Federal prosecutors sometimes lose trials, and it is usually not considered too much of a setback. But when the loss involves only the second prosecution for a new crime called “spoofing,” it raises questions about how the government will pursue future cases.
A former UBS precious metals trader, Andre Flotron, was acquitted by a jury in Connecticut last month after only a few hours of deliberation. Mr. Flotron had been charged with conspiracy to commit commodities fraud for allegedly placing “trick orders” designed to fool others into believing there was more buying or selling interest than actually existed.
The verdict shows that prosecutors will continue to struggle to prove when a trading strategy crosses the line into criminal conduct. Seven other defendants are facing spoofing charges in Chicago and Houston, and their lawyers are sure to try the same tactics that worked in defending Mr. Flotron.
The crime of spoofing was added to the criminal lexicon in the Dodd-Frank Act in 2010. The law prohibits “bidding or offering with the intent to cancel the bid or offer before execution.” Like most white-collar crimes, it revolves largely around proving the defendant’s intent to affect the market by placing orders with no plan to have them filled.
The problem is that most orders in the securities and commodities markets go unfilled, so canceling orders cannot be criminal just by itself. A 2013 study by the Securities and Exchange Commission found that fewer than 5 percent of orders placed on stock exchanges were filled. So simply showing that an investor canceled trades on a regular basis may not be enough to prove the intent necessary for a spoofing violation.
The first spoofing conviction involved Michael Coscia, who was charged with creating an algorithm to enter and cancel large orders in milliseconds. Mr. Coscia would simultaneously put in small orders that would be profitable once other traders reacted to the artificial ones. In that case, the government focused on the large number of orders his algorithm generated, making his testimony that he wanted every order filled questionable. The jury returned its guilty verdict after only one hour of deliberation, showing that it found the statistical evidence of large-scale order cancellations persuasive.
The prosecution of Mr. Flotron, though, started badly for the government. Jeffrey Alker Meyer, a federal district judge in New Haven, dismissed six of the seven charges in February. The judge found that the trades identified in those charges occurred only in Chicago, where the commodities exchanges operate, so under the constitutional venue requirement no crime was committed in Connecticut. That left just the conspiracy charge.
To prove spoofing, the Justice Department relied on two traders who worked for Mr. Flotron to explain how he taught them to enter and then cancel orders to influence the direction of the commodity prices. Both testified after receiving non-prosecution agreements from the government, which meant their claims were open to question about whether they got a deal to point the finger at Mr. Flotron.
In Mr. Flotron’s case, there was no algorithm or automated trading for the government to point to. Instead, his orders were placed manually, and some were kept open for up to a minute. That made it more difficult for prosecutors to show that his goal was to manipulate other traders, when there was at least a chance the order would be filled.
Adding to the government’s burden, there are few mom-and-pop investors putting in orders for precious metals like gold and silver futures and other complex financial products that Mr. Flotron traded. Most transactions involve sophisticated firms that use algorithms to try to predict price movements and profit from small changes. That meant prosecutors could not offer up appealing victims as witnesses.
The elusive issue in white-collar cases is almost always intent. Spoofing puts the spotlight on distinguishing between ordinary trading activity and a pattern of order cancellations that crosses an unidentified line of criminality.
Mr. Coscia’s conviction gave prosecutors greater confidence in how to prove spoofing. Mr. Flotron’s acquittal raises the question of how many cancellations are too many to show an illegal intent rather than a permissible trading program.
For defendants facing charges of spoofing, that means the more they can show the human element in trading — and how their conduct differs little from that of other players in the markets — the greater the possibility that the jury will return a verdict in their favor.