Shearman & Sterling LLP | Government Regulatory Enforcement Blog | Seventh Circuit Upholds First Spoofing Conviction Against High-Frequency Trader<br >  
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  • Seventh Circuit Upholds First Spoofing Conviction Against High-Frequency Trader
    On August 7, 2017, the Seventh Circuit upheld the conviction of Michael Coscia, founder of Panther Energy Trading LLC, for a market manipulation tactic known as “spoofing,” under Section 6c(a)(5)(C) and 13(a)(2) of the Commodity Exchange Act.  United States v. Coscia, No. 16-cr-3017 (7th Cir. Aug. 7, 2017).  Coscia’s conviction is the first of its kind under this statute, which was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 and prohibits “bidding or offering with the intent to cancel the bid or offer before execution.”  The Seventh Circuit rejected Coscia’s claim that the statute was unconstitutionally vague and found that Coscia’s conviction was supported by sufficient evidence. 

    Coscia’s “spoofing” conviction related to his alleged use of two programming algorithms that enabled him, in his own words, to “‘pump [the] market.’”  Specifically, these programming algorithms allowed Coscia to cause desired price changes in the fast-paced commodities market.  As part of his alleged scheme, Coscia placed a small order to buy or sell a commodity, and then placed large volume orders on the opposite side of the market, which risked up to $50 million for a given trade.  For example, Coscia would place a small, legitimate order to buy Brent oil futures below market price.  Then, he would seek to drive the market price down by placing large volumes of sell orders for Brent futures, in the hopes that such sell orders would cause the market price to reach his buy position.  Coscia also configured his algorithms in a manner that ensured his large volume orders would never all be filled, which helped to hedge the risk associated with this strategy; Coscia, for example, ensured that his algorithm would automatically cancel large orders if a set time passed (only a few milliseconds), if one of the large volume orders was filled, or once the small order (on the opposite side of the trade) was filled.

    Coscia asserted that the spoofing statute was void for vagueness, arguing that the statute fails to give adequate notice of what constitutes criminal conduct and also encourages arbitrary enforcement.  Coscia specifically noted that high-frequency traders cancel 98% of orders before execution and that there are no “‘tangible parameters to distinguish [Mr.] Coscia’s purported intent from that of the other traders.’” 

    The Seventh Circuit squarely rejected all of Coscia’s arguments.  The plain language of the statute, the Court held, is sufficient to put individuals on notice of the behavior it prohibits—placing orders without intent to execute them.  Further, the Court noted that punishment of an individual who intends to engage in this prohibited activity is not arbitrary.  The Court further reasoned that lower courts will be able to distinguish between legitimate high-frequency trading, and the unlawful form of high-frequency trading.  In particular, the Court explained that, for example, legitimate high-frequency traders place orders with the intent to cancel if some future, independent market event occurs.  Coscia, by contrast, never intended to fill the orders he placed, which is by definition spoofing. 

    The Seventh Circuit also made clear that high-frequency trading and other algorithm-based trading techniques involving cancelled orders can be a legitimate means of trading, and can utilize small natural price discrepancies to make a profit.  The Court distinguished such forms of lawful trading strategies from that of spoofing, in which the trader intentionally places an order with no intention of filling it under any circumstances, thus artificially creating price discrepancies to manipulate the market.  In this era of high frequency trading, courts will no doubt be presented with fact patterns that do not neatly fit within either continuum.  The Seventh Circuit set forth some useful principles in interpreting the “spoofing” statute, and we will continue to monitor additional developments in this area, including enforcement cases that contain spoofing-based allegations.  This opinion serves as a reminder that blatant attempts to manipulate the market may result in criminal penalties.