In the Courts

Seventh Circuit Upholds Spoofing Conviction

The first trader charged and convicted under Dodd-Frank's anti-”spoofing” provision lost his appeal at the U.S. Court of Appeals for the Seventh Circuit on Aug. 7. Michael Coscia, 54, was convicted by an Illinois federal jury in November 2015 on six counts of spoofing and six counts of commodities fraud. He was sentenced to three years in prison for perpetrating the bait-and-switch scheme. The Seventh Circuit upheld Coscia's conviction and rejected his arguments against the constitutionality of the anti-spoofing provision.

Spoofing is a method of manipulating future markets by placing large, fake orders intended to deceive other traders into thinking supply or demand for a given commodity has changed. The deception influences prices in a way that benefits smaller, real orders placed by the spoofing trader on the opposite side of the market. Once the price has moved in the direction he wants, the trader cancels the large orders before they can be filled and takes the profits on his smaller orders. The practice was first outlawed by the Dodd-Frank act in 2010 and carries a maximum sentence of 10 years in prison.

At the time of the spoofing in late 2011, Coscia was head of the futures and trading firm Panther Energy Trading LLC. Testimony at his trial showed that he used a sophisticated algorithm to place, cancel and execute orders on the Chicago Mercantile Exchange at the most opportune times. Coscia's algorithm could supposedly cancel large orders one quarter of a second after his smaller order was picked up.

Coscia testified that he had not been deceptive and intended to execute all the orders he placed. He presented evidence showing that 90% of all futures orders are cancelled before they are executed. He also claimed not to have known about Dodd-Frank's prohibition on spoofing, and ended his strategy after just 10 weeks following warnings from exchange regulators.

Prosecutors countered that Coscia frequently placed high-value orders that he later canceled. The designer of Coscia's algorithm programs, Jeremiah Park, testified that Coscia asked him to create programs that would act “like a decoy” and “pump the market.” Prosecutors claimed that Coscia earned $1.4 million by spoofing the soybean, gold, euro and British pound futures market.

On appeal, Coscia argued that Dodd Frank's anti-spoofing provision is unconstitutionally void for vagueness and that he therefore was not given proper notice of the law. He claimed that the use of quotations around the word “spoofing” indicated Congress's mistaken belief that spoofing was an established term of art in the industry. Further, he argued that the nonexistence of an official industry definition coupled with the lack of a Commodity Futures Trading Commission (CFTC) rule on the subject makes the term indecipherable for the average person. The Seventh Circuit rejected Coscia's arguments outright, pointing to the statute's definition of the term in a parenthetical immediately following the word “spoofing.” The court also said that Coscia's conviction was supported by sufficient evidence.

Although it took five years for prosecutors to gain their first spoofing conviction, regulators appear to be targeting perpetrators regularly now. CFTC Enforcement Director Aitan Goelman recently said, “Spoofing is a significant threat to market integrity that the CFTC will continue to vigorously investigate and prosecute.” A British trader, Navinder Sarao, pled guilty to spoofing U.S. futures markets in November 2016, allegedly earning himself $12.8 million in profits. He has not yet been sentenced. In January, Citigroup paid $25 million to settle claims by the CFTC that its traders spoofed U.S. Treasury futures from 2011 to 2012. The CFTC also fined the Japanese Bank of Tokyo-Mitsubishi UFJ $600,000 for the spoofing of U.S. futures markets.

—€ Dennis Mahoney, Mayer Brown