Spoofing Orders

Verified Timeline

Lore & Background

The narrative weight of spoofing lies in its role as a catalyst for regulatory investigation and legal consequences. Under the 2010 Dodd–Frank Act, spoofing is defined as 'the illegal practice of bidding or offering with intent to cancel before execution.' In July 2013, the US Commodity Futures Trading Commission (CFTC) and Britain's Financial Conduct Authority (FCA) brought a milestone case against spoofing, representing the first Dodd-Frank Act application. A federal grand jury in Chicago indicted Panther Energy Trading and Michael Coscia, a high-frequency trader. In 2011, Coscia placed spoofed orders through CME Group Inc. and European futures markets with profits of almost $1.6 million. Coscia was charged with six counts of spoofing, each carrying a maximum sentence of ten years in prison and a maximum fine of one million dollars. The illegal activity took place in a six-week period from August 8, 2011 through October 18, 2011 on CME Group’s Globex trading platform. They used a 'computer algorithm that was designed to unlawfully place and quickly cancel orders in exchange-traded futures contracts.' They placed a 'relatively small order to sell futures that they did want to execute, which they quickly followed with several large buy orders at successively higher prices that they intended to cancel.' Britain's FCA also fined Coscia and his firm approximately $900,000 for 'taking advantage of the price movements generated by his layering strategy' relating to his market abuse activities on the ICE Futures Europe exchange. They earned US$279,920 in profits over the six weeks period 'at the expense of other market participants – primarily other High Frequency Traders or traders using algorithmic and/or automated systems.'

In Their Own Story

On April 21, 2015, five years after the incident, the U.S. Department of Justice laid '22 criminal counts, including fraud and market manipulation' against Navinder Singh Sarao, who became known as the Hounslow day-trader. Among the charges included was the use of spoofing algorithms, in which, just prior to the 2010 Flash Crash, he placed thousands of E-mini S&P 500 stock index futures contract orders. These orders, amounting to about '$200 million worth of bets that the market would fall' were 'replaced or modified 19,000 times' before they were cancelled that afternoon. The CTFC concluded that Sarao 'was at least significantly responsible for the order imbalances' in the derivatives market which affected stock markets and exacerbated the flash crash. Sarao began his alleged market manipulation in 2009 with commercially available trading software whose code he modified 'so he could rapidly place and cancel orders automatically.' Sarao is a 36-year-old small-time trader who worked from his parents’ modest semi-attached stucco house in Hounslow in suburban west London. For years, Sarao denounced high-frequency traders, some of them billion-dollar organisations, who mass manipulate the market by generating and retracting numerous buy and sell orders every millisecond ('quote stuffing') — which he witnessed when placing trades at the Chicago Mercantile Exchange (CME).

Reader's Guide

Spoofing operates by creating a false signal in the order book to manipulate price discovery. In Australia, layering and spoofing in 2014 referred to the act of 'submitting a genuine order on one side of the book and multiple orders at different prices on the other side of the book to give the impression of substantial supply/demand, with a view to sucking in other orders to hit the genuine order. After the genuine order trades, the multiple orders on the other side are rapidly withdrawn.' In a 2012 report, Finansinspektionen (FI), the Swedish Financial Supervisory Authority defined spoofing/layering as 'a strategy of placing orders that is intended to manipulate the price of an instrument, for example through a combination of buy and sell orders.' In the U.S. Department of Justice April 21, 2015 complaint against Navinder Singh Sarao, he appeared 'to have used this 188-and-289-lot spoofing technique in certain instances to intensify the manipulative effects of his dynamic layering technique...The purpose of these bogus orders is to trick other market participants and manipulate the product's market price.' He employed the technique of dynamic layering, a form of market manipulation in which traders 'place large sell orders for contracts' tied to the Standard & Poor's 500 Index. CFTC's Enforcement Director, David Meister, explained the difference between legal and illegal use of algorithmic trading: 'While forms of algorithmic trading are of course lawful, using a computer program that is written to spoof the market is illegal and will not be tolerated. We will use the Dodd Frank anti-disruptive practices provision against schemes like this one to protect market participants and promote market integrity, particularly in the growing world of electronic trading platforms.'

Did You Know?

• Under the 2010 Dodd–Frank Act, spoofing is defined as 'the illegal practice of bidding or offering with intent to cancel before execution.'
• Michael Coscia was charged with six counts of spoofing, each carrying a maximum sentence of ten years in prison and a maximum fine of one million dollars.
• Navinder Singh Sarao placed about '$200 million worth of bets that the market would fall' which were 'replaced or modified 19,000 times' before they were cancelled on the day of the 2010 Flash Crash.
• The CME group was described as being in a 'massively conflicted' position as they make huge profits from HFT (high frequency trading) and algorithmic trading.
• On 18 April 2014, a class-action lawsuit was filed on behalf of the city of Providence, Rhode Island, naming 'every major stock exchange in the U.S.' and major Wall Street firms including Goldman Sachs, Citigroup, JPMorgan and the Bank of America.