Alleged spoofing occupied center stage in financial services last week. The Securities and Exchange Commission charged a trader  — Eric Oscher — and his firm with spoofing after the trader made complaints to the New York Stock Exchange of spoofing by other traders, while both parties to a criminal case alleging spoofing by Michael Coscia on CME Group exchanges and ICE Futures Europe in 2011 fine-tuned their arguments in anticipation of the commencement of his trial later this month. Meanwhile, a US presidential candidate offered her vision of enhanced regulation of financial services firms and markets, including imposing a transaction tax on firms with excessive levels of order cancellations. As a result, the following matters are covered in this week’s edition of Bridging the Week:

• SEC-Sanctioned Trader Began Alleged Spoofing After Complaining About Spoofing by Others to NYSE;

• Government and Defendant Fine-Tune Spoofing Arguments in Advance of Coscia Criminal Trial (includes Legal Weeds);

• US Supreme Court Declines to Consider Appellate Decision Tossing-Out Todd Newman's Insider Trading Conviction;

• Candidate Clinton Calls for High-Frequency Trading Tax and Toughening Volcker Rule (includes My View);

• Broker-Dealer and Affiliated Investment Adviser Sanctioned for Sharing Non-Public Information;

• SEC Alleges Investment Advisers’ Failure to Disclose Pocketing of Legal Fees Discount Constitutes Conflict of Interest;

• ICE Futures U.S. Sanctions Firms for Block Trade and Position Reporting Infractions (includes Compliance Weeds); and more.

SEC-Sanctioned Trader Began Alleged Spoofing After Complaining About Spoofing by Others to NYSE

Eric Oscher and Briargate Trading, LLC, a company 50 percent owned by Mr. Oscher, agreed to pay an aggregate fine of US $500,000 and disgorge profits of $525,000 to resolve charges brought by the Securities and Exchange Commission that they engaged in prohibited spoofing activities involving securities listed on the New York Stock Exchange from October 2011 through September 2012.

According to the SEC, during this time, Mr. Oscher caused his company to place a series of large, non-bona fide orders to buy or sell certain stocks prior to NYSE market open (the SEC termed these non-bona fide orders “spoofs”). The intent of these orders, claimed the SEC, was to drive the price of the stock up or down in the pre-open period by contributing to a perception that there was a large buying or selling interest.

Briargate would then place orders in the opposite direction of its spoofs on other markets that listed the same stock but that opened prior to NYSE. After these bona fide orders were executed, Mr. Oscher would have Briargate cancel its NYSE pre-market open orders. He would then cause Briargate to liquidate its executed positions after the relevant stock price reacted to elimination of the large non-bona fide buying or selling interest.

Mr. Oscher and Briargate engaged in this type of trading activity in 242 instances during the relevant time, realizing US $525,000 in profits, said the SEC.

The SEC claimed that Mr. Oscher began utilizing this trading strategy in October 2011 after he had complained to NYSE,

…that other market participants were engaging in manipulative conduct involving large cancelled orders. For example, in the spring of 2011, Briargate complained to the NYSE that the data feeds provided by the NYSE were “susceptible to manipulation where parties look to gain advantage by entering non bona fide orders to entice others to trade.”

The SEC claimed that defendants trading was “manipulative” and thus violated provisions of law that prohibit engaging in transactions “creating actual or apparent actual trading” in a relevant security “or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.” The SEC also charged that defendants’ trading constituted a device, scheme or artifice to defraud or was an act or practice that operates as a fraud or deceit.

The defendants also agreed to pay prejudgment interest of almost US $38,000 as part of their settlement.

Government and Defendant Fine-Tune Spoofing Arguments in Advance of Coscia Criminal Trial:

With the scheduled criminal trial of Michael Coscia for alleged spoofing scheduled to commence two weeks from today on October 26, 2015, the US Attorney’s Office in Chicago indicated its intent to narrow the theory of its case, while both parties made motions to prevent the other side from introducing certain evidence during trial and arguments they claimed might inflame and distract the jury.

Mr. Coscia, who was the subject of and settled civil enforcement actions brought by the Commodity Futures Trading Commission, CME Group exchanges and the Financial Conduct Authority for alleged spoofing activities involving futures traded on CME Group exchanges and ICE Futures Europe from August through October 2011, was indicted in Chicago in October 2014 for some of the same transactions.

Although Mr. Coscia had been charged in his indictment with engaging in conduct that “is of the character or known to the trade as spoofing” – paralleling the relevant provision of law — the US Attorney’s Office advised the court hearing the matter that it only intends to prove that each relevant transaction is spoofing. According to the US Attorney’s Office,

[t]his decision will streamline the trial and avoid the need for any litigation as to whether defendant’s trades are ‘of the character’ of spoofing or were ‘commonly known in the industry’ as spoofing. Evidence on these matters, including the industry’s understanding of the term "spoofing," will be irrelevant.

The US Attorney’s Office also requested the court to bar defendant from introducing evidence or arguments related to possible vagueness of the relevant spoofing law, or regulations or interpretations of the CFTC, FCA, CME Group or ICE related to spoofing. “This Court will define the law and the sole issue at trial is whether the defendant committed a crime, not whether his action violated a CFTC regulation or a CME Group rule,” argued the US Attorney’s Office in its motion papers.

Mr. Coscia similarly made a motion to bar the government from introducing evidence or arguments related to regulatory investigations into defendant’s conduct and his settlements; alleged market harm or disruption that is unrelated to Mr. Coscia’s trading activities; any reference to manipulation; lay witness descriptions of defendant’s trading as “spoofing;” and complaints by non-testifying market participants regarding Mr. Coscia’s trading.

Mr. Coscia settled his civil enforcement actions for an aggregate fine in excess of US $3 million, disgorgement of US $1.3 million of trading profits and trading suspensions. (Click here for further background)

Legal Weeds: The US Attorney’s strategy in this case is interesting. Under the plain language of the relevant statute, “spoofing” is the “bidding or offering with the intent to cancel the bid or offer before execution.” However, as the CFTC said in its interpretive guidance regarding this provision (click here to access), spoofing may be defined a certain precise way in the statute, but the conduct defined as spoofing may not always be prohibited conduct. According to the CFTC, “a spoofing violation will not occur when the person’s intent when cancelling a bid or offer before execution was to cancel such bid or offer as part of a legitimate, good-faith attempt to consummate a trade.” The CFTC appears to recognize there is a distinction between spoofing the law and spoofing the lore: “[a]s with other intent-based violations, the Commission intends to distinguish between legitimate trading and ‘spoofing’ by evaluating all of the facts and circumstances of each particular case, including a person’s trading practices and patterns.” This interpretation is consistent with guidance by CME Group and ICE Futures U.S. (Click here for background on CME Group’s interpretation of its Rule 575 and here for background on ICE Futures U.S. interpretation if its Rule 4.02(l).) In other words, the statute may endeavor to define spoofing, but that’s not what spoofing — the prohibited conduct — always is.

Briefly:

• US Supreme Court Declines to Consider Appellate Decision Tossing-Out Todd Newman's Insider Trading Conviction: The US Supreme Court declined to hear an appeal from the decision of a federal appeals court in New York in December 2014 that set aside the convictions of Todd Newman and Anthony Chiasson for insider trading. The appeals court had claimed that, in its prosecution of the defendants, the US government failed to demonstrate that the initial insiders from whom defendants’ liability ultimately derived received sufficient personal benefit to establish their (let alone defendants’) securities law liability. Moreover, said the court, the US government failed to provide any evidence that the defendants knew “they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.” Mr. Newman—a former portfolio manager at Diamondback Capital Management, LLC—and Mr. Chiasson—a former portfolio manager at Level Global Investors, L.P., were previously charged and convicted of trading in securities based on illegally obtained insider information initially provided by employees at publicly traded technology companies, subsequently shared with analysts at hedge funds and investment firms, and ultimately provided to the defendants. The US Department of Justice previously had requested the US Supreme Court consider to reverse the appellate court'a decision. Click here for background)

• Candidate Clinton Calls for High-Frequency Trading Tax and Toughening Volcker Rule: Presidential candidate Hillary Clinton laid out her purported populist vision of financial services regulation in a position paper entitled Wall Street Should Work for Main Street. According to Ms. Clinton, the Dodd-Frank Wall Street Reform and Consumer Protection Act was a good start to enhance oversight of the financial services industry, but more needs to be done. Among other things, Ms. Clinton also recommended imposing a risk fee on the largest financial institutions. Under her proposal, banks with more than US $50 billion in assets and other financial institutions subject to enhanced oversight would pay a graduated fee each year – with firms with larger amounts of debt and “riskier, short-term forms of debt” paying the highest charges. She also recommended giving regulators the “explicit statutory authorization” to require large financial firms to “reorganize, downsize or break apart” if the firms could not demonstrate they could be managed effectively. Ms. Clinton also called for imposing margin and collateral requirements on repurchase agreements and other securities financing transactions; instituting a “high-frequency tax” on firms trading with“ excessive levels of order cancellations;” ensuring that individuals are held accountable for corporate breaches of law; preventing banks from investing up to 3 percent of their capital in hedge funds (as currently permitted under the so-called “Volcker Rule”); and encouraging other worldwide financial centers to impose regulations as tough as those in the United States – “leveling the playing field for US firms and safeguarding global stability.” Ms. Clinton also expressed her support for the reinstatement of the swaps push-out rule that was mostly eliminated in 2014 as part of a government funding compromise (this rule would have required that banks conduct most derivatives trading outside of federally insured entities or entities with access to the discount window of the Federal Reserve System). Additionally, Ms. Clinton recommended increased funding for the Commodity Futures Trading Commission, Department of Justice and the Securities and Exchange Commission, as well as greater independence for the CFTC and SEC from the appropriations process.

My View: It is easy for politicians to get caught up in the enthusiasm of a campaign and issue proposals and make promises that, in practice, are very hard and impracticable to realize. As Ms. Clinton’s campaign’s chief financial officer, Gary Gensler, had to recognize as chairman of the Commodity Futures Trading Commission, there is even a big difference between enacting purported populist regulations and having such regulations achieve their intended purpose (particularly without unintended consequences) – as evidenced by the steady stream of no-action letters and other forms of guidance the CFTC has had to issue in connection with its Dodd-Frank-instituted regulations to clarify, delay or conform the regulations to reality.

• Broker-Dealer and Affiliated Investment Adviser Sanctioned for Sharing Non-Public Information: Wolverine Trading LLC (“WT”), a registered broker-dealer, and its affiliate, Wolverine Asset Management LLC (“WAM”), a registered investment adviser, each agreed to pay fines of US $375,000 to the Securities and Exchange Commissions to resolve charges related to their alleged sharing of non-public information about a certain exchange-traded note from February through March 2012. According to the SEC, during the relevant time, WT shared information with WAM regarding its trading positions, transactions and strategies involving the note after the issuer announced a temporary suspension of new issuances on February 21. This suspension caused the note to trade at a premium to its indicative value. During the relevant time, the affiliates also discussed issues related to the potential ending of the suspension that occurred on March 28, the SEC said. Just prior to the issuer’s announcement of the lifting of the issuance suspension, the price of the note declined. WAM was able to profit from this price decline because of “information and opportunity that other market participants did not have,” alleged the SEC. The SEC charged each firm with violating provisions of law requiring them to maintain and enforce procedures aimed at preventing the misuse of material, non-public information. In addition to paying a fine, WAM also agreed to disgorge US $365,000 in profits and pay prejudgment interest of almost US $40,000 to resolve this matter. The SEC noted that it considered “remedial acts promptly undertaken” by each defendant in settling this action.

• SEC Alleges Investment Advisers’ Failure to Disclose Pocketing of Legal Fees Discount Constitutes Conflict of Interest: Three private equity fund advisers – Blackstone Management Partners L.L.C., Blackstone Management Partners III L.L.C., and Blackstone Management Partners IV L.L.C. – settled charges brought by the Securities and Exchange Commission that they failed adequately to disclose in advance a certain fee they charged to funds they managed, as well as a legal discount they received, but did not pass along in its entirety to the same funds. According to the SEC, each Blackstone-advised fund owns multiple investment companies for which it provided various consulting and advisory services in return for an annual fee. Typically these agreements were for 10 years, and some included automatic renewal provisions. The SEC said that, from at least 2010 through March 2015, in some instances, Blackstone terminated the monitoring agreements and accelerated monitoring payments to itself (i.e., received the discounted present value of its fees for the contract duration) even when Blackstone ceased working with the investment company. The SEC charged that Blackstone never disclosed its practice of accelerating fees until after it received an accelerated fees payment. Similarly, said the SEC, from 2008 through early 2011, Blackstone passed along legal fees to funds it advised at a rate higher than a discounted rate it negotiated with its preferred law firm. Blackstone, charged the SEC, did not disclose that it retained the difference to the funds’ investors. These practices violated applicable provisions of law, charged the SEC. To resolve the SEC’s complaint, the respondents agreed to pay a total fine of US $10 million, and to disgorge profits of over US $26 million plus prejudgment interest of almost $2.7 million.

• ICE Futures U.S. Sanctions Firms for Block Trade and Position Reporting Infractions: ICE Futures U.S. agreed to settle a number of disciplinary actions arising from alleged violations of its block trade and position reporting rules, among other matters. In two apparently related actions, BP Energy Company and EOX Holdings, LLC were charged for violating prohibitions against accommodation trades and transacting block trades at prices that were not “fair and reasonable.” In both of these actions, IFUS said that an employee of each firm transacted a buy and sell trade “to correct an erroneous allocation and move a position from one proprietary account belonging to the counterparty to another proprietary account belonging to the counterparty.” The two respondents agreed to pay fines in aggregate of US $32,500. Separately, SG Americas Securities, LLC agreed to pay a fine of US $100,000 for allegedly not reporting correct open interest in three futures contracts from May 29 through June 27, 2014. Likewise, Barclays Capital, Inc., settled allegations that it failed to accurately report open interest on three last trading days and expiration dates for one energy futures contract in October, November and December 2014. The firm agreed to pay a fine of US $20,000 to resolve this matter.

Compliance Weeds: Accommodation trades are typically transactions entered into by a trader to assist another trader with prohibited transactions. Such trades are prohibited under applicable law (click here to access Commodity Exchange Act §4c(a)(2)(i)) and exchange rules (click here, e.g., to access IFUS rule 4.02(c) and here for Chicago Mercantile Exchange rule 534).

And more briefly:

• Gemini Bitcoin Exchange Receives Regulatory Authorization by NYS Department of Financial Services: Gemini Trust, LLC – a Bitcoin exchange based in New York City – has been granted a charter under the New York Banking Law by the New York State Department of Financial Services. As a condition of its charter, the firm is required to comply fully with NYDFS’ BitLicense regulatory framework.

• CME Group Updates Disruptive Practices MRAN in a Minor Way: CME Group proposed minor changes to its advisory regarding its prohibition against disruptive trading practices to clarify that it is prohibited to enter a trading at settlement or trading at marker order into Globex prior to receiving notice that the market has transition to pre-open status. CME Group has also clarified that entry of a bona fide order into Globex that is intended to be executed is authorized even where an execution might serve some other risk management purpose, such as testing the flow of a trade through a firm’s back office system. The changes will be effective October 26, 2015, absent objection by the Commodity Futures Trading Commission. (Click here to access CME Group’s prohibition against disruptive practices – Rule 575.)​

• ESMA Says 2016 Goal Is Regulation Convergence: The European Securities and Markets Authority announced its key priorities for 2016 last week. These include encouraging convergence by different regulators in Europe regarding the implementation, supervision and enforcement of common EU rules; developing guidance and questions and answers to help with the “consistent implementation” of the Markets in Financial Instruments Directive II across Europe; and fulfilling legal requirements related to data collection and reporting under MiFID II and the Markets in Financial Instruments Regulation.

• ESMA’s Final Rules on Indirect Clearing Will Be Delayed: The European Securities and Markets Authority wrote to the European Commission saying it will be delayed in submitting proposed final rules related to indirect clearing under the Markets in Financial Instruments Directive II. This delay is necessitated, said ESMA, in order to ensure requirements under the European Market Infrastructure Regulation and MiFID II are consistent. Indirect clearing refers to the chain of relationships necessary to enable an entity that is a client of a broker that is not a member of a clearinghouse to ultimately have its position cleared through the relevant clearinghouse.

• SEC Approves FINRA Rule to Increase OTC Equities Transparency: The Securities and Exchange Commission approved a recently proposed rule by the Financial Industry Regulatory Authority aimed to enhance the transparency of over-the-counter equity securities. Under the rule, FINRA will include all equity volume executed over-the-counter by FINRA members outside of alternative trading systems in the volume of alternative trading system volume it currently publishes.