Spoofing Mistrial Shows the Limit of Dodd-Frank on Fake Trade Orders

(Bloomberg) -- A decade after the U.S. government outlawed bogus trading orders known as spoofing, prosecutors are finding there are limits to how aggressively they can crack down on some forms of market manipulation.

The case of Jitesh Thakkar, the first non-trader charged under anti-spoofing laws, ended this week in a mistrial. Jurors in Chicago were split over whether he broke the law by developing software that someone else used for fake market orders, even after hearing detailed testimony from his client, convicted Flash Crash trader Navinder Singh Sarao.

“Getting someone who is a step removed from trading is difficult” for prosecutors, said Peter Henning, a law professor at Wayne State University. “If you don’t actually engage in trading, how do you prove spoofing?”

Spoofing occurs when a trader enters orders to buy or sell with no intention of completing the transactions. The intent is to influence prices by creating order flow that is a false market indicator, and then profiting by taking the opposite position. Traders like Sarao say the practice is common.

Since anti-spoofing laws passed under the Dodd-Frank financial reforms in 2010, the government has prosecuted almost a dozen criminal cases. Also, the Commodity Futures Trading Commission initiated 15 civil complaints in 2018, up from nine in 2017, but before then, the regulator averaged about one a year, said Greg Kaufman, a Washington-based lawyer who specializes in defending traders in enforcement actions.

For all of the individuals charged, only three stood trial so far and the results are decidedly mixed: in 2015, Michael Coscia was convicted in Chicago and sentenced to three years in prison; last year, Andre Flotron was acquitted after a Connecticut judge threw out most of the charges saying the government should have brought the case in Chicago, where the trading occurred; and now Thakkar is up in the air with a hearing April 25 to decide what happens next.

Recent Manipulation Cases

While the government has secured several guilty pleas, including from Sarao, Craig Pirrong, a professor at the University of Houston Bauer College of Business, says prosecuting such cases seems like a waste of government resources, especially in big markets where identifying actual harm from spoofing is nearly impossible. “I have yet to see a convincing statement about who lost and how much,” he said, adding that the potential punishments seem to far outpace the severity of the crimes.

By putting Thakkar on trial, the government may have been sending a message to programmers whose work aids spoofing, said Patrick Cotter, a former federal prosecutor who is now a white-collar criminal defense lawyer. The message is that they need to “be more careful,” Cotter said. “You can’t just wash your hands of this.”

Did He Know?

Thakkar was paid $24,000 to develop some trading software for Sarao, who prosecutors say was a key figure in the 2010 stock market Flash Crash that briefly wiped almost $1 trillion from the value of American equities, though critics like Pirrong say the charges against Sarao were overkill. A key issue in the trial was whether Thakkar knew Sarao would use the program to spoof the market.

But after two days of deliberation, jurors weren’t able to reach a verdict, which could lead to charges being dropped, a plea agreement or a new trial. U.S. District Judge Robert Gettleman called the case against Thakkar “thin” and, in a highly unusual move, threw out a conspiracy charge after the prosecution rested.

Thakkar’s legal team said he didn’t do anything wrong by simply fulfilling a request by his client to build a customized trading program. The jury was split 10 to two in favor of the defense when the mistrial was declared, according to Thakkar’s lawyer, Renato Mariotti.

“There wasn’t enough evidence to bring this case,” Mariotti said. “I hope the government doesn’t continue down this path.” He said he plans to renew his request to have the case thrown out.

‘Unusual Crime’

“Spoofing is such an unusual crime,” said Cotter, the former prosecutor. “Where’s the line between being really smart and fast, and being a crook? Only in unusual cases are you going to be able to prove intent.”

Email messages between Sarao and Thakkar made clear that the programmer knew his client didn’t want to execute his orders, the prosecutor said. In hypothetical scenarios that the two discussed, Sarao told Thakkar he might place orders for 300 contracts at a time, an unusually large trade that would have cost around $25 million at the time.

Thakkar was familiar with trading jargon and strategies, and served on a CFTC committee on high-frequency trading where spoofing was discussed, prosecutors said.

“He’s as guilty as if he pressed the buttons himself,’’ prosecutor Mark Cipolletti said in his closing remarks to the jury. “Common sense tells you that he knew what the program does.’’

The case is U.S. v. Jitesh Thakkar, 18-cr-36, U.S. District Court, Northern District of Illinois (Chicago).

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