.[8]

Also in April 2015, CME Group's Comex division suspended two metals traders for 60 days for alleged spoofing violations.[9]

In January 2017, the CFTC fined Citigroup $25 million for spoofing between July 2011 and December 2012 in the US Treasury futures.[10]

On January 29, 2018, the US Justice Department and the CFTC filed civil and criminal charges against UBS, Deutsche Bank and HSBC and six individuals in the largest spoofing case to date. The CFTC issued an order filing and settling charges against Deutsche Bank AG and Deutsche Bank Securities Inc., charging the firm with spoofing on precious metals futures on CME Group's COMEX market from February 2008 to September 2014. The firm was fined $30 million. UBS was charged with attempting to manipulate precious metals futures contracts on COMEX between January 2008 and December 2013. It was ordered to pay $15 million in fines. HSBC was charged with numerous acts of spoofing in gold and precious metals futures on COMEX through one of its traders based in New York. It was fined $1.6 million.

Six individuals were also charged. Krishna Mohan was charged with spoofing on the CME Group Mini-sized Dow futures, Jitesh Thakkar of Edge Financial Technologies with spoofing in CME Group E-mini S&P 500 futures, Jiongsheng Zhao, of Australia, with spoofing and engaging in a manipulative and deceptive scheme in the E-mini S&P 500 futures, James Vorley, a U.K. resident, and Cedric Chanu, a United Arab Emirates resident, in precious metals, and Andre Flotron, of Switzerland, in precious metals. [11] [12][13]

Also See: "Layering"

References

  1. As ‘Spoof’ Trading Persists, Regulators Clamp Down. The Wall Street Journal.
  2. SEC CHARGES SIX INDIVIDUALS WITH SPOOFING. Securities and Exchange Commission.
  3. 5 Things to know about spoofing in financial markets. The Wall Street Journal.
  4. High Frequency Trader Sentenced In First Criminal "Spoofing" Case. Mondaq News Alerts.
  5. As ‘Spoof’ Trading Persists, Regulators Clamp Down. Wall Street Journal.
  6. New CME Rule on Disruptive Trading Practices Summary Chart. JD Supra.
  7. U.K. Man Arrested on Charges Tied to May 2010 ‘Flash Crash’. The Wall Street Journal.
  8. CFTC Charges U.K. Resident Navinder Singh Sarao and His Company Nav Sarao Futures Limited PLC with Price Manipulation and Spoofing. CFTC.
  9. CME Group suspends two gold futures traders for allegedly spoofing. Reuters.
  10. Citigroup to Pay $25 Million to Settle Spoofing Claims. Wall Street Journal.
  11. CFTC Files Eight Anti-Spoofing Enforcement Actions against Three Banks (Deutsche Bank, HSBC & UBS) & Six Individuals. CFTC Press Release.
  12. U.S. authorities charge three banks, eight individuals in futures 'spoofing' probe. Reuters.
  13. Justice Department Charges Eight Traders With Deceptive Futures Market Trading. Wall Street Journal.