The Detection Series: ‘Spoofing’, a playful name for a serious financial crime

New guidelines open the door to prosecution

Three more years passed before a regulatory body, in this case, the Commodity Futures Trading Commission (CFTC), finally defined the rules and consequences for violating the terms of the Act in 2013. One full year later, Michael Coscia would be the first person prosecuted under the CFTC guidelines. Coscia was charged and sentenced to three years in prison with six counts of commodities fraud, specifically, spoofing.

As a result of the case, the CFTC submitted an additional rule to specify the illegality of spoofing. Shortly thereafter, the Intercontinental Exchange followed suit in 2015 with clarifications regarding the practice of placing a large order to buy or sell a financial asset (stock, bond or futures contract) with no intention of executing the transaction. By “spoofing” the market, traders and investors are given the artificial impression that there is a high demand for the asset, unaware of the pending market manipulation.

Those clarifications led to the subsequent prosecution of Navinder Singh Sarao who was charged in parallel by UK and US authorities for market manipulation and commodities fraud. Specifically, he was charged for using a spoofing strategy. His name became synonymous with the Flash Crash of 2010 which erased over $1 trillion in market value across US platforms. In December 2016, two New Jersey day-traders, Joseph Taub and Elazar Shmalo, were arraigned in federal court for suspected spoofing and layering.

Spoofing is more widespread than you might think

However, individuals are not the only bad actors. In 2015, Citi Group was suspected of then later charged with spoofing and fined $25 million USD. The more critical fact to point out is how these updated definitions of the Act by the CFTC can be interpreted as a “per se offense.” Given this interpretation, no proof of intent is required but the consequences are still dire: any trader who violates the Act may be liable regardless of whether they aided the bid or offer a transaction intentionally, unintentionally, or negligently. Ergo an effective solution to detect spoofing through the analysis of trading patterns and/or e-communications is essential to mitigate both personal risks and to protect the financial institution enacting the trade or bid.

Not surprisingly, the newest asset, cryptocurrency, offers a haven for unchecked market abuse including wash trades, spoofing, and layering. In 2017, one or more anonymous traders, infamously dubbed with the moniker, “Spoofy,” was(were) flagged for suspected market manipulation within the Bitfinex trading platform. Spoofy routinely places trades in excess of $50 million and, through a complex series of suspected market manipulations via spoofing, as well as wash trading which we covered previously, she/he/they essentially trades with her/him/themselves to handsome profit.

Existing laws still have loopholes

Earlier this year, a mistrial in the case of Jittesh Thakkar, a non-trader from Chicago, USA, illustrated the limited reach of the Dodd-Frank Act. And how, despite numerous clarifications since it was enacted, market manipulation is still subject to interpretation. Thakkar developed the software to enable the placement of fake market orders for the aforementioned Flash Crash trader, Sarao. The jury was hung up, unable to determine if Thakkar broke any laws by developing software that he, himself, did not use to break the law.

The CFTC has recently been stepping up its efforts, lobbing nine civil complaints in 2017, up from an average of one per year prior to that. And, most recently, filed 15 such complaints in 2018. To date, only three individuals have actually stood trial which underscores the need for better solutions that can detect, flag, and report suspicious transactions or the purported intention to engage in illicit deals. Traders, exchanges, brokers, and financial institutions need to take action now with a complete solution for proactive surveillance, eComms compliance, and investigation to reduce the risk of spoofing and other forms of market abuse.