Complex spoofing techniques avoiding detection

By Rebekah Tunstead | 3 July 2019

Increasingly sophisticated techniques adopted by participants to spoof deep, liquid markets are allowing perpetrators to escape notice, according to Damon Batten, managing consultant at Bovill. 

 “If we are taking about the likes of the London Stock Exchange (LSE), equity exchanges, exchanges where there are depths of volume, then the only way to be successful [in spoofing] is to have a sophisticated technique. Otherwise, you are going to be picked off by other algorithmic traders in the market or by the exchanges’ own controls,” says Batten.

 “There may be a reasonable number of cases [of market abuse] out there that are going undetected just because there a lack of consistency in the level of sophistication of detection across the different trading venues,” said Batten.

Spoofing is an illegal method of market manipulation carried out when a trader places a larger order to either buy or sell without executing the orders.

On June 25, the US Commission Futures Trading Commission (CFTC) fined Merrill Lynch Commodities $25m for “spoofing, manipulation, and attempted manipulation over a six year period,” the regulator said in a statement.

“We are disappointed by the conduct of the former Merrill Lynch Commodities employees named in this matter and have cooperated with the investigations,” said Bill Halldin, a spokesman for Bank of America Merrill Lynch in an email.

Earlier this year, the first spoofing case taken against a non-trader, Jitesh Thakkar, ended in a mistrial Bloomberg reported.

Market watchdogs are looking to artificial intelligence and machine learning to assist, according to Saeed Patel, director of product strategy at KRM22.

“Regulators are also developing sophisticated technologies themselves to identify market manipulation behavior. We are seeing regulators use AI and ML to undertake what I would describe as predictive behavior analysis to identify future misconduct in the market place,” says Patel.

Although exchanges' market surveillance technology is advancing, Batten says it won’t reduce the time regulators need to bring perpetrators to justice.

“Even if you have the controls and the ability to observe in real time what is happening, the actual process of prosecuting this is always going to take longer. So, if you are an exchange and you see in real time that someone has potentially spoofed the market or engaged in some other kind of order book behavior which would be considered market abuse, you might be able to see it in that moment, you may be able to intervene from preventing that particular participant from placing any more orders. Even if you capture all of that information in real time, the actual regulatory outcome is almost certainly going to take not months, but years,” says Batten.

“What you can do in the meantime might be limited because unless it is a proven case of market abuse, you wouldn’t as an exchange want to disallow membership of your exchange to a counterparty if there is just a suspicion and not a proven case of market abuse. So, while the technology becomes more sophisticated, I wouldn’t necessarily see the timeline from incident to outcome necessarily shortening that much,” he says.

On July 1, the CFTC awarded around $2m to two whistleblowers “who provided the agency with significant information that prompted the CFTC to open an investigation.”

However, the stance of UK regulators remains unchanged. In July 2014 the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) published a report outlining why both regulators did not believe financial incentive would encourage a significant increase in whistleblowing.

For Patel, financial incentive for whistleblowing is again coming to the fore of regulators’ conversations.

 “There’s an ongoing discussion among other global regulators as to whether they should follow the CFTC with regards to its whistleblowing policy rules,” says Patel. “The rules mandate that in the US an individual that raises a whistleblowing case which culminates in a successful enforcement action is potentially entitled to a fee associated with the fine that is levied. And so, we have seen a real uptake in whistleblowing cases in the US since that came into enforcement.”



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