The US clampdown on firms “spoofing” the markets

What’s happened?

A few weeks ago the big US bank JPMorgan Chase admitted that its then-employees fraudulently rigged precious-metals and Treasury (US government bond) markets tens of thousands of times between 2008 and 2016. As part of its settlement with the US authorities, it agreed to pay a total of $920m in fines and restitution (including $172m in “disgorgement”, meaning paying back its ill-gotten gains). The bank admitted that traders based in New York, London and Singapore – working in the gold, silver and other precious metals futures markets, as well as the Treasury cash and futures markets – had engaged in the practice known as “spoofing” on thousands of occasions over the course of eight years.

What does spoofing involve?

It means quickly placing and then withdrawing buy or sell orders to trick other traders by giving them a false sense of current market demand. The idea is that you confuse the market and move the price in your favour. So if you want to sell silver, say, you could place a series of multiple smallish buy orders at different prices (a technique known as “layering”, which looks less suspicious than placing one big order). This dupes other market participants into pushing prices higher, meaning you can sell your silver at a higher price before cancelling your phoney buy orders.

Is that easy to get away with?

Like many forms of market manipulation, spoofing is a pretty crude ruse that would have been relatively hard to get away with when traders worked together in a pit in an old-fashioned exchange. But it’s been a growing problem since the rise of rapid-fire, computer-driven trading around 15 years ago. The dominance of algorithmic trading systems, which rapidly analyse order books to work out where the markets are heading next, makes it easier (and more tempting) for actual humans to spoof them. Indeed, many traders would (quietly) argue that spoofing is merely a modern form of bluffing – a perfectly legitimate trading tactic that levels the playing field for humans against the machines. As one JPMorgan trader put it, according to prosecutors, the tactic was “a little razzle-dazzle to juke the algos”.

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But it’s illegal?

Yes, but it’s only been specifically outlawed in the US since 2010. Spoofing can be a hard crime to prove, since the authorities have to show that the trader intended in advance to cancel their original order – it is, after all, perfectly legal to change your mind. Even so, in the past two years, many of the leading global banks have paid penalties to regulators on spoofing charges – including Deutsche, HSBC, Merrill Lynch and UBS. Just last month, two former Deutsche Bank metals traders in Chicago were convicted of the offence. But the $920m penalties handed to JPMorgan Chase are several times as large as previous examples. It represents a step change by US regulators.

Don’t banks get fined all the time?

Indeed, since the global financial crisis of 2007-2008, banks worldwide have paid around $30bn in regulatory fines each year on average. That period has seen a series of banking-sector scandals relating to various forms of market manipulation and collusion, including the Libor scandal of 2012; the Forex scandal of 2014; and the Wells Fargo fake account scandal of 2016. According to an exhaustive study by the Boston Consulting Group compiled in 2017, banks had paid $321bn in fines in the previous decade, with North American banks accounting for 63% of that. A 2018 tally by Keefe, Bruyette and Woods (a US research firm) came up with a similar figure. They surveyed fines on just US banks, and put the total at $243bn. Bank of America was the top offender with $76bn of fines, and JPMorgan Chase second with $44bn.

Do fines work as a deterrent?

Compared to the size of their balance sheets and revenues, the fines levied on banks look like a pretty manageable cost of doing business. According to research conducted by John Coffee of Columbia University’s law school, who looked at a sample of the 25 biggest fines imposed on listed US companies (not all of them banks), fines don’t have much of a deterrent effect on top executives, or even worry shareholders that much. Indeed, on the day the regulators’ fines were announced to the market, the share price of the affected company rose significantly in almost all cases, presumably due to relief that the issue had been settled. “This is not a call for lower penalties, but for a focus on individual executives,” says Coffee. “Today, when faced with a governmental investigation, corporate executives – high and low – face a choice: do they risk personal liability or do they settle with their shareholders’ money? Surprise of all surprises, they would prefer to plead the corporation guilty or in a civil case to pay a large settlement to the SEC and others.”

Aren’t the JPMorgan traders facing jail?

Yes – not least because US prosecutors have charged their suspects under the Racketeer Influenced and Corrupt Organisations (Rico) Act – a law targeting organised crime. These include Michael Nowak, the bank’s former head of precious metals trading, and Gregg Smith, a senior gold trader; both men have pleaded not guilty to all charges. Using the Rico Act against legitimate businesses, rather than mobsters, has few precedents. But the Department of Justice has decided that the evidence from JPMorgan meets the criteria of a racketeering conspiracy – a pattern of illegality over time, with individuals working together to further the goals of the allegedly criminal enterprise. It has been decades, says Tom Schoenberg of Bloomberg, since the US government “has attempted to apply the anti-racketeering law to members of a major bank’s trading desk”. It places Nowak and others “in crosshairs once trained on the likes of the Latin Kings and the Gambino crime family”. If that doesn’t concentrate minds on Wall Street, it’s hard to see what will.