The Last Word on the Use of the Wire Fraud Statute to Prosecute Spoofing in the Futures Markets
R Tamara de Silva
On September 2020, a jury convicted two former Deutsche Bank metals traders, James Vorley and Cedric Chanu, of several counts of wire fraud based on allegations that the pair placed $2.6 billion worth of cancelled orders (what the jury found to fake trades) on the Chicago Mercantile Exchange’s Globex system, between 2008 and 2013.
This week, the U.S. Supreme Court refused to hear the appeal of the two ex-Deutsche Bank traders for their convictions for spoofing. USA v. Vorley, et al is significant because it is the first time the government has used wire fraud by itself to prosecute spoofing. (18 U.S.C. §1343)
The Seventh Circuit previously held in United States v. Coscia that a computerized spoofing scheme (bidding or offering with the intent to cancel the bid or offer before execution) can constitute a scheme to defraud under the commodities fraud statute.[i] The conviction for spoofing in Coscia was based primarily on the testimony of a cooperating witness, the programmer Coscia used, who stated that Coscia asked him to design a trading algorithm that would act, “like a decoy…to pump [the] market.” [ii] The algorithm generated orders that were unexecutable-meaning they had no chance of being filled. This is an important distinction between facts in the Coscia case and the USA v. Vorley to keep in mind as you read this.
When I first wrote about the Vorley case, I explained that the Dodd-Frank Act of 2010 defines “spoofing” as placing an order to buy or sell “with the intent to cancel” the order before it is filled. This definition is somewhat vague because it can encompass perfectly legal trading behavior-cancelling orders. Spoofing is a disruptive market practice because it can create a false impression of supply and demand. But the intent requirement of spoofing is difficult to prove because the same conduct alleged to be spoofing can be facially legitimate. Hence spoofing is often proven by circumstantial evidence…or now, after Vorley, the more broadly ranging federal wire fraud statute.
Judge Jed S. Rakoff, before he became a federal judge and was a prosecutor described the mail and wire fraud statutes, “our Stradivarius, our Colt 45, our Louisville Slugger, our Cuisinart-and our true love.”[iii] They have been used broadly to expand the reach of federal criminal law.
The significance of the Vorley case is that the indictment did not bring charges under the Dodd-Frank Act, which amended the Commodity Exchange Act (“CEA”), it brought them under the far more general and amorphous federal wire fraud statute.
Doing so advantaged the prosecution. Wire fraud does not require proof of affirmative misstatements-implied misrepresentations are enough for criminal culpability.
Another advantage gained by the U.S. Department of Justice’s use of the wire fraud statute, is it allowed them to amend the indictment to include conduct going as far back as from 2008 onwards. This conduct would have otherwise been outside the five-year statute of limitations for spoofing under the CEA and commodities fraud statute of limitations of six years -to the wire fraud statute’s ten years.
It also meant that instead of spoofing, as it was found in the Coscia case as an instance of commodity fraud, the DOJ’s use of wire fraud meant that fraud could be implied by every spoofing order considered as an implied misrepresentation.
The Defense in Vorley pointed out that unlike in the Coscia case, their thousands of orders were in the market for much longer periods of time, and all of them could have been executed. They further argued that the government was cherry picking trade data to portray a pattern of spoofing.
In the Vorley case, the government used the following circumstantial evidence; a chat message in which the defendants were complaining about spoofing at another investment bank; the statements of a trading colleague who had turned government witness; select trading data to prove patterns of both traders placing opposing orders; and Chanu and Vorley’s trade fill ratios.
A fill ratio is the ratio of the quantity of orders that are filled versus what are submitted to be filled. The ratio data in Vorley showed that when the defendants used iceberg orders (a type of order used by institutional traders to execute an order without disrupting the market by breaking up a large order into smaller limit orders that obscure the quantity/size of the single order), they had a fill rate of 90%. But when they used visible orders, they fill rate was only .2%. What the trier of fact and perhaps even the Seventh Circuit Court of Appeals may have not adequately understood is that there is nothing inherently duplicitous about iceberg orders. They are an entirely legal order type. The use of iceberg orders is not shady, though a juror could think this without adequate explanation. And the two defendants had to use them as they were trading for a large investment bank.
The indictment against the defendants Vorley and Chanu was opposed by industry groups like the Bank Policy Institute, the Securities Industry and Financial Markets Association, and The Chamber of Commerce who together wrote an amicus brief asking the court to dismiss the indictment. It was also opposed in an amicus brief submitted by the Futures Industry Association.
The Futures Industry Association pointed out using wire fraud’s implied misrepresentation standard, where there was already an established regulatory regime for the futures markets established by Congress with the Commodity Exchange Act and the Dodd Frank Act, was unnecessary. They also argued that an order, by itself, does not have “an intent.”
As the defendants’ and the other amici’s briefs make clear, the government’s position can never overcome the fact that an open, executable order does not represent any facts regarding trading intentions, except to honor the order according to its terms if it is executed.[iv]
With the Supreme Court refusing to hear the appeal of the Vorley defendants, the use of the wire fraud statute to prosecute and allege spoofing in the futures markets has a precedent.
The ambiguity left by Dodd-Frank’s definition of spoofing is being lessened by federal prosecution, which is not ideal for the industry as it may encompass legitimate conduct. Market participants may choose to disguise their trading strategies by placing orders that are inconsistent with them for various reasons, among them, liquidity constraints. For example, institutional traders often have to disguise their position by splitting large orders and using multiple brokers-this may be someone's idea of an implied misrepresentation but it is also rational market behavior.
If you are facing charges of spoofing at even the exchange level, do not proceed alone or without experienced counsel, who is also experienced in and understands the trading markets.
R Tamara de Silva