By Bob Fallon, Engleman Fallon, PLLC, email@example.com
Developers of computer software that enables traders to engage in spoofing can now find themselves charged by the Commodity Futures Trading Commission with aiding and abetting manipulative behavior. On September 15, 2020, the CFTC settled a claim brought in U.S. District Court for the Northern District of Illinois against software developer Edge Technologies (Edge) for (i) $72,600 ($24,200 in disgorgement (the profits from developing the software that enabled the manipulative spoofing) and a civil penalty of $48,400) and (ii) a two-year ban on providing any computer programming services in connection with trading in CFTC-regulated markets. The Edge settlement is a case of first impression by the CFTC. https://www.cftc.gov/PressRoom/PressReleases/8243-20 (Consent Order)
An entity engaging in spoofing creates a false impression of demand and supply. As explained in our April 9, 2018 post, the “spoofer” enters into a transaction — the spoofed transaction — that it intends to cancel before execution. The spoofed transaction is bait for a market reaction that will benefit the spoofer’s real transaction. Once the market reacts, the spoofer pulls, i.e., cancels, the bait. If the spoof works, the “spoofer” often repeats the spoof.
While a funny name, spoofing is serious business and the CFTC is cracking down. The CFTC created the Spoofing Enforcement Task Force, which in recent years entered into numerous spoofing settlements, see e.g., https://www.cftc.gov/PressRoom/PressReleases/8031-19 (settling spoofing charges against two trading firms and one bank) and obtained at least two criminal convictions, including one the week of September 22, 2020, see e.g., https://www.bloomberg.com/news/articles/2020-09-25/ex-deutsche-bank-gold-traders-foundguilty-in-spoofing-trial.
Most likely, Edge found itself in the CFTC’s spoofing crosshairs because the spoofer (Trader A) found itself in trouble with the CFTC and turned on Edge to lessen its penalty. See Enforcement Advisory, Updated Advisory on Self-Reporting and Full Cooperation, at 2 (if “a company or individual self-reports, fully cooperates, and remediates, the Division [of Enforcement] will recommend that the Commission [CFTC] consider a substantial reduction from the otherwise applicable civil monetary penalty.”) Once in the crosshairs, the CFTC found Edge liable for developing software that aided and abetted manipulative behavior 1/ — spoofing and use of a manipulative deceptive device, scheme or artifice to defraud — because (i) the software enabled Trader A to engage in spoofing and (ii) Edge “knew or should have known” that the software it developed would be used for manipulative purposes.
Edge’s software aided and abetted spoofing in two ways. First, the software minimized the chance that the spoof orders (the bait) would be executed before the spoofer cancelled them. Second, the software automatically pulled, i.e., cancelled, the bait as soon as any portion of the preferred transaction was filled by another market participant. As the Consent Order concluded, the software enabled the spoofer “to trick other market participants into executing against orders he placed on the opposite side of the market-allowing Trader A [the spoofer] to profit, mitigate potential losses, and/or liquidate positions at more favorable prices than were otherwise available without the use of the Back-of-Book Program [the software.]” Consent Order at P 26.
Under the Consent Order, Edge “knew or should have known” that Trader A would use the software to spoof. Edge had “experience working with traders to develop trading software applications.” Id. at P 30. Further, Edge worked closely in developing this specific software – numerous e-mails and conversations including hearing Trader A explain how “he wanted the custom software application to place and cancel orders in response to changing market prices.” Id. at P 28. Finally, the written statement of work for this specific custom order expressly stated that “he [Trader A] doesn’t want to be hit on the join orders [the bait]” placed with the software. Id. Based on this experience, the Consent Order said that Edge “knew or should have known and understood that market participants would react to the false signals communicated by the Spoof Orders [the bait] Trader A intended to place with the Back-of-Book function [the software] and would use that information in making trading decisions.” Id. at P 30. As the Consent Order concluded, “Edge programmed the Back-of-Book function [the software] to help Trader A accomplish his goal of tricking other market participants and luring them into making decisions and executing trades based on the false signals communicated by his Spoof Orders.” Id.
In announcing the settlement, CFTC Enforcement Director James McDonald said, “[w]e [the CFTC] cannot allow companies to profit from creating programs intended to help traders spoof and manipulate,” adding “[e]stablishing that entities can be held civilly liable for aiding and abetting such illegal conduct, as charged in this case of first impression, strengthens the CFTC’s enforcement mission. We will not hesitate to bring charges against entities and individuals for similar conduct in the future.” https://www.cftc.gov/PressRoom/PressReleases/8243-20
1/ Under §13c(a) of the Commodity Exchange Act, “[a]ny person who commits, or who willfully aids, abets, counsels, commands, induces, or procures the commission of, a violation of any of the provisions of this chapter, or any of the rules, regulations, or orders issued pursuant to this chapter… may be held responsible for such violation as a principal.” As the court said in In Re: London Silver Fixing, LTD, 213 F. Supp.3d 530 (S.D. New York 2016), a “claim for aiding and abetting liability under the CEA [Commodity Exchange Act] requires that the defendant [Edge here] associate himself with the venture, that he participate in it as in something that he wishes to bring about, that he seek by his action to make it succeed,” citing In re Amaranth Nat. Gas Commodities Litig., 730 F.3d at 182 (quoting United States v. Peoni, 100 F.2d 401, 402 (2d Cir. 1938)).