Spoofing and Layering: SEC and CFTC Enforcement.

The primary difference between SEC and CFTC spoofing enforcement cases is the applicable federal statute. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act included an express spoofing prohibition (Section 747) in the Commodity Exchange Act, which imposed federal spoofing liability on a new array of actors. As amended, the federal securities law, however, contains no standalone offense labeled spoofing. As a result, the same actions that may constitute spoofing in the commodities markets will trigger enforcement action under different federal securities laws in different contexts.

Layering is often described as another form of spoofing; however, the term describes a method of spoofing rather than a distinct statutory offense under the federal securities laws. This distinction does not exist in CFTC cases, as the Commodities Exchange Act’s spoofing prohibition specifically defines “spoofing” as a practice that includes layering.

Three Key Differences Between Spoofing and Layering

1. The Elements of the Offense

The following three concepts are critical to understanding the difference between spoofing in the commodities markets and spoofing in the securities markets. (i) Spoofing under the federal securities laws is an antifraud violation. As a result, in order to prove a spoofing violation, prosecutors must prove that the actor had the intent to deceive or mislead. By contrast, spoofing under the Commodity Exchange Act is a separate offense. (ii) To establish liability for spoofing under the Commodity Exchange Act, prosecutors must demonstrate that the defendant canceled the order for reasons other than changes in the market price of the relevant security. Again, this is different from the federal securities laws, which require proof of intent to deceive. (iii) Finally, while both SEC and CFTC enforcement cases are subject to the same burdens of proof, there is a difference in the types of penalties that are available. In recent years, the SEC has successfully pursued spoofing cases against traders and financial firms alike. Similar to the CFTC, however, it has never charged a financial firm with spoofing in the securities markets under the Commodity Exchange Act.

Which Regulator Has Authority Over My Market?

The Commodity Futures Trading Commission (CFTC) generally has enforcement authority over traders in futures markets, options markets involving futures contracts, and the swaps market. The Securities and Exchange Commission (SEC) has enforcement authority over the securities market and the security-based swaps market. However, the two federal regulators maintain overlapping jurisdiction in some areas. For example, while options on security derivatives are a form of futures contract that could potentially be subject to the CFTC spoofing provision, they are a form of securities contract as well, and the SEC maintains exclusive jurisdiction.

Digital Asset Market Jurisdiction

Determining jurisdiction in the digital asset market is even more complex than determining jurisdiction in other markets. The SEC maintains enforcement authority over all transactions involving digital assets that are security-based derivatives. As a result, for example, the SEC may pursue enforcement action against any digital asset holder that spoof the market with “leveraged” trades. The CFTC has enforcement authority over digital asset transactions that fall within the scope of the Commodity Exchange Act. While the CFTC’s enforcement authority covers “spot” transactions in cryptocurrencies like bitcoin and ethereum, its authority over other digital asset transactions varies.

The U.S. Department of Justice

While the SEC does not have the authority to prosecute criminal charges, the U.S. Department of Justice frequently gets involved in cases of spoofing and other types of market manipulation. The Department of Justice may prosecute spoofing and other fraudulent schemes if these schemes have an impact in the United States. With regard to civil and administrative enforcement actions, both the SEC and CFTC have the authority to impose severe penalties on all applicable parties. While the SEC can impose civil and administrative penalties, the CFTC can impose civil monetary penalties that include disgorgement of the gains obtained from the fraudulent conduct.

FINRA and Other Regulatory and Oversight Bodies

In addition to federal regulators, other regulatory and oversight bodies may also have jurisdiction in spoofing cases. For example, FINRA Rules 2020 and 5210 apply in relation to manipulative quotations that are deemed to affect the financial markets. Internationally, various regulators maintain similar enforcement powers as well. In 2022, the UK Financial Conduct Authority (FCA) imposed a civil monetary penalty on a hedge fund for allegedly spoofing Italian government bond futures.

What Must the SEC and CFTC Prove?

What Must the SEC Prove in a Spoofing Case?

In SEC spoofing cases, the agency routinely asserts claims under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. To prove fraud under Rule 10b-5, the SEC must prove:

• Deceptive or manipulative conduct;
• A connection with the purchase or sale of a security (or other instrument covered by Rule 10b-5); and,
• Violation of the federal securities laws.

In cases of alleged “spoofing” and “layering,” the conduct of entering and canceling orders may constitute deceptive or manipulative conduct, depending on the circumstances involved. To establish liability under Rule 10b-5, the SEC must also establish the defendant’s scienter. Scienter, which the Supreme Court defined in Ernst & Ernst v. Hochfelder as “the intent to deceive, manipulate, or defraud,” can be established in SEC civil enforcement actions by showing that the defendant acted recklessly. If the federal government is seeking to establish criminal liability for “spoofing,” federal prosecutors must show that the defendant acted willfully and with the requisite intent to defraud investors. To impose disgorgement or a civil penalty, the SEC will also have to show that the conduct at issue constituted a “spoofing” or “layering” violation. While the SEC does not need to show investor losses in order to prove a Rule 10b-5 violation, showing losses will be necessary if the SEC is seeking to recover restitution or disgorgement.

What Must the CFTC Prove in a Spoofing Case?

Unlike the SEC, the CFTC does not need to establish scienter in order to establish liability under the Commodity Exchange Act. The CEA’s explicit definition of “spoofing” includes a provision that states that, “no profit or market-impact shall be required.” Establishing liability for “spoofing” in the securities markets under the Commodity Exchange Act requires proof that (i) a trader has entered an order to sell or buy with the intent to cancel the order before execution; (ii) the trader has entered a bid or offer to sell or buy a commodity under conditions where the trader knows that the bid or offer is not bona fide; and, (iii) the trader has intentionally canceled a bid or offer to sell or buy a commodity.

What is the Difference Between a Rule 10b-5 Enforcement Action and a CEA Section 4c(a)(5)(C) Enforcement Action?

While Rule 10b-5 and CEA Section 4c(a)(5)(C) both relate to market manipulation, there is a major difference between the two when it comes to the federal government’s burden of proof. Under Rule 10b-5, there is a requirement that the actor’s conduct be “connected with” the purchase or sale of a security. While CEA Section 4c(a)(5)(C) does not carry a similar requirement, it requires proof of the actor’s intent to cancel the order when that order is first entered. Finally, in a Rule 10b-5 enforcement action, the SEC must establish the defendant’s scienter. This is not necessary under the CEA, and established liability in the commodities markets requires proof only that the trader’s bid or offer was not “bona fide.”

Can Cancellations, Fills, Order Size, or Order Speed Prove Intent?

Do Cancellations, Fills, Order Size, or Order Speed Prove Intent Independently?

No. The fact that a trader has canceled an order, that the order was never filled (i.e., it did not result in a trade), that the order was particularly large in size, or that the order was canceled rapidly all tend to be viewed as indicators of intent in SEC and CFTC spoofing and layering cases. However, no one factor independently establishes a trader’s intent, and the only factor that is not essential to establishing liability for spoofing is that of an order never actually getting filled.

How Can Intent Be Proven in Spoofing Cases?

While no one factor is sufficient to independently establish a trader’s intent to spoof or layer, the SEC and CFTC can prove intent circumstantially using various other pieces of evidence. These can include, but are not limited to, a trader’s order history, execution history (i.e., fill rate), use of algorithmic trading software, communications, testimony from colleagues or other coworkers, and the trader’s cancellation-to-fill ratio, among others.

Can Legitimate Reasons for Cancelling Orders Defeat Spoofing Liability?

Yes, evidence that a trader cancelled their order due to legitimate reasons can be a powerful defense in federal spoofing and layering cases. In addition to changing market conditions, other potential legitimate reasons for cancelling an order include changes to a trader’s or investor’s trading strategy, new information, mistakes made when entering the order into the market, and other various circumstances that will depend on the specific case in question.

If evidence that the trader has the ability to execute all or most of the order also is available, this can provide further protection against findings of spoofing and layering liability.

Does Partial Execution of a Spoof Order Defeat Liability?

No. While the partial execution of a spoof order may help defeat liability for spoofing in some cases, the partial execution does not, by itself, necessarily defeat a trader’s liability for spoofing. The fact that the trader has partially executed an order could indicate that the trader did not intend to cancel the order, but it may also serve as further proof of the trader’s attempt to mislead other market participants.

Can an Executable Order Still Be a Spoof?

Yes, a technically executable order can still constitute a spoof if it was entered with the intent to cancel. This is one of the key features of a spoofing violation, as it differs from other types of market manipulation, such as wash sales, which may require proof of “non-bona fide” offers. However, to establish liability, the SEC or CFTC will have to provide evidence of the trader’s intent to cancel the order when entering the order into the market.

Does Rapid Cancellation Prove a Trader’s Intent to Spoof?

Rapid cancellation of a trader’s bid or offer is generally considered to be indicative of intent to spoof. This is another feature of the federal government’s spoofing and layering cases, but it does not mean that there is a statutory threshold for rapid cancellation that has to be met. Evidence of rapid cancellation can lead to, and help support, findings of spoofing and layering liability; however, rapid cancellation alone is not determinative of liability for spoofing.

Does Large Order Size Prove a Trader’s Intent to Spoof?

Similarly, the size of an order for a large number of securities or commodities that would, by itself, affect the price of the security or commodity is generally considered to be indicative of intent to spoof. However, there is no statutory threshold for order size, and large order size alone is not sufficient to establish liability for spoofing.

Does a Trader’s Cancellation-to-Fill Ratio Prove Intent?

A trader’s cancellation-to-fill ratio is another metric that can help establish a trader’s intent to spoof. However, this ratio is not determinative of intent. While high cancellation-to-fill ratios may be used as a trigger for investigation, the fact that a trader’s cancellation-to-fill ratio is high may not, by itself, establish the trader’s subjective intent.

If you are facing this situation, Spodek Law Group handles federal criminal defense matters nationwide, from offices in New York and Los Angeles.

When Can a Spoofing Investigation Become a Criminal Case?

What is the Difference Between a Civil Spoofing Case and a Criminal Spoofing Case?

The difference between civil and criminal spoofing cases boils down to (i) what is at issue, (ii) the standard of proof, and, (iii) the specific intent required. In civil cases brought by the SEC and CFTC, the burden of proof is Generally the preponderance of the evidence, but in criminal cases the burden of proof is proving the defendant’s guilt “beyond a reasonable doubt.” While not all spoofing cases have the potential to result in criminal charges, some do. For example, while criminal liability under the Commodity Exchange Act (CEA) requires a knowingly and willful violation of Section 4c, criminal liability under the Anti-Commodity Fraud statute requires the government to prove that the individual acted with intent to defraud.

How Does the Anti-Spoofing Statute Stand Up to Constitutional Challenges?

In United States v. Coscia, 866 F.3d 782 (7th Cir. 2017), the court rejected the argument that the definition of spoofing under the Commodity Exchange Act is too vague to satisfy the constitution’s due-process requirements. The court explained that the statute’s definition of “spoofing” provides an average trader with enough guidance that they should understand what types of market manipulation are forbidden. This case also went on to result in the first conviction under the newly added spoofing provision in the Commodity Exchange Act.

Does the U.S. Supreme Court’s “Right to Control” Theory Limitation Apply to Spoofing Cases?

The U.S. Supreme Court’s recent decision in Ciminelli v. United States, which found that “right to control” theory of losses for criminal wire fraud was unlawfully expansive, does not impact the outcome of criminal cases involving spoofing, layering, and other forms of market manipulation. This was most recently discussed in United States v. Vorley. The Seventh Circuit Court of Appeals again rejected the defendant’s wire fraud charges, and again affirmed the defendant’s conviction on criminal charges for attempted wire fraud.

Can a Trader Face Civil, Regulatory, and Criminal Spoofing Investigations at the Same Time?

Yes. Civil, regulatory, and criminal spoofing investigations can proceed in parallel. For example, while the SEC or CFTC pursues a civil enforcement action, the Department of Justice may simultaneously pursue a criminal case. If federal prosecutors are involved, these other agencies may also be involved. However, they will each pursue their enforcement action independently of each other, and each must separately establish the elements required to prove liability under the pertinent federal laws.

Is the SEC and CFTC Actively Prosecuting Spoofing, Layering, and Other Types of Market Manipulation?

Yes. While Michael Coscia was the first to be prosecuted for spoofing and layering under the Commodity Exchange Act, he was not the last. Since then, the SEC, CFTC, and the Department of Justice have initiated numerous enforcement proceedings, civil and criminal in nature. Most recently, in 2023, the Department of Justice brought criminal spoofing charges against two traders, and the CFTC filed a separate civil enforcement action against an investment firm seeking restitution.

Can a Broker Face Liability for a Customer’s Spoofing?

Yes. While brokers themselves may not actively engage in spoofing and layering schemes, they are still at risk of facing liability if the federal authorities believe the broker’s controls are deficient in mitigating customer spoofing. The evidence of coordinating a spoofing strategy across different venues can often be gleaned by examining the timing and volume of a trader’s or customer’s orders executed in the order book. Evidence of an order’s lifecycle can also be crucial, as opposed to just looking at an order’s execution. As a result, firms’ surveillance programs need to be updated on a regular basis to ensure that they are using the most current, up-to-date software programs capable of detecting fraud.

What Rules Apply to Brokerage Firms and Exchanges?

While these rules are not exclusive to spoofing and layering cases, Exchange Act Rule 15c3-5 requires broker-dealers to establish controls to maintain effective risk management systems, and FINRA Rule 3110 requires member firms to maintain written procedures for supervising all devices, processes, and systems. As a result, these rules have been asserted in many cases where the SEC and FINRA have pursued enforcement against brokerage firms for their alleged failure to properly monitor their clients’ orders.

Can a Trading Firm Face Enforcement Action for Deficient Monitoring Systems?

The SEC filed its complaint against Lek Securities (March 10, 2017) because its trading clients (Avalon) purportedly spoofed the market in hundreds of securities across dozens of trading venues. Allegations of spoofing and layering are serious matters, and it is important to contact a legal defense attorney as soon as possible to defend against any allegations of deceptive practices.

The allegations in this case were similar to those of the SEC enforcement action against Bleecker Street Capital in 2021. Bleecker Street Capital allegedly entered orders intended to deceive, mislead, and create a false appearance of market interest. It is important to note that Bleecker Street Capital only entered an “offer” for a security or commodity when they had a corresponding “bid” open for the same security or commodity. This is considered “spoofing,” whereas adding “layers” to the same side of the book is considered “layering.”

What Should a Hedge Fund Do When Facing Charges of Spoofing and Layering?

The Securities Exchange Act of 1934 and the Commodity Exchange Act are complex federal statutes, and they have both been heavily scrutinized recently. This means that both the SEC and CFTC have been looking to take action where necessary, and hedge funds must take this seriously. If a hedge fund or its representative or fund manager is accused of spoofing and layering by the SEC or CFTC, the first thing it should do is contact an experienced securities lawyer at Spodek Law Group or another reputable law firm. An experienced lawyer will need to quickly get the case-related information and a strong understanding of how a particular trader’s behavior was scrutinized to formulate an effective defense strategy.

What Penalties and Deadlines Apply in Spoofing Cases?

What Remedies Are Available in SEC Spoofing Cases?

The remedies available to the SEC in civil spoofing and layering cases include:

• Injunctive relief;
• Disgorgement of net illegal profits;
• Monetary penalties;
• Industry bars; and,
• Additional sanctions as applicable.

In criminal cases, a conviction for spoofing and layering is a federal offense, which can lead to imprisonment and financial penalties.

The U.S. government can pursue criminal charges even after it has concluded its civil investigation, or the DOJ may decide to pursue a criminal case independently of the SEC.

In securities litigation, the five-year statute of limitations for federal civil penalties generally applies. However, under Exchange Act Section 21(d)(8), ten years can apply for disgorgement in certain cases involving scienter based on the fraudulent conduct at issue.

What Is the SEC’s Disgorgement Right Under U.S. Law?

The U.S. Supreme Court limiting the SEC’s disgorgement rights in the case of Liu v. SEC, 591 U.S. 71, 140 S. Ct. 1936 (2020), is not uncommon as disgorgement has been subject to scrutiny by the courts in recent years. The SEC may still pursue disgorgement, provided that the funds are obtained as restitution to the injured party and that they are only the amount of net profits obtained by the violator.

What Are the Monetary Penalties in SEC Spoofing Cases?

In SEC spoofing cases, the ceiling for civil monetary penalties is generally determined by a combination of factors. For example, in third-tier penalties, the ceiling is determined by either (i) the gross pecuniary gain to the violator (or the losses caused to others) or (ii) a fixed amount per violation. In the case of Avalon, the SEC obtained a March 2017 order that froze the defendant’s assets, effectively making it an instrument to recoup disgorgement and interest in the future.

What Are the Monetary Penalties in CFTC Spoofing Cases?

Under the Commodity Exchange Act, the CFTC can impose civil monetary penalties up to three times the violator’s monetary gain obtained from the violation. While the disgorgement remedy is also available under the Commodity Exchange Act, this penalty may not be available if the trader has not gained financially from the violations.

Is Prosecution for Spoofing and Layering Common?

Spoofing, layering, and other forms of market manipulation are the subject of federal enforcement actions. The U.S. government considers these matters to be extremely serious, and traders should contact a reputable securities lawyer at Spodek Law Group or another reputable law firm to discuss their defense strategies. The government has already begun to prosecute several individuals and firms under the new anti-spoofing legislation, so traders should take all allegations of this nature seriously.

Get Advice on Your Situation

If you want someone to look at the specifics of your case, Spodek Law Group handles federal criminal defense nationwide from New York and Los Angeles. The firm has been practicing since 1976 and its motto is simple: we owe loyalty to only you. Call 212-300-5196.