Regulatory and enforcement agencies, market exchanges, and at least one private party have brought legal actions for alleged spoofing in futures markets. These actions have exposed a variety of spoofing strategies.
Those who bring actions against spoofers bear the burden of proving the defendant’s intent to defraud. Establishing this requisite intent, without an admission from the trader, can be particularly challenging.
Satisfying the legal evidentiary standard is complicated by the fact that neither the statutory nor regulatory definition of spoofing provides an objective benchmark against which spoofing allegations may be measured and proved. To meet applicable standards of proof, attorneys are increasingly turning to expert testimony regarding statistics and econometrics to prove and refute spoofing allegations in litigation.
Potential Avenues for Investigating Spoofing Behavior
Attorneys can find valuable futures trading data that will help them develop the circumstances surrounding a client’s trading activities. Expert economists can help develop the data and compare and contrast it with other available information to help establish or refute fraud.
The CME Group is the largest futures exchange operator in the United States. It sells historical futures trading data that can offer insight into historical trading patterns. Some of the data they offer include:
- Top-of-Book: All top bid, bid size, top ask, ask size, last trade, trade volume, and time-stamp data.
- End-of-Day: All official closing information, including the open, high, low, close, open interest, total volume, volume breakdown by venue, settlement, delta, and implied volatilities.
- Market Depth: All market data messages required to recreate the order book: five to ten orders deep in futures markets and three orders deep in options markets, as well as trade data for all CME Globex-traded products.
- Time and Sales: Trade times, prices, and quantities for all trades and bids and offers that better the traded prices.
These data are helpful in analyzing market trends on previous trading days but they do not contain anonymized trader/firm identifiers necessary for the prosecution or defense of manipulative and deceptive trading allegations. Those seeking to hold alleged market manipulators accountable for spoofing activities must navigate the data and develop evidence that proves the alleged spoofer entered spoof orders with the required intent to manipulate the market. Experts for the defense will use the same data to show that the client’s trades were legitimate.
Important Considerations When Working with Historical Futures Data
Using historical futures data to investigate spoofing allegations can be challenging because of the size and granularity of the data. Experts should keep the following in mind when evaluating such data:
- Data Cleaning: Depending on the data format and the software used to process the data, various fields can have whitespace and/or decimal digits that may hinder accurate order, trader, and/or instrument matching. Careful cleaning and review of the data is necessary to ensure each order present in the order book is accurate.
- Unique Order IDs: A unique, reliable ID for each order placed in the futures market is necessary to track orders throughout their lifecycle, from placement to fulfillment, cancellation, or expiry. Order IDs must be specific to trader, instrument, order type, and market side. Without a reliable unique identifier for each order, it is impossible to compare, for example, the cancellation rates, fill rates, and different trading patterns of each trader.
- Order Types: Understanding the types of orders traders use and adding appropriate order type controls in the analysis of market trades helps maintain the integrity of any conclusions drawn from those trends. Different order types include limit, stop, and market orders. They may be resting or aggressing, iceberg or fully visible, and they may remain active until the end of the trading day/session, until canceled, until a specified date, or until a minimum quantity is filled.
- Market Price and Order Book: Keeping track of the last trade price and the evolution of the order book over the course of a trading day provides insight into market conditions. Identifying where in the order book traders place their orders, at what times, and for what quantities, sheds light on borrower trading strategies.
Expert Testimony in Spoofing Litigation
At least one trader has been acquitted of spoofing charges. In 2018, a federal jury acquitted Andre Flotron on the charge of conspiracy to commit commodities fraud. Mr. Flotron had been accused of leading a five-year spoofing conspiracy using a strategy similar to that used by Michael Coscia. This case demonstrates the value of expert economist testimony in spoofing cases.
Mr. Flotron’s former trainee, Mike Chan, agreed to testify against Mr. Flotron in exchange for the government not prosecuting him for his own spoofing activities. Mr. Chan testified at trial that he learned about Mr. Flotron’s spoofing techniques when they worked together and he employed those techniques in his own trading.
The defense pointed out Mr. Chan’s motivation to testify the way the government wanted him to. The defense also called an expert witness, Emre Carr, a former Securities and Exchange Commission economist, who analyzed and compared the trading practices and patterns of both Mr. Flotron and Mr. Chan. Here was a witness who claimed he learned how to spoof from the defendant. If this was true, Chan’s trading practices likely would look very similar to those of Mr. Flotron’s. Accordingly, the expert, Mr. Carr, examined the practices of each and found that they were, in fact, significantly different. Such testimony tends to undercut allegations of a conspiracy.
In particular, Carr highlighted the fact that Mr. Chan’s order cancellation rate for large orders was twice that of Mr. Flotron’s. High cancellation rates are considered an indication of possible spoofing. Further, and importantly, he testified that Mr. Flotron filled more orders than someone with the intent to spoof would have filled.
This case demonstrates the value and importance of expert testimony in litigating spoofing claims. Given the essential element of intent in spoofing allegations and the difficulty in establishing such intent without clear admissions from the accused party, placed orders and trading patterns must be the focal point in expert testimony. Some of the factors that experts may consider include:
- Cancellation and fill rates: In many cases prosecuted to date, the rates at which transactions are filled or canceled have been used to establish intent. An expert who can demonstrate lower cancellation rates and/or higher fill rates can help undermine claims of spoofing.
- Depth at which orders are placed: Is there a statistically significant pattern in the levels at which orders are placed such that they are likely to generate price movements, avoid execution, and/or ensure fulfillment? Expert economists are uniquely qualified to analyze such questions and offer testimony regarding such patterns.
- Length of time orders remain active: Do the trades remain active an inordinate amount of time? Is there a pattern to the length of time that orders remain active? Again, expert economists can analyze the data and educate juries on such issues.
- Movements in market price: Can cancellations be explained by movements in the market price away from the order or by market depth movements? Just because a trader cancels an order doesn’t mean the order was fraudulently entered. Many factors justify canceling such orders and an expert economist can analyze the surrounding market conditions, other than an intent to commit fraud, that might have led to these cancellations.
- Order types: Does a trader use a specific order type to spoof and/or execute a trade? An expert can develop patterns and practices to explain how a trader conducts business.
A trader’s entire profile based on a host of criteria, including those just discussed, must be developed in the context of other market participants to develop a legitimate argument in support of or in defense against spoofing allegations. The mere fact that a trader cancels some orders cannot, alone, provide the intent required under Dodd-Frank to prove spoofing. Expert witnesses are essential in analyzing the patterns and practices traders use and are uniquely qualified to develop the full picture that shows whether a trader has been guilty of spoofing.
Vega Economics is an economic consulting firm specializing in expert testimony and data analysis. We deliver exceptional quantitative solutions for both litigation and consulting engagements. Contact us to learn how our prior experience on spoofing cases, familiarity with large datasets, innovative problem-solving, and comprehensive client support can meet your spoofing litigation needs.
Vega was recently retained by Dechert on behalf of James Vorley, an ex-Deutsche Bank’s trader, in connection with sentencing in a criminal proceeding to analyze the relevant economic issues and trading records associated with the spoofing conduct in precious metals future markets. To learn more about this engagement, please visit our engagement page.