A warning for all spread betters from the FSA

published 1 July 2011

It was quite a shock for Barnett Alexander. But the FSA's decision to impose a substantial fine on him initially set at £1m and then reduced to £700,000 for market abuse, sent a shock wave around much of the spread betting community. Worse, for him, he has been effectively banned from trading for five years. Other spread betters beware.

The full details of what upset the FSA can be read here along with the precise details of the trades in question.

In short, Barnett was accused of influencing the bid to offer spread on London Stock Exchange listed shares in order to make a higher than normal profit from trades involving spread bets and CFDs. The trick worked for him because the London Stock Exchange order book for shares (which queues up unfulfilled orders from its members) always looks to place orders of whatever size - at the top of the list if they are at the market's best prices.

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That means the highest "bid" (order to buy) and the lowest "offer" (order to sell) get positioned on the "touch" this is where the share's quoted bid to offer spread comes from. So hypothetically - if the highest bid is for 1,000 shares at £2 and the lowest offer is an order to sell 2,000 shares at £2.20, the bid to offer spread will be quoted as 200-220. Now, if I put even a very small order onto the book to buy say 20 shares at 210p, my order moves to the top of the buy queue and the spread narrows to 210-220.

Here's the trick. Immediately prior to placing my small buy order on the order book for shares, I place a much bigger buy order for a CFD, or I place a large "long" spread bet in the same underlying share. Since these derivatives tend to be priced off the LSE order book bid to offer spread I get to buy into my derivatives position at say 200p. However the effect of my small buy order for 20 shares at the LSE is to move my provider's derivative price up to say 210p. That's because many spread betting and CFD providers use automatic computer programs that simply mirror the bid to offer spread at the LSE for shares when setting the equivalent bid to offer spread for a derivative. In a nutshell they are set up to simply follow the LSE order book. I could narrow the spread further using a small order to sell shares on the LSE order book and then setting up a much larger CFD or spread bet downbet, or "short" trade. So I can now close out my spread bet or CFD position at a profit (and reverse any orders on the LSE order book).

Now, to some traders this would previously have been known as "arbitrage" taking advantage of pricing anomalies to make a profit. However, the FSA now calls it market abuse unfairly rigging the market in your favour. Since the line between the two seems to be getting ever finer, all spread betters should take note of this latest action. After all, you don't want the next person to fall the wrong side of them to be you.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.