Spoofing: Defining the Indefinable

Definitions are tricky things. For proof, simply look at spoofing. 

Earlier this month Michael Coscia was convicted of spoofing and could face up to 25 years in prison. Coscia’s case marked the first time the US government looked to prosecute a trader for spoofing. 

Look up any story on the case and I can almost guarantee that some form of the word “intent” appears at least once. Coscia was prosecuted because he submitted orders that he never intended to fill; his intent ─ according to the prosecution ─ was malicious. 

But how can we know what a person’s true intention is? I’m not defending Coscia’s actions, but as we move forward, and new cases are brought against other traders, how can the government definitively prove that a trader was purposely submitting and cancelling orders with the intent of rigging the market for his or her benefit?

More Technology, More Problems

That was the debate brought up at a panel I recently attended at Baruch College’s Financial Markets Conference. 

Gregg Berman, who spent over five years with the US Securities and Exchange Commission’s (SEC’s) before joining EY this year, said the problem has been greatly compounded by technology. Years ago, fewer trading platforms and markets meant when a trader started cancelling several orders at once it was obvious they were doing something manipulative. 

With the rise of machines, however, that line has gotten very blurry. 

“In today’s environment there are an incredible number of economically driven reasons that are completely legitimate to orders being cancelled very quickly,” Berman said. “So when regulators look at the construct of someone who is sending in an order and then cancelling it, it’s very difficult to look at that in the abstract. … You have to see what else is that person doing. What’s the strategy that’s being deployed? What’s the economic reason for doing that? The vast majority of time you’re going to find that it’s actually fine; not only is it ok, but if that activity wasn’t happening there would be direct harm to retail investors by getting bad prices when they’re trying to line up a certain product.”

The problem that arises is how many times those legitimate instances occur throughout the course of a normal trading day, making it that much harder to pinpoint those who are actually trying to manipulate the market. 

Indefinable 

To remedy this, definitions have been created. John Zecca, senior vice president of MarketWatch and head of market regulation for US markets operated by Nasdaq, said that hasn’t exactly cleared things up, though. The two themes consistently discussed when it comes to identifying spoofing are: the trader had no intent to actually execute the trade, and the trades were not correlated to the market. 

Neither of those reasons, according to Zecca, can be the sole criteria of identifying spoofing. 

It’s enough to make a chief compliance officer go crazy, according to Berman, who said it’s completely conceivable to have an algo that continues to be tweaked eventually start spoofing without that being the actual intent of the developers and traders. 

All of this has made Greg Wood, who handles algorithmic execution for listed derivatives and foreign exchange (FX) with Deutsche Bank, extremely concerned. 

“If I place my order into any market with the simplest execution algo you can find because I only want to show 100 shares of the 1,000 that I want to do because I know that I could have an impact on price discovery, is that deceit?” Wood asked. “My intent is to trade all of it, but I’m doing what I would do as a trader. I’m trying to be smart.”

It’s a difficult line traders have to balance, and one that might not get easier anytime soon. No matter how much regulators’ technology improves, there is no way they’ll be able to build a machine that can actually get into a trader’s head. 

“Do I think that there is room for improvement in definition over time? Yes,” Nasdaq’s Zecca said. “But it is always going to be a hard one to define.”

Food for Thought

• My colleague Elizabeth Wu wrote up a nice piece on spoofing from the perspective of the vendors. Definitely worth a read. Click here to check it out. 

• Kristaps Porzingis! As a lifelong Knicks fan, it’s been a long time since I’ve been this excited about a young player on our team. I know it’s only 12 games into his rookie year, but it seems like he’s the real deal. I never thought this kid would grow up to be someone that would bring me so much joy.

• I gave out some unprompted television advice last week, and I figured I might as well do it again. The Leftovers might be the best show on television right now. For those of you on the border, I strongly encourage you to dive in. You will not be disappointed. Here’s a trailer for the first season.