JP Morgan’s $920 million fine for having manipulated gold markets with order spoofing was widely ridiculed by observers and deserved to be. The fine represents 0.7% of the bank’s $118.884 billion in revenue last year, and 3% of its 30.6 billion in pre-tax income, and the damage it does to the institution’s reputation is liable to last a whole news cycle. The 200 year old bank has $2.6 trillion in assets, making any meaningful sanction against it, like a removal or suspension of its charter, an effective wound to a vital organ of the financial system.
Racketeering charges wil proceed against the traders who oversaw the fraud-assisted trades, but a settlement agreement with the various branches of government that brought the action takes the bank out of any sort of criminal bind.
There still aren’t a lot of details about the scheme itself, and we may have to wait for the racketeering trials of the traders to get a detailed look at the mechanics of the spoofing, but The Dive explained the basic mechanics of order spoofing in Part 1; illustrating a process in which orders are placed to drive the market to a preferred condition, then cancelled after the target trade is executed. To fade that sort of action in the deep, rich, international precious metals markets, Novak needed the backing and capital of JP Morgan, making the fact that the institution is skating while the individual has to face the music all that much more of an affront to our sense of justice.
Small Cap Spoofing
But the more thinly-traded markets for venture-stage securities in Canada can be managed into a state that favors a trader’s price with a lot less at-risk capital. Almost every veteran self-directed investor with an online account has seen orders appear and disappear in concert, jumbling lineups and frustrating order entry. Ultimately, the organized pros who are on a mission complain, and it gives them pause the next time they’re thinking of taking on another position in a venture stock, and the die hard story stock junkies just put up with it.
In Canada, where markets are (self) regulated by the Investment Industry Regulatory Organization of Canada (IIROC), “spoofing” has a much narrower definition than it does in the United States. For fake orders to be considered “spoofs” north of the border, they have to be put up in the pre-market, where they can’t be filled, then pulled at the open. Putting up live orders that one does not intend to fill for the purposes of forcing the market into a desired order is still against the rules, but it’s referred to as “layering.”
By virtue of the definition, Canadian spoofing cases are easy to identify, because when orders are made before the open, then pulled at the bell by a trader who then makes an at-market trade, the order records have the trader dead to rights. Layering can be more difficult to find and more difficult to prove, because the offending offers are being placed in a real-time live market, and have to survive un-filled and cancelled all at once to be proven not to not be bona fide orders.
Spoofing and layering tactics have always been against the rules, but they came under greater scrutiny in 2012 during the rise of automated trading strategies and high frequency trading. The IIROC issued a guidance memo in February of 2013 meant to clarify that its member institutions had to watch out for it but, prior to 2013, the fines levied against traders who got caught were curiously much larger. A 2007 case concerning a W.D. Latimer trader, one Micheal Bond, who was disciplined for stacking the bid on thinly traded TSX.V stocks in 2005, saw Mr. Bond fined $100,000, $25,000 in costs, and suspended from access to all regulated marketplaces for two years.
Before issuing the 2013 guidance on order spoofing, the IIROC reached out to member firms to let them know what the regulator was thinking as it tightened up rules concerning manipulation and penalties. Scotia Bank replied to IIROC’s request for comment with a letter outlining their concerns about the proposed change to their responsibilities as market regulators.
Among other things, Scotia was concerned that IIROC would have them develop and use pre-trade controls, favoring post-trade detection of spoofing and layering. The bank (which turned a $6.4 billion profit in 2012), felt that a system detecting layering and spoofing ahead of trades would be one hell of a project, and represent “significant technology costs.”
One of Scotia’s better points is that IIROC itself would be a better entity to be detecting the fake orders of traders trying to manipulate markets because, in theory, a dedicated operator could place the fake bids through accounts at another brokerage, forcing them into a data set over which Scotia has no purview.
IIROC’s final 2013 guidance note did require pre-trade monitoring, but the extent to which it’s used to successfully identify fraudulent orders isn’t clear, and a low volume of cases and sanctions may indicate that the systems aren’t doing much in the way of flagging suspicious orders, if they are in fact in place. It isn’t clear what IIROC is doing about spoofing and layering that is being executed by individuals using different accounts for the fake orders and the real orders.
What does it cost to manipulate a market in Canada?
The largest fine that we could find for spoofing and layering post-2013 IIROC guidance notice is also the only one levied against an institution. Quebec-based online broker Jitneytrade, who had had been previously sanctioned and fined for not implementing sufficient controls, admitted in 2017 to letting one of its institutional clients run wild with fake orders on their system. It cost them $200,000 plus $25,000 in costs. JitneyTrade was acquired 14 months later by Canaccord. Terms of the deal weren’t disclosed, but Cannacord’s 2018 financials indicate that the broker invested $73.3 million in acquisitions in fiscal 2019, a year in which it generated $704.3 million in revenue.
Searches of the IIROC web page indicate that the investment dealers charged with keeping Canada’s investment dealers fair and honest have managed to bring cases against a total of three (3) individuals since the February, 2013 guidance notice that clarified that the practice was a contravention of IIROC’s universal market integrity rules.
We were able to find record of only one decision against a trader for layering, a Mr. Russell Waddington, a Vancouver Mackie-Research trader who admitted to layering activity in five TSX.V-listed stocks in 2017. Waddington agreed to a one year suspension, a $10,000 fine, and to pay $1,000 in costs. The IIROC unpaid fines report indicates Mr. Waddington has made partial payment of those fines.
Toronto broker Robert Edward Sole got jacked up on spoofing and layering charges by the IIROC in 2016 for questionable trading activity in 2013 and 2014, while he was working for famously cagey securities and market making firm W.D. Latimer, whose web-page contains about as little info as a company’s web page could.
Sole agreed to pay a $10,000 fine, $1,000 in costs, and have his trading privileges suspended for one year, but didn’t have all that much respect for the suspension, apparently taking a job at a proprietary trading firm where he entered orders in contravention of his suspension. Upon learning this, IIROC engaged the due process that resulted in a lifetime suspension for Mr. Sole, as well as a $90,000 fine, bringing the former broker’s fine total to $101,000, all of which remains unpaid.
The only successful spoofing action we could find that wasn’t also a layering charge was brought against former W.D. Latimer trader Aidin Sadeghi, who represented himself at his hearing, but didn’t do a very good job. IIROC was able to show conclusively that Mr. Sadeghi had a habit of placing pre-market orders that disappeared at the bell, then filling smaller orders on the other side of the market.
Sadeghi was suspended from all IIROC marketplaces for five years, given a fine of $9,111.75, representing disgorgement of the financial benefit received by Mr. Sadeghi as a result of his improper trading activity, an additional fine of $25,000, and ordered to pay costs of $25,000. His name does not appear on the IIROC list of unpaid fines.
And so we beat on, boats against the current, borne back ceaselessly into the past.
If we accept the premise that spoofing and layering are fairly reliable ways to manipulate markets, and that there is a noted un-willingness or inability on behalf of the self-regulating layer of the Canadian markets to effectively police them or even survey for them, then it stands to reason that they’re creating a regular perversion of the public markets. That, in turn begs the question: why do investors keep going back?
Likely, there’s no one reason. Clearly, there’s a compulsion at play, but the roots of it are the potential that exists in venture-stage businesses. Being one of the early identifiers of a valuable business venture, then getting paid off when everyone else realizes the value is one of the most satisfying feelings in investing. We tell ourselves that order manipulation is just another one of the many traps that venture stage investors are subjected to in their search for successful businesses.
Information for this briefing was found via Sedar and the companies mentioned. The author has no securities or affiliations related to the organizations discussed. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.