A New Jersey trader became the first person to be convicted on a charge of "spoofing," flooding the market with orders he did not intend to execute.
Though the conviction involved attempts to manipulate the commodities futures market, the ruling has implication for stock trading as the case provided a guideline to the somewhat nebulous concept of "spoofing."
Spoofing was made illegal by the 2010 Dodd-Frank Act.
Michael Coscia owned Panther Energy Trading, a New Jersey-based firm that traded commodity futures. The prosecution charged that over a three-month period in 2011, he made $1.4 million by "spoofing" in several commodity futures markets, including corn, soybeans, high-grade copper and gold.
As a greatly simplified example, prosecutors argued that Coscia might enter a series of orders to buy a commodity future at prices slightly higher than the market. Market participants would move the price up but when they tried to interact with the buy order it would vanish.
At the same time, the trader would sell contracts he or she already had bought at prices higher than was available a moment before.
This is not a new strategy. Stock manipulation — or commodity manipulation — has been around since the dawn of trading. This is a variant of the old "pump and dump" strategy. High-frequency trading just makes it faster to do it.
Coscia's attorney had argued that the law was vague and it was unclear what "spoofing" was, but the jury disagreed. It appears to have come down on the side of the prosecution, which had argued that "spoofing" occurs if a trader has an algorithm that is specifically designed to be canceled when anyone tries to interact with it.
The indictment also alleged that he had designed his programs to cancel orders within a fraction of a second, regardless of how they market was moving, because he had no intention of filling them, he simply wanted to trick others into reacting to the false prices.
In other words, intent plays a large part in defining "spoofing."
The jury in federal court in Chicago convicted him on six counts of commodities fraud and six counts of spoofing. The maximum sentence for commodities fraud is 25 years on each count and a $250,000 fine. Spoofing carries a maximum sentence of 10 years on each count and a $1 million fine.
The case is being watched closely by the second person to be criminally charged with spoofing, Navinder Sarao, a London-based trader also accused of market manipulation. Sarao has denied the allegations.
The case raises the following issues:
1) Will the verdict encourage more prosecutors to bring market manipulation cases? It's not clear, since these are very complex cases. But it certainly creates a clearer legal framework for prosecution.
2) Will it cause some traders to alter their trading strategies? Since Coscia's orders were only on the books for a fraction of a second, his target was clearly HFTs. Citadel and other HFT firms testified for the government against Coscia.
Since this is the first case brought under the new law, there's a good chance the verdict will be appealed. I'm sure there will be discussion around the judge's instructions to the jury on how they decided Coscia had a clear intent to defraud.