By Dave Michaels
A government crackdown on traders accused of price manipulation faces one of its biggest tests next week, as a pair of former Deutsche Bank traders face trial on charges related to rigging precious-metals prices using a strategy known as spoofing.
Traders at Citadel Securities and Quantlab Financial, high-speed trading firms that use models to automate their buying and selling, are among the witnesses scheduled to testify against the ex-traders, James Vorley and Cedric Chanu. The criminal trial will take place in Chicago with protocols aimed at reducing the risk of coronavirus spread, including the use of masks and a requirement to maintain social distancing.
The Justice Department has lost two of three prior trials over spoofing, a type of price manipulation that involves bluffing other traders into thinking supply or demand has changed.
Prosecutors have faced hurdles on their way to the latest trial, with the judge in the case expressing skepticism in recent weeks about whether evidence supports the claims of fraud.
"There is probably some additional pressure to win this one," said Aitan Goelman, a partner at Zuckerman Spaeder LLP who is a former senior regulator and federal prosecutor. "I don't think that means if they lose, they will never bring another spoofing case. But they have not had a particularly successful run so far in prosecuting spoofing."
One concern is persuading a jury that bluffing is actually fraud. The traders argue they made no false statements -- usually a precondition for fraud -- by sending orders they wound up canceling. The electronic orders didn't convey any intent or promises, the traders say, likening it to a poker player who bluffs by upping the ante but doesn't talk about what cards he holds.
Nonetheless, prosecutors have obtained eight guilty pleas from other traders accused of spoofing, including one who is scheduled to testify against the former Deutsche Bank duo. A Justice Department spokesman declined to comment.
In one episode from 2009, Mr. Chanu exchanged chat messages with another Deutsche Bank trader about spoofing, according to court filings. The other trader placed and canceled within seconds a flurry of orders to buy gold futures, helping Mr. Chanu sell gold at a higher price. The other trader wrote: "Got that up 2 bucks...that does show you how easy it is to manipulate sometimes."
"Basically you tricked alkll [all] the algorythm," Mr. Chanu replied in a message cited by prosecutors.
Spoofing involves sending orders that a trader doesn't intend to have filled, essentially a feint designed to trick other traders into posting prices the spoofer wants. Once spoofers accomplish the trade they wanted, they cancel the orders that caused the market to move in their favor.
Messrs. Vorley and Chanu, who worked in London, were charged in 2018 with wire fraud and conspiracy, but not spoofing. Much of the trading at issue dates from 2009 through 2011, when spoofing could have been considered illegal but wasn't yet defined in federal law. Congress explicitly outlawed spoofing in the 2010 Dodd-Frank financial overhaul law.
Attorneys for Messrs. Vorley and Chanu declined to comment.
"In some ways it feels like the department is trying to fit a square peg into a round hole" by charging fraud and not spoofing, Mr. Goelman said. "But I do think the government can make a case there is an element of deception there. Just the fact that spoofing is now illegal means it might be easier to prove a fraud case."
The Justice Department's fraud section has carved out a niche prosecuting the cases, charging nearly 20 defendants since 2015.
Some critics have questioned whether spoofing should be prosecuted as a crime, instead of a civil regulatory violation handled by the Commodity Futures Trading Commission. Deutsche Bank paid $30 million in 2018 to settle CFTC claims tied to the traders' spoofing. Other experts say the Justice Department's attention is warranted because manipulation affects commodity prices as well as correlated assets, such as stocks.
"It is basically lying to people about their willingness to trade and lying about the liquidity in the market," said James Angel, a finance professor and regulatory expert at Georgetown University's McDonough School of Business.
Repeated many times over, spoofing can be profitable, although traders fighting the Justice Department say the losses they are accused of causing are limited. In a separate case that could go to trial next year, the alleged spoofing by two former Bank of America traders caused losses for other traders of about $300,000 over seven years, according to court filings.
In a filing made early this month, prosecutors outlined the role of another former Deutsche Bank trader who plans to testify about his colleagues' conduct. That trader, David Liew, pleaded guilty in 2017 and will testify that he learned to spoof by watching Messrs. Vorley and Chanu, according to court filings. An attorney for Mr. Liew and a Deutsche Bank spokesman declined to comment.
Traders at Citadel Securities and Quantlab are expected to testify that bluffing is fraud because traders assume orders are genuine, and not a feint designed to achieve something else. A spokeswoman for Citadel Securities declined to comment, as did a spokesman for Quantlab.
The mechanics of the trial have been modified in light of concerns about the spread of Covid-19. Federal courts around the country -- most of which shut down or severely limited operations in March -- have taken various precautions to address the pandemic, with some even postponing jury trials until next year. The Administrative Office of the U.S. Courts published a guide in June to help judges navigate through the thicket of public-health concerns.
The case was filed in Chicago because CME Group Inc., which operates the exchanges used by Messrs. Vorley and Chanu, is based there. Potential jurors for the trial won't approach the judge's bench during the jury-selection process and will instead wear headsets to answer questions from the judge and attorneys. Those who are picked will be spread across half of the courtroom in order to force social distancing, and will deliberate in a separate courtroom instead of meeting in a smaller jury room.
Write to Dave Michaels at firstname.lastname@example.org