“A little razzle-dazzle to juke the algos.”

Eloquently put by a JP Morgan trader who seemed to boast about the spoofing tactic that certain traders in the bank had participated in, between the years’ 2008-2016. Personally, if I had been caught in such a ruse, I might perhaps show a bit more remorse. Especially to a prosecutor.

However, as the saying goes, “each to their own.”

Summary 

The story goes a little something like this. JP Morgan Chase (JP) recently admitted to manipulating precious metal futures and US government bond markets for almost a decade (2008-2016) through spoofing.[1] The bank agreed to pay $920 million in settlement fees to prevent further investigations by law enforcement and various other regulators. The costs were split in the following ways: a $436.4 million fine, $311.7 million in restitution to parties harmed by its practices, and $172 million to pay back unlawfully earned profits.[2] To sweeten the deal, JP will avoid criminal proceedings through a three-year deferred prosecution agreement.[3] An agreement a company makes with a prosecutor after being charged with a criminal offence, to automatically suspend criminal proceedings. In exchange the company agrees to a number of conditions; e.g. implementation of compliance programmes and financial penalties.[4] 

It is also safe to assume that JP will now be placed under even more scrutiny than it was before, not least because most financial institutions have been distrusted by regulators, since the 2008 financial crisis. Now, JP has added fuel to that fire. Was it worth it? I’ll leave you to decide.

What is Spoofing?

Spoofing is a form of market manipulation whereby a trader submits and then cancels offers or bids in a security or commodity on an exchange or other trading platform with no intent or willingness to execute those orders when placed.[5]

For example, I am a trader trying to sell my gold stock. Instead, I place a series of orders to buy lots of gold stock. By placing lots of ‘buy orders’, I have created the illusion to other traders/investors that there is a rise in demand for gold on the stock market. As a result, prices for gold skyrocket, increasing the value of gold massively. I then sell my gold stock that I was trying to sell originally, now for a higher price and cancel the ‘buy orders’. I potentially have now made some profit through spoofing (due to the increase in the value of gold that I caused by my fake ‘buy orders’).

 Spoofing is illegal in both the US and the UK.

In the US, spoofing in commodities trading is a specified criminal and civil offence.[6] In the UK, spoofing is not a specified offence. However, spoofing behaviour may contravene civil and/or regulatory provisions in the EU Market Abuse Regulation (596/2014) (MAR) (which has direct effect in the UK) and/or amount to a criminal offence under the Financial Services Act 2012 (FS Act 2012) or the Fraud Act 2006.[7]

Issues and Legal Talk

Spoofing is incredibly difficult to prove, at least in the US, because a trader’s intent is pivotal to any prosecution. Therefore, placing the burden on the prosecutor to prove intent to spoof. The UK is more result oriented, looking instead in both civil and criminal cases, at the effect that the behaviour had on the market, (though, some element of intent is required in criminal cases).[8]

The difficulty arises when proving intent because traders change their minds all the time for legitimate reasons, and don’t always carry out the order that they originally intended. For example, there is the ‘fill or kill’ order, which is legal and demands immediate execution or cancellation. It typically involves a designation added to an order instructing the broker to offer or bid one time only; if the order is not filled immediately it is then automatically cancelled.[9] 

However, the crucial difference is intent. Spoofing along with other manipulation practices involves an intent or at least some knowledge that a specific action will put the trader at an advantage at the disadvantage of others. Essentially it is unfair. However, even with that in mind, there is a subtle difference between clever trading tactics and outright market manipulation.

Additionally, the phrase above portrays that it was indeed a widely practiced act at JP, so much so that the DoJ alleged that Mr Trunz, a former JP trader who pled guilty stated that he “learned to spoof from more senior traders and spoofed with the knowledge and consent of his supervisors.”[10] Intent was indeed obvious here.

It is worth noting, that spoofing is even more difficult for prosecutors to spot now, due to high-frequency trading technology (algorithmic traders),[11] that looks to take advantage of algorithms that look for price disparities in the market. Technology has thus, to some extent made it easier to blur the line between legal and illegal activities.

One must ask whether ‘unfair’ should mean ‘illegal.’ 

Perhaps think about ‘insider trading’ as somewhat of a comparison. Essentially, certain traders are able to profit off the stock market, from information that other traders/investors do not have access to. The concept remains the same, a group of traders are at an advantage at the expense of the market to some extent. This promotes unfair market practices. So perhaps rightly so that spoofing is illegal, and even more so, that JP received such a hefty fine.

I might also add that other financial institutions, including Deutsche Bank, UBS and HSBC have been fined for spoofing precious metals markets.

Financial institutions should indeed be clamped down on, especially with their specialist knowledge of markets and to add to that, the fact that they can afford such technologies that already put them at such an advantage in comparison to individual investors/traders.

Conclusion

The huge record breaking fine of $920 million shows that regulators are increasingly clamping down on market manipulation practices. Regulators have zero tolerance. As a result, financial institutions will have to be extra cautious in market dealings, seeking advice from law firms that have a strong grounding in finance and dealing with regulators such as the SEC, CFTC (in the US) and the FCA (in the UK). So as to avoid such penalties. Top tier law firms in such an area should see an increase in demand for legal services. This means that as a lawyer dealing with financial institutions and other public companies on various stock exchanges like the LSE and the NYSE, you will be engaged in a lot of due diligence, cross checking against Listing Rules (in the UK) for example, and various other regulations that financial institutions and public companies must abide by.

 

[1] https://www.ft.com/content/f2c918c2-2659-4513-8851-cc40379d4840

[2] https://www-economist-com.iclibezp1.cc.ic.ac.uk/finance-and-economics/2020/10/03/jpmorgan-chase-faces-a-fine-of-920m-for-market-manipulation

[3] https://www.ft.com/content/c6b34081-d3b6-4a85-8fd0-fe4a3b5e7a47

[4] https://www.cps.gov.uk/publication/deferred-prosecution-agreements-code-practice

[5] https://www.kslaw.com/attachments/000/007/103/original/Spoofing_the_market_a_comparison_of_US_and_UK_law_and_enforcement.pdf?1564509484

[6] https://uk.practicallaw.thomsonreuters.com/w-020-1043?comp=pluk&__lrTS=20201008103007981&transitionType=Default&contextData=(sc.Default)&firstPage=true&OWSessionId=385c0b4cbb564267872c6c88363e063f&skipAnonymous=true#co_anchor_a131917

[7] ibid.

[8] https://www.kslaw.com/attachments/000/007/103/original/Spoofing_the_market_a_comparison_of_US_and_UK_law_and_enforcement.pdf?1564509484

[9]  https://uk.practicallaw.thomsonreuters.com/w-020-1043?comp=pluk&__lrTS=20201008103007981&transitionType=Default&contextData=(sc.Default)&firstPage=true&OWSessionId=385c0b4cbb564267872c6c88363e063f&skipAnonymous=true#co_anchor_a131917

[10] https://www.ft.com/content/c6b34081-d3b6-4a85-8fd0-fe4a3b5e7a47

[11] https://www-economist-com.iclibezp1.cc.ic.ac.uk/finance-and-economics/2020/10/03/jpmorgan-chase-faces-a-fine-of-920m-for-market-manipulation

Ikenna Henry Onyebuchi

Ikenna Henry Onyebuchi

Hello there! I am Ikenna Henry Onyebuchi, a graduate from the University of Exeter with an LLB Law degree. I am currently on a Career Commitment Scholarship, studying at BPP University Law School, enrolled on the Legal Practice Course, with the combined master’s in law degree. I am also currently in search of a training contract to embark on my journey to becoming a solicitor in England, and I will be sharing my journey through BAME Nation!

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