First-Ever "Spoofing" Conviction Upheld by the Seventh Circuit
In today's computer-driven world, trading firms use computer software to execute, at very high speed, large volumes of trades. Their trading strategies take advantage of minor discrepancies in the prices of securities or commodities that often emerge between national exchanges.
"Spoofing" – bidding or offering with the intent to cancel the bid or offer before execution – differs from legitimate trading and artificially moves the market price of a stock or commodity up and down, instead of taking advantage of natural market events. In the wake of the Great Recession of 2008, Congress criminalized "spoofing" as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The Coscia Trial
In October 2014, a grand jury indicted Michael Coscia for "spoofing" and commodities fraud based on trading activity he engaged in during 2011. Pretrial, Coscia moved to dismiss the charges against him on the grounds that they were void because the term "spoofing" was vague. His motions were denied.
Coscia and his team had designed a computer program that allowed him to artificially manipulate the price of a stock. For a 10-week period, he used the algorithm-based program to place a small order on a particular futures contract, which Coscia intended to trade at a price that did not exist in the market at that time. Then, Coscia entered a series of larger orders, or "quote orders," on the opposite side of the market. The intent of these large orders was to make it appear that there was a lot of interest in the particular type of futures contract he desired to trade. If the original small order that Coscia actually intended to trade was filled, Coscia's trading algorithms canceled the large orders in the blink of an eye-within about 250 milliseconds.
Coscia argued that his trades were not manipulative and that he intended to fulfill every order he placed. Coscia also argued that 90 percent of all orders entered in the commodities marketplace are canceled before the execution and, therefore, he could not have known he was doing something wrong.
In October 2015, he proceeded to trial and was convicted on all counts. Coscia was then sentenced to three years in prison.
On appeal, Coscia argued three points: (1) that the anti-spoofing provision of Dodd-Frank is void-for-vagueness; (2) that the government's failure to define "spoofing" bolstered his void for vagueness argument; and (3) even if the "spoofing" provision is not void for vagueness, the statute, as written, encourages arbitrary enforcement.
In a 42-page unanimous decision, the Seventh Circuit rejected each of Coscia's arguments. First, it held that the statute clearly defines the term "spoofing", and, thus, provided sufficient notice of the conduct that it criminalized. Second, the Court held that because of the statute's "willful" intent requirement, on its face, it did not encourage arbitrary enforcement.
The Seventh Circuit's decision was a big win for the government. However, it leaves open questions for future cases. In Coscia's case, his algorithm was designed to shift the market towards an artificial price, which, in turn, provided sufficient evidence that his conduct was "willful" and criminal. The opinion, however, does not provide guidance as to whether future traders, who use unique trading approaches, could be prosecuted for criminal conduct in the absence of similar evidence. Subtle distinctions in trading programs and strategies can make a substantial difference in whether traders have run afoul of Dodd-Frank. As the Seventh Circuit acknowledged, there are legitimate trading activities that allow for a trader to avoid execution of a trade for reasons unrelated to market manipulation.
In today's markets, traders are often outpaced by advanced computer algorithms such as those created by Coscia and his team. Going forward, traders can expect that prosecutors – emboldened by the Seventh Circuit's ruling – will view those, who cancel orders entered with the intent to push the market in the direction they desire, as potential targets in criminal investigations.
If you have questions about this decision or other areas of securities, commodities, or criminal litigation, please contact Leigh Roadman, Mason Floyd, Matthew Ruza, or another member of Clark Hill's Litigation practice group.
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