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The Justice Department has tried to crack down on traders who try to move markets by entering and quickly canceling orders, conduct that goes by the catchy moniker “spoofing.”
But the government’s early prosecution of the crime has faced a big setback. In just the second trial for spoofing, which the Dodd-Frank Act outlawed, a Connecticut jury acquitted a former trader at UBS of spoofing this spring. That raised questions about whether prosecutors can pursue these cases.
Late July the Justice Department took a new tack. Rather than use the spoofing law, prosecutors charged two former Deutsche Bank traders, James Vorley and Cedric Chanu, with wire fraud. The government claims the pair placed and quickly canceled orders for precious metals futures contracts to create the impression that there was greater supply or demand.
That sounds like spoofing, which is defined as “bidding or offering with the intent to cancel the bid or offer before execution,” and a criminal complaint filed in January accused the two men of that very offense. But when the current indictment hit, it only accused them of wire fraud and conspiracy.
One advantage of the wire fraud statute is that it gives prosecutors 10 years to pursue their case when a bank is involved, rather than the usual five-year limitations period. That may explain, in part, why prosecutors are pursuing this approach, but the change may well reflect lessons learned from the Connecticut acquittal.
The challenge in a spoofing case is that traders frequently cancel orders, and most high-frequency trading involves a rapid flow of orders that are rarely filled. Jurors in the Connecticut case rejected the government’s theory that Andre Flotron, a former trader at UBS, placed orders to mislead other traders.
The wire fraud statute covers broad conduct designed to mislead others and is not so closely tied to canceling orders. That approach may allow federal prosecutors to win a conviction.
The government has a cooperating witness, David Liew, who worked with Mr. Vorley and Mr. Chanu. Mr. Liew pleaded guilty in June 2017 to a charge of conspiracy and can provide testimony about his interactions with the defendants and how they tried to trick other traders.
Prosecutors can be expected to use electronic chats among the three traders to bolster their case. In one, Mr. Vorley wrote to Mr. Liew that their trading “was cladssic [sic]/jam it,” drawing the reply “tricks from the master.” In another exchange, Mr. Chanu wrote to Mr. Liew, “u be careful sweetie.”
Will a cooperating witness and those exchanges be enough to show a scheme to defraud? Perhaps not. There were two cooperating witnesses in Mr. Flotron’s case, and the jury apparently discounted their testimony in acquitting him.
The futures market for precious metals is populated by sophisticated traders who understand that others are trying to game the system to generate profits. As I pointed out in a recent column, defrauding this type of trader may be much more difficult to prove because orders in the market may not actually mislead anyone.
Studies have shown that most orders are canceled, and traders thrive on trying to outsmart others by forecasting trends in the market. The question is whether the mere entry and cancellation of orders are enough to show that traders were actually misled and defrauded.
The government will face another challenge in pursuing a wire fraud case rather than the more narrowly drawn spoofing prohibition. Prosecutors will have to show that entering and canceling orders not just deceived other traders but also deprived them of property.
The Justice Department has taken an aggressive stance against traders entering orders that are quickly canceled. In addition to Mr. Vorley and Mr. Chanu, charges against five other defendants for spoofing are pending in Chicago and Houston. Mr. Flotron’s acquittal may factor into the government’s strategy for pursuing wire fraud rather than spoofing.
But there is the risk that a jury will not find enough evidence to say there was fraud rather than just an aggressive trading strategy. That might lead traders to push even harder to take advantage of others to generate profits.
