Page 8 - Litigation

S8 | MONDAY, JULY 17, 2017 | Litigation
| NYLJ.COM
‘Spoofing’: The SEC Calls It Manipulation, But Will Courts Agree?
is outside of the scope of this article, it is worth noting that §9(a)(2) governs “transac- tions in any security.” 15 U.S.C. §78i(a)(2). Arguably, bids and offers are not “transac- tions” until they are executed.
But the question of whether spoofing can in fact constitute illegal market manipulation under §10(b) and Rule 10b-5 is far from clear. While courts in different jurisdictions have handled this issue differently, in ATSI Com- munications v. Shaar Fund, 493 F.3d 87 (2d Cir. 2007), the U.S. Court of the Appeals for the Second Circuit held that open-market securi- ties transactions cannot form the basis for a manipulation scheme under §10(b) and Rule 10b-5 without “something more.” Since so- called “spoofing” orders are executable in the open market any time prior to cancellation, they arguably do not meet the ATSI standard. So far, no court in the Second Circuit has addressed this issue. This article analyzes spoofing under the open-market manipula- tion case law, focusing on the Second Circuit, where ATSI is binding precedent.
Circuit Split
The SEC has long expressed the view, endorsed by the D.C. Circuit, that otherwise legal open-market securities transactions can violate §10(b) and Rule 10b-5 if they are executed with the intent to move the price of a security. Markowski v. SEC, 274 F.3d 525, 528 (D.C. Cir. 2001); see also Koch v. SEC, 793 F.3d 147, 151 (D.C. Cir. 2015). By contrast, the Sec- ond Circuit in ATSI has applied a more exact- ing standard, requiring “something more” to assert a valid open-market manipulation claim. 493 F.3d. 87 (2d Cir. 2007). The standard is also the law in the Third Circuit under GFL Advantage Fund v. Colkitt, 272 F.3d 189, 207 (3d Cir. 2001), which was cited approvingly by the Second Circuit in ATSI, 493 F.3d at 101.
In ATSI, the plaintiffs asserted that the defendants engaged in “death spiral financ- ing,” where they shorted a stock to drive its price down, to obtain discounted shares through the financing that could be used to cover their short position for a profit. 493 F.3d at 100. Plaintiffs alleged market manipulation under §10(b) and Rule 10b-5. The Second Cir- cuit affirmed the lower court’s dismissal of the complaint, holding that, “[t]o be action- able as a manipulative act, short selling must be willfully combined with something more to create a false impression of how market participants value a security.” 493 F.3d at 101 (emphasis added). The court found that the short sales, though undertaken with the intent to drive down the price, were not illegal because they were not “aimed at deceiving investors as to how other market participants have valued a security.”493 F.3d at 100. The court distinguished open-market short sales from traditional forms of manipulative trading such as “wash sales” and “matched orders,” which involve traders transacting with them- selves or co-conspirators for the purposes of rigging stock prices. 493 F.3d at 100-101 (citing Santa Fe Indus. v. Green, 430 U.S. 462, 476-77 (1977) (internal quotations omitted)). A wash sale is a “sale of securities made at about the same time as a purchase of the same securities ... resulting in no change of beneficial ownership.” A matched order is an “order to buy and sell the same » Page S13
BY MICHAEL A. ASARO
AND RICHARD R. WILLIAMS JR.
In recent years, the U.S. Securities and Exchange Commission (SEC), Commod- ity Futures Trading Commission, and the Department of Justice have pursued an increasing number of cases involving a rela- tively new form of alleged market manipula- tion known as “spoofing.” See, e.g., U.S. v. Coscia, No. 14-cr-00551 (N.D. Ill.); In re Pan- ther Energy Trading, CFTC Docket No. 13-26 (2013); CFTC v. Nav Sarao Futures, No. 15-cv-
MICHAEL A. ASARO is a partner and RICHARD R. WIL- LIAMS JR. is an associate at Akin Gump Strauss Hauer & Feld.
03398 (N.D. Ill.); In re Hold Brothers On-Line Investment Services, Exchange Act Release No. 67924 (SEC Sept. 25, 2012); SEC v. Lek Secs., No. 17-cv-1789 (S.D.N.Y.).
If securities or commodities trading were a poker game, spoofing would be loosely analogous to bluffing your opponent. Typi- cally, spoofing occurs when a trader sends a large order (for example, a “bid” or “buy” order) into the market with an intent to can- cel it before it can be executed, while at the same time placing a smaller order on the other side of the market (for example, an “offer” or “sell” order) that they hope will be executed. The “spoofer” uses the large buy order to encourage other market par- ticipants—who may assume the large order means prices are trending upwards—to transact with them by executing against their
smaller sell order. Once the smaller order is executed, the spoofer will quickly cancel their large buy order since their goal was never to have it executed in the first place. Spoofers will often reverse and repeat this behavior over and over again, sometimes hundreds of times, each time earning a small profit.
In 2010, as part of the Dodd-Frank Act, Congress specifically prohibited spoofing in the futures markets under the Commodity Exchange Act (CEA). 7 U.S.C. §6c(a)(5)(C). However, there is no such specific prohibi- tion under the federal securities laws. As a result, the SEC has typically prosecuted spoof- ing under the general anti-fraud provisions of §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The SEC has also pros- ecuted spoofing claims under §9(a)(2) of the Exchange Act. While this statutory provision
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