‘Spoofing’ on U.K. Regulator’s Radar for Past Six Years Traders say practice is still rife despite warnings
Spoofing, which is illegal in the U.K. and the U.S., involves placing numerous trades to create an impression of demand and then quickly canceling them to trick markets. The practice hit the U.K. headlines last month when a British trader, Navinder Singh Sarao, was arrested after U.S. authorities alleged he manipulated the S&P futures market for years and contributed to the so-called flash-crash of 2010. U.S. authorities allege that Mr. Sarao made $40 million through "numerous aggressive spoofing tactics" to manipulate the U.S. futures markets using a souped-up version of commercially available software operating out of a semidetached house in Hounslow, a London suburb close to Heathrow Airport.
Mr. Sarao is currently being held in prison in the U.K. awaiting an extradition hearing to the U.S. scheduled for September. Mr. Sarao couldn't be reached for comment. His lawyer didn't respond to requests for comment. Mr. Sarao is seeking to block the extradition request.
The trading strategies he is accused of using were raising concerns at U.K. regulators for years. In 2009, the U.K.’s Financial Services Authority, which was subsequently replaced by the Financial Conduct Authority, warned brokers in an industry newsletter about trading strategies aimed at gaming markets, saying it had "concerns about order book conduct and the intentional pattern of behavior called layering or spoofing."
In 2012, the regulator reiterated its concerns in a letter sent to U.K. regulated brokers warning that it could "consider supervisory or enforcement action" if abusive trading had taken place or if controls for stopping it were inadequate.
At the Futures Options Association Compliance Forum, also in 2012, the FSA’s head of market monitoring said that firms with insufficient monitoring systems and controls to prevent spoofing could potentially be subject to criminal or civil enforcement actions.
Despite the warnings though, some U.K. traders said such strategies are rife.
Firms can put in thousands of orders to buy or sell securities and then cancel them milliseconds later, even if they are not always attempting to manipulate markets, said Paolo Rossi, co-founder of Futex Global, the brokerage where Mr. Sarao learned to trade.
Exchanges should introduce measures to stop fast trade cancellations and slow down price movements, Mr. Rossi said.
"You go to shake my hand and I pull my hand away," he said. "I don’t see there is any integrity behind it,"
Paul Rotter, a former trader who now runs Rotter Invest Asset Management, an asset management company, said that the regulators may have encouraged misbehavior by failing to take tougher action.
"Hundreds of market participants are using this market placing and withdrawing order strategy," said Mr. Rotter, who was nicknamed "the flipper" because he frequently switched the direction of his trading. Some traders think "if you can watch it for years, it must be legal, because the regulators don’t stop it," he added.
The FCA has brought three public, noncriminal enforcement cases against firms or individuals accused of using trading strategies to manipulate markets, including "spoofing". In all cases, traders were fined and their assets were frozen.
Exchanges, which are obliged to pass on alerts about suspicious activity to regulators, say they have introduced measures to try to prevent spoofing.
"We continually police and prosecute disruptive trading activity, including spoofing," said a spokesperson for the Chicago Mercantile Exchange, of which Mr. Sarao was a member.
The CME has been developing technology to help detect a wide range of complex abusive trading techniques, according to a 2013 patent filed by the CME. The new technology is also designed to automatically comb through data from dozens of social media sites, including Twitter and Facebook, to determine whether a trader’s activity could be explained by something posted on one of them.
Deutsche Börse introduced a new surveillance software in 2011 called Cinnober Surveillance, which is meant to catch unusual trading patterns. "We are committed to ensure orderly trading above all. To do so, there are several layers of market supervision," a spokesman for the Boerse said.
The U.S. Commodity Futures Trading Commission filed civil charges against Mr. Sarao, while the Justice Department has filed criminal charges. They allege his strategies contributed to the flash crash of May 6, 2010 when a dramatic swing in prices knocked a trillion dollars of value from the markets before a sharp rebound.
