It finally happened. The Commodity Futures Trading Commission, empowered by Dodd-Frank, flexed its muscles and called foul on a high frequency trading firm.
The Wall Street Journal reports: "Panther Energy Trading LLC, a high-speed trading firm, was fined by regulators for alleged manipulative trading in commodity markets, in commodities regulators' first case using new enforcement powers granted under the Dodd-Frank financial law."
Panther Energy was charged with "spoofing" for over two months in 2011. Spoofing is defined as a disruptive tactic in which false bids are submitted and recalled. The practice signals false high-volume to the market, helping to game the system.
The firm, which made $1.4 million using the strategy, agreed to a $2.8 million fine and one-year trading ban. The trading ban, while short, is no laughing matter. It is undeniably a black mark on the shop and an immense hurdle for acquiring future investments. It could also be seen as a benchmark for all future charges by the CFTC.
Crossing the Line
To be fair, spoofing, to a degree, happens all the time. Nearly all algorithmic trading places bids and offers with the intention of canceling some of them. The difference between legitimate cancellations and spoofing has to do with frequency. "At some point regulators have to judge if there are excessive cancellations," explains John Edge, managing director, Capital Markets and Business Development at NICE Actimize, a financial crime, fraud and compliance solutions provider. "And what is excessive cancellation? It has some subjectivity to it, but regulators will look at a ratio: Did you have 100 orders and 99 cancellations, or 1 cancellation? A 1% cancel ratio is no issue, but 99%, that’s suspicious."
This should also serve as a warning to anyone with a compliance role in a trading firm. "Too many people out there would say they don’t need to monitor their investors, but if even one person in your company is running algorithms with a suspiciously high cancel rate, the entire firm is at risk. If you run a business you need to know, and that can only come from investment and compliance technology."
What Took So Long?
CFTC's actions are certainly eye opening for an industry that’s been arguably under-policed, yet it begs the question, why did it take so long for regulators to act? After all, Dodd-Frank was made effective in 2010, and the rules were well articulated to the trading community.
There are two explanations. The first of which simply comes down to resources and manpower. "I'm sure if the regulators had more they would have put in more cases, but a lot of time and effort goes into making sure it’s done right. Do I think the community is concerned? I would say yes, because what this is demonstrating is an increase in the level of capability."
[For more on High Frequency Trading see Is HFT Leveling the Playing Field?]
For the second, Edge, who used to run electronic trading at JP Morgan, has a controversial theory:
"The best and the brightest, generally, want to go and work at Goldman Sachs because that is where they'll find the highest wealth creation. You can tier that down to analysts, so it’s not a leveling playing field with the regulators who don't have those advanced degrees and years of experience… High frequency firms are hiring the best and brightest and regulators can't keep up."
But watch out, the tables are turning. CFTC Commissioner Bart Chilton said, "The good news is that regulators around the world are starting to catch up and we are shutting them down when they violate the law."
The keyword here is "catch up." And it's true. CFTC is increasingly being staffed with ex-traders who have the experience and know-how to catch rule-breakers and suspicious activity. "What you're seeing is a change in personnel of the regulators," explains Edge. "These people are from global trading firms hired by the regulators and used to enforce cross border regulations."
Perhaps the old saying still rings true: It takes one to know one.
Trading Technology Continues to Lag
"The only thing that continues to surprise me is the dislocation between trading systems and the technology used to monitor them," says Edge. "Traders are building advanced machinery but the machinery to check it is still twenty versions behind. In this market place, the regulators need to get their monitoring equipment up to speed." Becca Lipman is Senior Editor for Wall Street & Technology. She writes in-depth news articles with a focus on big data and compliance in the capital markets. She regularly meets with information technology leaders and innovators and writes about cloud computing, datacenters, ... View Full Bio