On May 6, 2010, in what become known as the “Flash Crash,” the Dow fell almost 10% before recovering much of that loss within an hour. Years later, a whistleblower who had analyzed market data (but had no inside knowledge himself) filed a report with the CFTC identifying a market participant in the S&P 500 E-Mini as a major cause of the Flash Crash.[1] The CFTC investigated and identified this actor as Nav Sarao, a trader who had been spoofing the market from the basement of his mother’s flat in suburban London. Determining that this was likely a criminal violation of the new anti-spoofing section of the Commodity Exchange Act (“CEA”),[2] the CFTC brought in the Fraud Section of the U.S. Department of Justice’s (“DOJ’s”) Criminal Division. The Fraud Section (and the CFTC) pursued the investigation with vigor, and in April 2015, Mr. Sarao, whom the British tabloids subsequently nicknamed the “Hound of Hounslow,” was arrested by Scotland Yard. Sarao ultimately pleaded guilty and agreed to cooperate with U.S. authorities.
The Sarao case intensified the relationship between the Fraud Section and the CFTC’s Division of Enforcement. Since that time, an attorney from the Enforcement Division has been seconded to the Fraud Section, which post-Sarao created an Anti-Spoofing Task Force that began to generate its own spoofing investigations and cases. Now, the Fraud Section appears to be doubling down on its commitment to criminally prosecuting CEA violations. In 2019, the Fraud Section attorney who had led the Sarao prosecution was made Chief of the Section, and several months later, DOJ announced a reorganization of what had previously been called the “Securities and Financial Fraud” Unit of the Fraud Section. Henceforth, it would be known as the “Market Integrity and Major Fraud Unit,” and it would contain a subsection specifically dedicated to pursuing Commodity Fraud. This unit, in turn, would be headed by the trial lawyer who is currently responsible for the investigation into spoofing at the metals desk at JP Morgan. Weeks later, the government made the unprecedented move of labeling JP Morgan’s metals trading desk a racketeering enterprise in an indictment brought against individuals who had worked on that desk.[3]
It is hard to overstate the significance of these developments to the future of criminal enforcement of the CEA. That law makes any willful violation of its provisions a felony. But until the last several years, criminal prosecutions of CEA violations were vanishingly rare. In 2014, the U.S. Attorney’s Office for the Northern District of Illinois indicted Michael Coscia for spoofing in what was, at the time, a very controversial move in the derivatives industry. The same year, the Chicago U.S. Attorney’s Office created its specialized Securities and Commodities Fraud Section. The Southern District of New York has long had its own Securities and Commodities Fraud Task Force. But this unit was colloquially known as the “securities” unit, and for good reason; the number of securities cases brought, in the SDNY and elsewhere, has always dwarfed the number of commodities prosecutions.
There’s no reason to believe that this discrepancy is attributable to there being less misconduct in the derivatives markets than in the equities markets. Rather, it’s because securities fraud is more familiar to many prosecutors, and because the CFTC, despite its responsibility for regulating a market with a notional value in the trillions and the role that derivatives played in precipitating the 2007-2008 financial crisis, has a budget that is a rounding error compared to that of the SEC. In fact, the CFTC Division of Enforcement is no bigger now than it was before the Dodd-Frank Act exploded the agency’s responsibilities and armed it with powerful new statutory authorities, including the anti-spoofing provision and new tools to go after fraud and manipulation.
The relatively miniscule size of the CFTC directly impacts the number of criminal commodities cases that are charged because, when the CFTC Enforcement Division finds evidence of egregious misconduct, it generally refers those matters to the criminal authorities, as it did in the Sarao case. But since the Fraud Section stood up its Anti-Spoofing Task Force, it’s been able to generate its own matters, without relying on referrals from the CFTC. Often, these investigations have been data-driven. Sophisticated software can crunch data from various market feeds to detect suspicious patterns, like the classic spoofing pattern, where a large spoof order is entered on one side of the market, usually far enough away from the price point to minimize the chances of getting hit, while a much smaller order (the “real” order) is resting on the other side of the market. This is designed to fool trading algorithms into believing that there is more demand, or supply, than there truly is. Other patterns, like “vacuuming” (spoofing’s lesser-known doppelganger) are also detectable by software used by the government.
And unlike the CFTC, the Fraud Section is not lacking for resources. After a decade of explosive growth, there are now more than 150 prosecutors in the Section. To put that number in perspective, the SDNY has slightly more prosecutors to cover the entire waterfront of federal crimes.
The last several years have demonstrated the Fraud Section’s appetite for bringing spoofing cases, and its mixed record of success in early spoofing trials[4] does not appear to have dented that enthusiasm. The new unit devoted to commodities fraud means that future cases likely won’t be confined to the anti-spoofing section of the CEA. The CEA’s definition of a “commodity in interstate commerce” is breathtakingly broad, and includes, for example, spot cryptocurrency, which the CFTC already has found is a commodity.[5] Given this position and the CFTC’s willingness to bring crypto-based enforcement actions since 2015, the new Commodities Fraud unit seems like a natural choice for future prosecutions involving fraud and manipulation in the crypto markets.
So it is eminently reasonable to expect an uptick, in both numbers and variety, of criminal CEA cases coming out of the Fraud Section. We probably won’t start seeing criminal prosecutions for willful violation of position limits or other regulatory sections of the statute. But it’s pretty clear that the Fraud Section is not going to be confined to the spoofing pen any longer.
Footnotes
[1] I can reveal this without violating whistleblower confidentiality rules because the whistleblower’s attorney issued a press release describing his role when Sarao was arrested. Hagens Berman, “Hagens Berman CFTC Whistleblower Helps CFTC and DOJ Bring Charges Against Flash Crash Market Spoofing Fraudster” (Sep. 16, 2015), available here.
[2] 7 U.S.C. § 6c(a)(5)(C).
[3] See Ind., United States v. Smith et al., No. 19-CR-669 (N.D. Ill.) (Aug. 22, 2019), available here.
[4] See, e.g., Emily Flitter, “Former UBS Trader Is Cleared in ‘Spoofing’ Case,” N.Y. Times (Apr. 25, 2018), available at https://www.nytimes.com/2018/04/25/business/ubs-trader-spoofing-flotron.html; Peter J. Henning, “Conviction Offers Guide to Future ‘Spoofing’ Cases,” N.Y. Times (Nov. 9, 2015), available at https://www.nytimes.com/2015/11/10/business/dealbook/conviction-offers-guide-to-future-spoofing-cases.html.
[5] Order, In re Coinflip, Inc., d/b/a/ Derivabit, et al., CFTC Docket No. 15-29 (Sept. 17, 2015), available here (PDF: 456 KB).
Aitan Goelman is a partner in the Washington, DC office of Zuckerman Spaeder and a member of PCCE’s Advisory Board. He was Director of the CFTC’s Division of Enforcement from 2014 to 2017.
Disclaimer
The views, opinions and positions expressed within all posts are those of the author alone and do not represent those of the Program on Corporate Compliance and Enforcement (PCCE) or of New York University School of Law. PCCE makes no representations as to the accuracy, completeness and validity of any statements made on this site and will not be liable for any errors, omissions or representations. The copyright of this content belongs to the author and any liability with regards to infringement of intellectual property rights remains with the author.