Spoofing – Why Do Regulators Treat It Differently?
Last Thursday we took a road trip to Washington DC to meet with some of our regulators and also give an equity market structure briefing to a number of Congressional staffers. Here is part of the press release from Congressman Lynch on our briefing:
Lynch Hosts Equity Market Structure Briefing
Oct 25, 2014
| WASHINGTON, D.C. – On Thursday, October 23rd, the Office of CongressmanStephen F. Lynch hosted a briefing on equity market structure with Joseph Saluzzi.
Joseph Saluzzi is partner, co-founder and co-head of equity trading at Themis Trading LLC, a leading independent agency brokerage firm that trades equities for institutional money managers and hedge funds.
One topic that came up during one of our other meetings in DC was “spoofing” and how the SEC and CFTC differ in their definition of this illegal activity. The CFTC was issued new powers under Dodd-Frank (section 747) which allows them to much more aggressively pursue spoofers:
Section 4c(a)(5) of the Commodity Exchange Act (CEA) as amended by Dodd-Frank Act section 747 makes it unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that–
1. violates bids or offers;
2. demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or
3. 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).
In their final interpretative guidance on section 747, the CFTC said:
“The Commission interprets a CEA section 4c(a)(5)(C) violation as requiring a market participant to act with some degree of intent, or scienter, beyond recklessness to engage in the “spoofing” trading practices prohibited by CEA section 4c(a)(5)(C).
When distinguishing between legitimate trading (such as trading involving partial executions) and “spoofing,” the Commission intends to evaluate the market context, the person’s pattern of trading activity (including fill characteristics), and other relevant facts and circumstances.
As with other intent-based violations, the Commission intends to distinguish between legitimate trading and “spoofing” by evaluating all of the facts and circumstances of each particular case, including a person’s trading practices and patterns.
The CFTC rules allow them to more aggressively pursue spoofers since they are not required to prove manipulative intent but only required to prove some degree of intent (the CFTC has already used their new powers in the Panther Energy Trading case ).
However, the burden of proof for spoofing is much higher for the SEC which is probably why we have not seen many securities spoofing cases. The most recent case that the SEC brought was against Visionary Trading in May of this year. They had to prove that Visionary “willfully violated Section 9(a)(2) of the Exchange Act, which makes it unlawful “to effect, alone or with one or more other persons, a series of transactions in any security . . . creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.”
One reason spoofing is so difficult for the SEC to prove is the tremendous amount of data that they have to analyze across multiple market centers. Over two years ago, former SEC Chairman Schapiro recognized this problem and proposed the Consolidated Audit Trail to help the SEC deal with this avalanche of data. At the time she said :
“A consolidated audit trail that accurately tracks orders throughout their lifecycle and identifies the broker-dealers handling them will provide us with an unprecedented ability to effectively oversee the markets we regulate.”
Unfortunately, we are still years away from the CAT’s implementation. In the meantime, would-be spoofers in the securities market know they are being surveilled by a regulator that neither has the technology or the strict rules to catch them.