Expert testimony is sure to play a key role in the first criminal trial based on the “anti-spoofing” legislation that was enacted as part of the Dodd-Frank Act in 2010. The trial involves allegations that the defendant, Michael Coscia, manipulated the commodities market by placing orders that he never intended to fulfill.
The Practice of Spoofing
Spoofing is a way of manipulating a trading market. The manipulator “spoofs” by placing an order that is not “bona fide” with the intent to affect the price of a stock, commodity, or currency. When the price changes in response to the “spoof” order, the manipulator cancels the order and places another order to take advantage of the new price. For example, a buy order will be followed by a sell order, which may be followed by alternating buy and sell orders as the price rises and falls.
Spoofing artificially alters market prices. In Michael Coscia’s case, Panther Energy Trading placed small orders to sell contracts in futures markets (including soybeans, natural gas, and copper). It then placed large orders to buy similar contacts at higher prices. The buy orders gave the impression that demand for the commodity was increasing, signaling rising prices and inducing buyers to purchase the contracts that Panther had offered for sale. Panther would then cancel its buy orders and repeat the sequence in reverse by placing a small buy order for the same commodity, followed by large sell orders that it intended to cancel.
The Commodities Future Trading Commission (CFTC) accused Panther of manipulating the market. Panther agreed to pay an administrative penalty of $2.8 million to settle administrative enforcement proceedings.
In addition to the CFTC, the Securities Exchange Commission and other regulatory agencies have pursued civil or administrative remedies, including trading bans, license revocations, and the assessment of financial penalties, against firms that engaged in the practice of spoofing. Day traders have been prime targets of enforcement actions.
Spoofing usually relies upon computer algorithms that place and cancel bids in milliseconds. High-speed, high-frequency trading has come to dominate markets, enhancing the possibility of market manipulation. Its proponents, however, see high-speed computerized trading as a legitimate investment tool.
Spoofing Charges Against Michael Coscia
Federal prosecutors filed criminal charges for violating anti-spoofing laws against Michael Coscia for Panther’s trading activities. The federal indictment alleges that Coscia used his high-speed trading scheme to make $1.6 million in just three months.
Making money is not illegal. Making money by spoofing, on the other hand, is a crime. Coscia’s jury will be the first to consider criminal charges for violations of the anti-spoofing law. Whether Coscia manipulated the market or pursued a legitimate investment strategy is the question the jury will be asked to resolve.
Expert Testimony at Coscia’s Trial
Expert testimony may play a vital role for both sides in Coscia’s trial. Since placing and cancelling orders is not itself illegal, the government’s proof hinges on convincing the jury that Coscia intended to cancel the orders in order to manipulate the market. Coscia claims that he merely engaged in common trading practices. He will likely rely on financial experts to explain to the jury the frequency with which buy and sell orders are cancelled.
Coscia also contends that he abided by the rules of the exchanges in which he placed the orders and blames regulators for failing to provide clear guidance to investors. To establish that he had no intent to violate the law, Coscia plans to call an expert to testify about the industry’s understanding of anti-spoofing legislation in 2011, when his trades took place. Whether the judge will permit the expert to provide the detailed testimony that Coscia seeks is not yet clear.
Prosecutors will also need to rely on experts to educate jurors about how trades are made in the commodities market and about the programming of the software that Coscia relied upon to make those trades. Another trader, Navinder Singh Sarao, has been charged with using market manipulation tactics that were responsible for the “flash crash” of 2010. Prosecutors are relying on the expert opinions of Terrence Hendershott, a professor at the University of California -Berkeley, to make their case against Sarao, who is confined in a London prison as he resists extradition to Chicago.