Michael Coscia, the manager and
sole owner of a small New Jersey-based trading firm called Panther Energy Trading LLC (founded
in 2007), was the first person to be criminally prosecuted under the Dodd-Frank
Act’s spoofing provision, being sentenced to 3 years in prison, in relation to trading strategies he pursued between August 2011 and October 2011.
Before the indictment
On October 2011, Michael Coscia was notified by the US Commodity Futures Trading Commission (CFTC) and by the UK Financial Conduct Authority (FCA) for allegedly violating exchange rules and the Dodd-Frank Act’s spoofing provision.
Michael Coscia states that, after receiving such notice, he stopped using the suspicious trading strategy.
On July 2013, he settled with the above mentioned authorities, having disgorged all profits (amounting to 1,7 million USD), paid fines (amounting to 2,8 million USD) and been suspended from trading during the period of 1 year.
The indictment
In spite of the said settlements, Michael Coscia was indicted on October 2014 to 6 counts of commodity fraud (Title 18, United States Code, Section 1348) and 6 counts of spoofing (Title 7, United States Code, Sections 6c[a][5][C] and 13[a][2]) in relation to the said trading practices.
In general terms, the indictment states that:
The indictment also mentions how Michael Coscia used to pre-test the market so to verify whether the conditions were favorable to his spoofing strategy:
Before the indictment
On October 2011, Michael Coscia was notified by the US Commodity Futures Trading Commission (CFTC) and by the UK Financial Conduct Authority (FCA) for allegedly violating exchange rules and the Dodd-Frank Act’s spoofing provision.
Michael Coscia states that, after receiving such notice, he stopped using the suspicious trading strategy.
On July 2013, he settled with the above mentioned authorities, having disgorged all profits (amounting to 1,7 million USD), paid fines (amounting to 2,8 million USD) and been suspended from trading during the period of 1 year.
The indictment
In spite of the said settlements, Michael Coscia was indicted on October 2014 to 6 counts of commodity fraud (Title 18, United States Code, Section 1348) and 6 counts of spoofing (Title 7, United States Code, Sections 6c[a][5][C] and 13[a][2]) in relation to the said trading practices.
In general terms, the indictment states that:
- “COSCIA devised this strategy to create a false impression regarding the number of contracts available in the market, and to fraudulently induce other market participants to react to the deceptive market information that he created”;
- “COSCIA’s strategy moved the market in a direction favorable to him, enabling him to purchase contracts at prices lower than, or sell contracts at prices higher than, the prices available in the market before he entered and canceled his large-volume orders”;
- “COSCIA then repeated this strategy in the opposite direction to immediately obtain a profit by buying futures contracts at a lower price than he paid for them, or by selling contracts at a higher price than he paid for them”;
- “As a result of this strategy, COSCIA made approximately $1,592,867”;
- “COSCIA designed his programs to place several layers of “quote orders” on the other side of the market from his trade orders to create the illusion of market interest”;
- “COSCIA’s quote orders were either orders to buy contracts at a price higher than the prevailing offer, or orders to sell contracts at a price lower than the prevailing bid. The quote orders would typically be the largest orders in the market within three ticks of the best bid or offer price, usually doubling or tripling the total quantity of contracts within the best bid or offer price”;
- “It was further part of the scheme that COSCIA designed his programs to cancel the quote orders within a fraction of a second automatically, without regard to market conditions, even if the market moved in a direction favorable to the quote orders”.
Basically, the indictment describes a typical case of spoofing, in which the spoofer tricks other market participants into believing that there is an increased buying (selling) interest in order to move the market in such direction, and then trade on the other side of order book at more favorable terms.
As an example, the indictment
describes one entire spoofing action performed by Michael Coscia in the Euro FX market on 01/Sep/2011:
The indictment also mentions how Michael Coscia used to pre-test the market so to verify whether the conditions were favorable to his spoofing strategy:
- “COSCIA’s trading programs looked for market conditions such as price stability, low volume at the best prices, and a narrow bid-ask spread because his fraudulent trading strategy worked best under these conditions”;
- COSCIA’s trading programs sometimes placed a “ping order” of one contract to test the market and ensure that market conditions would allow his fraudulent trading strategy to work well;
Indeed, I would say that Coscia was seeking:
- Price stability, to ensure that his algorithms were the main drivers of price variations, i.e. to ensure that he had the price under his control;
- Low volume at the best prices, to ensure that he could place spoof orders that were large enough to move the best prices;
- Narrow bid-ask spread, to ensure that, by spoofing, he could sell at a higher price than he paid when buying the securities (with a wider bid-ask spread, the spoofing effort would have to be bigger).
The conviction at the Federal District Court
On November 2015, a jury in Chicago, after deliberating for one hour, convicted Michael Coscia of all charges (six counts of spoofing and the six counts of commodity fraud).
A conviction for spoofing requires that the prosecution prove beyond a reasonable doubt that Michael Coscia knowingly entered bids or offers with the present intent to cancel them prior to execution. And the high number of cancelled orders and the large size of such orders should not be sufficient by themselves to convict someone for spoofing.
However, the government presented evidence regarding of such intent:
A conviction for spoofing requires that the prosecution prove beyond a reasonable doubt that Michael Coscia knowingly entered bids or offers with the present intent to cancel them prior to execution. And the high number of cancelled orders and the large size of such orders should not be sufficient by themselves to convict someone for spoofing.
However, the government presented evidence regarding of such intent:
- Jeremiah Park, the designer of Flash Trader and Quote Trader, testified that Michael Coscia asked for these two programs to act "like a decoy" to be "used to pump the market";
- Flash Trader and Quote Trader were programmed to cancel the large orders (i) after the passage of time, (ii) if the small orders were filled, and (iii) if a single large order was filled;
- John Redman, a director of compliance for Intercontinental Exchange, testified that Michael Coscia:
- Filled only 0,5% of the 24.814 large orders placed, while filled 52% of the 6.782 small orders placed, with such practice being described by John Redman as very unusual – while high frequency traders do cancel a large percentage of their orders, they tend do it more homogeneously across order sizes;
- Was responsible for 96% of all Brent future cancellations during the period he employed his software;
- Mathew Evans, senior vice-president of NERA Economic Consulting, testified that Michael Coscia had an order-to-fill ratio of 15,9x, whereas other traders generally presented ratios of between 0,9x and 2,6x;
- According to one study, only 0,57% of Michael Coscia’s large orders were on the market for more than one second, whereas 65% of large orders entered by other high‐frequency traders were open for more than a second.
In addition, as traders from other firms testified that they incurred losses as a result of trading with Michael Coscia (spoofing is profitable only at the expense of other traders):
- Anand Twells, from Citadel, testified that his firm lost $480 in 400 milliseconds;
- Hovannes Dermenchyan, from Teza Technologies, testified that his firm lost $10.000 over the course of one hour;
- Alexander Gerko, from XTX Markets, testified that his firm probably lost hundreds of thousands of dollars.
During the trial, which lasted for 7 days, Michael Coscia denied any wrongdoing and testified that he intended to trade every order that he entered.
A Federal District Court judge sentenced him to 3 years in prison.
The rejection of the appeal by the Federal Court of Appeals
Michal Coscia's appeal argued that:
On August 2017, a three-judge Federal Court of Appeals panel in Chicago rejected such appeal. Please find below, this panel's conclusion:
"Mr. Coscia engaged in ten weeks of trading during which he placed orders with the clear intent to cancel those orders prior to execution. As a result, Mr. Coscia violated the plain wording of the Dodd‐Frank Act’s anti‐spoofing provision. Mr. Coscia engaged in this behavior in order to inflate or deflate the price of certain commodities. His trading accordingly also constituted commodities fraud. Finally, given the nature and complexity of his criminal enterprise, the district court did not err in imposing a fourteen‐point loss enhancement. For the foregoing reasons, Mr. Coscia’s conviction is affirmed. "
The rejection of the appeal by the Supreme Court
On May 2018, the US Supreme Court rejected Michael Coscia's appeal.
The rejection of the appeal by the Federal Court of Appeals
Michal Coscia's appeal argued that:
- The spoofing provision was unconstitutionally vague, by failing to clearly distinguish commonplace trading activity from illicit trading activity;
- The government produced insufficient evidence and that the trial court applied an incorrect materiality standard;
- The district court err in imposing a fourteen‐point loss enhancement, by erroneously employing his gain as a measure of loss in determining his sentence.
On August 2017, a three-judge Federal Court of Appeals panel in Chicago rejected such appeal. Please find below, this panel's conclusion:
"Mr. Coscia engaged in ten weeks of trading during which he placed orders with the clear intent to cancel those orders prior to execution. As a result, Mr. Coscia violated the plain wording of the Dodd‐Frank Act’s anti‐spoofing provision. Mr. Coscia engaged in this behavior in order to inflate or deflate the price of certain commodities. His trading accordingly also constituted commodities fraud. Finally, given the nature and complexity of his criminal enterprise, the district court did not err in imposing a fourteen‐point loss enhancement. For the foregoing reasons, Mr. Coscia’s conviction is affirmed. "
The rejection of the appeal by the Supreme Court
On May 2018, the US Supreme Court rejected Michael Coscia's appeal.
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