SPOOFING THE MARKET
The case of a U.S. commodities trader shows parts of Dodd-Frank legislation are working,
On March 17, 2016, commodities trader Michael Coscia is scheduled to be sentenced in a Chicago courtroom, having been convicted last month on six counts of commodities fraud and six counts of “spoofing.”
The etymology of spoofing in this application proves elusive, but the practice is easy enough to explain. As defined by the U.S. Commodity Exchange Act, spoofing is a technique where orders — bids to buy and offers to sell — are placed with the intent of cancelling the trade before execution. So the markets get spoofed. Fooled. Manipulated.
A flash boys trick, in other words, to create the illusion of trading activity with the fraudulent intent of capitalizing on any price movements that occur as a result of other traders being lured to the (nonexistent) action.
Leaving aside for a moment computer algorithms and the warpspeed world of high-frequency trading, let us cast our minds back a half century to the Queen Bee of mining — Viola MacMillan — and the heyday of penny mining prospecting in Ontario. Those with long memories, along with contemporary business students, will recall the Windfall scandal and MacMillan’s wash trading conviction in Consolidated Golden Arrow Mines.
Again, the illusion of hot trading activity was conjured, this time via a single player buying and selling — washing — trades through fictitious accounts. (MacMillan was sentenced to nine months and served seven weeks.)
Unearthing a comparison from the pre-computer era is apt because it was due to the Windfall scandal that the province ushered in tighter securities regulation, made the Toronto scene tougher on penny miners and witnessed the exodus of sketchy promoters to more welcoming regulatory climes. (Of course I mean Vancouver and of course by “welcoming” I mean “lax.”)
Again we learn the tried and true lesson that history is bound to repeat itself.
Coscia’s guilty conviction is worth citing for this purpose: it was the first conviction for that offence under the Dodd-Frank Act, the omnibus legislation that passed its fifth anniversary last summer.
In the wake of the financial crisis, Dodd-Frank was designed to usher in transparency and enhanced federal regulation as a fix for what U.S. President Barack Obama deemed a broken regulatory system for which Wall Street was to blame. Spoofing was included in the Disruptive Practices amendment to the Commodity Exchange Act. Coscia was found guilty of spoofing futures contracts on commodities including gold, soybean oil and high-grade copper. Each count carries a maximum 10-year prison sentence and a $1-million (U.S.) fine.
Coscia’s is not a stand-alone case. The industry will be keenly watching when Navinder Singh Sarao attends an extradition hearing in the U.K. in February. The flash trader, famous for making £30 million while trading from his parents’ modest home in suburban London, thus earning him the nickname the Hound of Hounslow, is wanted in the U.S. on 22 counts of fraud and commodity manipulation.
You might think that the spoofing cases would help burnish DoddFrank and its slate of initiatives, including creation of the Consumer Financial Protection Bureau (CFPB). But you would be wrong. The year ahead promises to be the staging ground for the fiercest attacks yet against the law, led by House Financial Services Committee Chairman Jeb Hensarling, a Republican from Texas. Hensarling is behind legislation now being drafted aimed at dismantling much of Dodd-Frank. Last summer, writing in the Wall Street Journal, he declared that it was time to “replace” Dodd-Frank, claiming that the legislation has done more harm to Main Street through tougher-toget mortgages and higher bank fees than it has done to rein in Wall Street. The complexity of the legislation has swamped community financial institutions, he wrote, and that in turn has had an impact on the issuance of small business loans.
Even the CFPB has drawn Hensarling’s wrath, calling it the “single most unaccountable agency in the history of America.”
The damnable part of this is that Hensarling’s pitch may sell well in an election year. The risk is that too much will be undone — even the parts that seem to be working.
You might think that the spoofing cases would help burnish the Dodd-Frank Act and its slate of initiatives. You would be wrong