On July 22, 2013, regulators from the United States Commodity Futures Trading Commission (CFTC) and the British Financial Conduct Authority (FCA) fined high frequency trader Michael Coscia (and his firm Panther Energy Trading) for engaging in spoofing transactions for the purpose of layering bids or offers. As we have previously written, a “spoof” occurs when a trader bids or offers with the intent—and intent is the key to a spoof—to cancel the bid or offer prior to execution. In this case, Coscia spoofed by placing algorithmic bids or offers on Globex, which he intended to, and did, cancel prior to execution.

Coscia spoofed to engage in layering. The FCA described layering as placing small orders and then larger orders to create a false impression of liquidity. Then the larger orders were cancelled, which induced the market to trade the small orders. The FCA said:

Coscia’s layering strategy typically meant placing a small order, which he intended to trade on one side of the order book, followed by a series of large orders on the opposite side of the order book, which were not genuine. These larger orders—typically 20 times the average size of orders placed by other market participants—were designed to create a false and misleading impression of liquidity for those products, and induce the market to trade the smaller orders. The execution of the small order would then trigger the immediate cancellation of the large orders. This pattern would then be repeated on the opposite side of the order book in order to make a profit from price movements generated by the trading strategy. FCA fines US based oil trader US $903K for market manipulation Financial Conduct Authority Press Release at note 3.

The CFTC described the spoofing and layering strategy in the context of trading Light Sweet Crude Oil futures. The strategy was to use large orders—which were intended to be cancelled—to induce the purchase of a small sell order at a profit (and at the expense of other high frequency traders or traders using algorithmic and/or automated systems.)

1. The algorithm placed a relatively small order on one side of the market at or near the best price being offered to buy or sell, in this instance a sell order for 17 contracts at a price of $85.29 per barrel, which was a lower price than the contracts then being offered by other market participants.
2. Within a fraction of a second, Coscia entered orders to buy a relatively larger number of Light Sweet Crude Oil futures contracts at progressively higher prices: the first bid at $85.26, the second bid at $85.27, and the third bid at $85.28. The prices of these bids were higher than the contracts then being bid by other market participants.
3. Coscia placed the large buy orders to give the market the impression that there was significant buying interest, which suggested that prices would soon rise, raising the likelihood that other market participants would buy the 17 lots he was then offering to sell.
4. But Coscia entered into the large buy orders with the intent that these buy orders be cancelled before the orders were actually executed.
5.  This strategy sought to capture an immediate profit from selling the 17 lots. As the CFTC concluded, “if the program successfully filled the small 17-lot sell order, the large buy orders were immediately cancelled and the algorithm was designed to promptly operate in reverse. That is, the algorithm would then enter a small buy order in conjunction with relatively large sell orders at progressively lower prices, which sell orders Coscia intended to cancel prior to execution.” In the Matter of: Panther Energy Trading LLC and Michael J. Coscia, CFTC Docket No. 13-26, Order Instituting Proceedings Pursuant to Section 6(c) and (d) of Commodity Exchange Act, as Amended, Making Findings and Imposing Remedial Sanctions, July 22, 2013, at 3.

For this activity, the FCA fined Coscia and Panther approximately $900,000, the first time the FCA has taken enforcement action against a high frequency trader. The CFTC fined them $1.4 million, ordered disgorgement of $1.4 million and prohibited them from trading on any registered entity for one year.

The one-year trading ban could have been higher. Referring to high frequency traders as “cheetahs” because of their speed, CFTC Commissioner Bart Chilton argued for a much more significant trading ban to “protect markets and consumers, and to act as a sufficient deterrent to other would-be wrongdoers.” Concurring Statement of Commissioner Bart Chilton in the Matter of Panther Energy Trading LLC and Michael J. Coscia at 1. He said, “[i]n today’s cheetah trading world where identities can be cloaked behind technology, a year trading ban might simply be a nice sabbatical for a cheetah trader to work on some new algo[rithm] programs to unleash after the trading ban has expired.” Id.