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CFTC First To Use Dodd-Frank To Charge HFT Firm

The CFTC has shown it's ready to use new regulatory powers to combat corruption in the marketplace. What took so long?

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

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kiers
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kiers,
User Rank: Apprentice
9/5/2013 | 4:32:57 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
indeed. and my point is not "about the crashes" as the media would (naturally) report. It is: the crashes show that algos print the tape. it's a different point than the standard news "take".
Byurcan
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Byurcan,
User Rank: Author
9/4/2013 | 12:11:13 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
I don't think Edge's second point is that controversial, it makes perfect sense. Any smart, creative innovative person would want to make money and do something intellectually stimulating rather than be a bureaucrat.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Apprentice
9/3/2013 | 4:53:44 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
Fair point. The debate about real liquidity vs fake liquidity (HFT) has been going on for a while. There have been very few, if any, cases of genuine liquidity vanishing all of a sudden. But, we see mini crashes all of the time on specific securities and the cause is usually HFT.
kiers
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kiers,
User Rank: Apprentice
9/3/2013 | 2:37:17 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
Yes, Greg, But i mean about HFT: It's hard to explain in a short post. The lesson of the Flash crash is NOT that "o look, computers run out of control and cause the market to crash". The correct lesson is "o look computers own the tape".

whoever owns the micro time domain owns the tape.
(it's a conceptual difference from the media coverage on HFT).

http://antisophism.blogspot.co...

Key Points:
Most HFT trading is IMMUNE to absolute price level. totally immune.

By taking over the micro-time scale, (which is devoid of any human activity based on fundamentals ) albeit with miniscule volumes, HFT literally prints the ticker tape

Even without the abusive practices (quote stuffing), HFT owns the tape, always providing the most current quote available to the human market at large at any given time

60%-70% of the trading activity on American financial markets simply does not care about what the market level is
----------------
So when u see the flash crash happened it's not the crash that's the lesson! the lesson is algorithms are CONSTANTLY setting the price and they don't care about that price per se. That's the conceptual difference.

And the algorithms are price-level immune. They make money from the "relative", not the absolute.

Hence the markets are fake.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Apprentice
9/3/2013 | 12:43:21 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
There has been a lot of criticism during the latest bull run that the markets have lost any connection to the economy. Corporate earnings are very high, companies have a ton of cash, but hiring is lagging and the economy is just sputtering along.
kiers
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kiers,
User Rank: Apprentice
8/31/2013 | 12:54:48 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
the markets are completely FAKE. what does it mean anymore? oh look the dow is at 18K...19K...20K....no meaning. No fundamental meaning whatsoever. Just a number. Completely fabricated.
Martin Jermakyan
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Martin Jermakyan,
User Rank: Apprentice
7/25/2013 | 4:22:56 AM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
Dear Ivy,

I think CME was perfectly aware of it. Otherwise CFTC would not be able to catch it. Generally, CFTC is not more competent than CME is. Why they didn't find it disruptive I don't know. It is likely that their pride didn't let them admit that they have left loopholes behind.

After all, they have nothing to gain from trades which are not executed. Furthermore spoofing hits their wallet negatively as it unduly utilizes processing power.
Martin Jermakyan
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Martin Jermakyan,
User Rank: Apprentice
7/25/2013 | 4:18:50 AM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
But I did say that I consider spoofing to be disruptive and blamed CME for it. My point was that if regulators should go after someone that should be CME. And I suggested a simple solution to the spoofing problem which CME and other exchanges can implement with a little effort.

Furthermore, I do think that price fixing and manipulation should be prosecuted. But these things have been committed since times immemorial in financial markets and not necessarily by HFTs. Every now and then someone will be tempted to commit it again. I have no sympathy for such counterparties.

However a trader should not be prosecuted for monetizing a loophole he/she has found in the rules of the game.

For instance a macro trader enters into trades because he/she identifies dislocations of capital resulted, for instance, from the policies of Federal Reserve, ECB, etc. He/she takes advantage of these partiesG«÷ distortive monetary policies.

No one I presume holds him/her responsible for frequently shuffling money between bond and stock markets with the purpose of favorable monetization of Fed induced macro-distortions.

Another illustration may be the entire modus operandi of regulatory arbitrage. The whole purpose of it is to find loopholes and distortions.

Why is in this particular case the trader blamed for monetizing CME induced micro-structural distortion resulted from order matching rules?

And one more comment: cancellation is not necessarily spoofing. Frequent cancelations frequently may have prudent risk management or price discovery motivations behind it.

One of such motivations is that when submitting orders one incurs not only price but also volumetric risk since parts of the orders may be only partially filled (or not filled at all) and one may arrive to a different portfolio than he/she intended to. And frequent cancelation may be a manifestation of an attempt to prevent or fix the portfolio from or as a result of such outcome.

The other mentioned situation can be relatively easily detected - usually minimal volume of orders are placed and quickly canceled as a manifestation of a price discovery effort.

Whether price discovery via a small order is a reliable practice for price discovery for larger orders is a contestable issue but this is what is behind some of the rapid cancelations I think.

And another thing: while the exchange can tell it, it is hard for outside observers to tell whether an order was cancelled or it simply expired.

And finally, consider an ordinary sales operation. Is it uncommon that out of 100 sales pitches only one may produce transaction? Did in the old days every yelling on the trading pit result in a transaction?

Why is electronic trading different and who is to judge what the intention of the counterparty submitting an order was?
IvySchmerken
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IvySchmerken,
User Rank: Author
7/24/2013 | 8:57:04 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
If exchanges are SROs (self regulatory organizations), how come CME didn't catch/detect the spoofing activity? Exchanges are policing their own markets everyday.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Apprentice
7/24/2013 | 7:58:33 PM
re: CFTC First To Use Dodd-Frank To Charge HFT Firm
I do not think it will be taken to such extremes, as you stated in your reply. The CFTC is looking at firms who have placed thousands of cancels with the intention of spoofing. Is spoofing OK? If the market says it is OK, then the regulators should go away and mind their own business. But i doubt that most traders would say that manipulating a market is OK. If it isn't OK, why didn't the CME take action? Was it unwilling? Unable? Not interested? If the SROs are unwilling/unable/not interested in stopping something that the market views as bad for the marketplace (manipulation, spoofing, price fixing), then regulators have no choice but to step in.
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