Prosecutors hunting down the market spoofers

Was that real - or a spoof? Traders on the floor of the New York Stock Exchange during the Flash Crash of 2010

Five years after Congress gave them new powers, American prosecutors are finally charging the traders they say "spoof" the market.

Navinder Singh Sarao was arrested in the UK on Wednesday, charged with fraud and market manipulation.

It follows the indictment in the US of Michael Coscia, owner of Panther Energy Trading in September on similar charges.

In both cases the defendants are alleged to have "spoofed" the market.

In the case of Sarao it is alleged he contributed to the Flash Crash, the 600 point fall in the Dow Jones Index in 2010.

Jacob Frenkel, partner at the US law firm Shulman, Rogers and a former US federal prosecutor, said: "I don't have a crystal ball but I believe there will be many more cases like these coming up."

He believes the authorities have always had the power to prosecute, but in 2010 the US Congress passed the Dodd-Frank Act containing clauses that specifically prohibit spoofing.

Even so the criminal cases have been a long time coming.

Mr Frenkel says: "The reason the cases have taken so long is they involve high frequency algorithmic trading.

"They are very difficult cases to prove. They are very labour intensive and have to be investigated at a granular lever to look at each trade, other trades going on at the same time and at market conditions."

Spoof

The way a spoof works is this: A trader places large orders to, say, sell a financial instrument.

Other traders, seeing the market move downwards, also sell and the price of the asset falls further.

However, the spoofer never intends to sell. Instead he cancels the order and instead buys the asset, making a profit as the price bounces back upwards.

More often than not the spoofer's profit is small, but when repeated the gains mount up rapidly.

Spoofers can always claim that they cancelled an order for legitimate reasons, such as a change in the market, access to new information or simply gut instinct.

Prosecutors though can use a trader's dealing patterns and the design of the algorithms themselves to prove a spoofer's deliberate intent to manipulate the market.

Civil cases

There have been a number of successful civil cases taken against traders for spoofing.

For instance Igor Oystacher, nicknamed "The Russian", was fined $150,000 (£100,000) for trying to manipulate oil and metals markets and given a one-month trading ban from the CME group exchanges in Chicago . He neither admitted nor denied the allegations.

Michael Coscia, the owner of Panther Energy Trading was fined around $3m (£1.95m) by the United States Commodity Futures Trading Commission and the UK Financial Conduct Authority (FCA).

It was alleged he manipulated commodities markets by using computer algorithms to submit false bids for gold, soyabean meal and copper futures, making almost $1.6m.

He also neither admitted nor denied the allegations.

Criminal cases

But now the criminal prosecutions have started.

Coscia was indicted in October by the U.S. Attorney for the Northern District of Illinois for six counts of commodities fraud and six counts of spoofing.

His attempts to have the indictment dismissed were rejected by a federal court judge last week.

Saroa is now on bail in the UK fighting extradition, wanted by the CFTC on civil charges, as well as the US Department of Justice.

Wednesday's headlines suggested Saroa's spoofing was behind the Flash Crash of 2010 when the Dow Jones Index plunged some 600 points.

However, the US Commodity Futures Trading Commission (CFTC) in its allegations admits the connection between Saroa's activities and the crash was tenuous.

It said his "manipulative activities" contributed to an "extreme" order book imbalance that "contributed to market conditions that led to the Flash Crash".

But the crux of its allegation is that he manipulated markets over a period of five years, from 2010 to 2015.

And Mr Frenkel says that while regulators had been able to prosecute market manipulators even in the days before Dodd-Frank, there is a growing determination to take them to court.

He said: "The market crash, corporate fraud, the flash crash, the London Whale, MF Global have all brought into focus the acceptability and desirability of prosecuting these cases."