Energy Trader Sentenced To Three Year Imprisonment For Dodd-Frank Violations
On July 13, 2016, a federal judge in Chicago, IL sentenced a commodity trader to three years in prison for violating a Dodd-Frank prohibition against “spoofing.” The trader in question was convicted in a criminal case that followed a settlement order with the CFTC. The criminal conviction represents the first prison term handed down to a commodity trader since Dodd-Frank was enacted six years ago. The relevant portion of Dodd-Frank provides that it is “…unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that is, is of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).” The trader in question, and his company Panther Energy Trading LLC, were accused by the CFTC of placing bids or offers for crude oil, natural gas, and agricultural futures, on one side of the market to give the impression of market interest on that side of the market and to increase the likelihood that their smaller orders sitting on the opposite side of the market would be filled and using an algorithm designed to cancel the large bids or offers prior to execution. In other words, the trader was convicted of manipulating the markets by making large bids or offers he did not intend the fill and then entering into smaller trades on the opposite side of the market.
While spoofing was made illegal under Dodd-Frank, similar conduct had been occasionally used, in one form or another, for a long time. While it was considered unethical and discouraged by most market participants, there was never a common consensus about what exactly were the boundaries of legitimate price discovery trades as opposed to intentionally sending a false signal to the market and causing a price movement that does not reflect market fundamentals, i.e., supply and demand. For example, energy traders with a naturally long position such as crude oil, natural gas, or electricity producers often start their trading by entering into a smaller long positions to test the depth of the market. This has been a common practice for many decades and was considered a legitimate price discovery tool. However, with broad and vague anti-disruptive and anti-manipulation regulations under Dodd-Frank, energy marketers must carefully evaluate some of their trading practices.
The key takeaways from this case are twofold. First, the CFTC intends to vigorously enforce market regulations. Second, all market participants must provide their marketers with adequate resources to ensure that they only execute legitimate trades consistent with the current regulations. This means that in addition to regular training, all market participants should have robust policies and procedures outlining the management approved trading or hedging strategies, products, and exposure parameters. Also, the policies and procedures should ensure that the front office personnel are accountable for identifying and properly vetting any trades that may fall into the gray area. From a practical standpoint, those market participants that only occasionally trade have a much steeper learning curve because they are less likely to have a robust trading infrastructure. For example, energy producers, transporters, and distributors, whose core business is not trading, are more likely to be at risk. The cost of non-compliance with market regulations is so significant that there should be no doubt that every market participant must take the necessary measures to minimize the regulatory risk as much as possible. The challenge will be, as always, to ensure that regulatory compliance is structured in such a way to allow the uninterrupted business flow.