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July 23, 2013

CFTC Going After the High Speed Computer Cheaters

The CFTC recently brought and settled a landmark enforcement case against Panther Energy Trading and their principal, Michael Coscia. The case marks the first enforcement action aimed at the disruptive practice of “spoofing,” which was singled out in Section 747 of the Dodd-Frank Act as a manipulative trading strategy that should be rigorously policed and prevented.
Spoofing means placing orders that one intends to cancel before they can be executed on. Such orders give the illusion of market depth and liquidity, only to snatch it away when market participants try to trade.
The specific scheme that Panther employed involved running an algorithm programmed to place an order to sell, and then immediately place a series of buy orders at progressively higher prices. These orders sent a signal to the rest of the market that there were interested buyers out there, which would suggest higher prices. Seeing this, other participants would quickly buy at the market price (anticipating that they could then flip the contract at a higher price). In the process, these participants would hit the sell order that Panther actually wanted to fill all along. Panther would then cancel the spoof buy orders, before repeating the whole process on the other side of the market. In this way, they could repeatedly buy low and sell high by fooling other participants with spoof orders.
Such manipulative schemes are rife in futures markets and other financial markets. They represent a de facto tax on the American businesses that use these markets for legitimate hedging activities. That pushes up prices for American households, with the added cost going towards funding lavish lifestyles for the traders who run the schemes.
The CFTC’s enforcement case represents a step in the right direction in beginning to address such schemes. But traders on the CME, as well as major media outlets like the Wall Street Journal, are convinced that many more such schemes exist, particularly among high frequency traders. Indeed, rumor has it that Panther was able to make an awful lot of money from their scheme before they got caught (some even say the profits they reaped were many times higher than the amount of their fines). The CFTC must build off this success and bring more enforcement cases. They must send a clear message that manipulative and disruptive trading simply will not be tolerated.


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