Regulatory Focus on Market
Structure and Trading Issues
Janet M. Angstadt, Esq.
Lance A. Zinman, Esq.
Partner
Katten Muchin Rosenman LLP
525 W. Monroe
Chicago, IL 60661
312.902.5494
janet.angstadt@kattenlaw.com
Partner
Katten Muchin Rosenman LLP
525 W. Monroe
Chicago, IL 60661
312.902.5212
lance.zinman@kattenlaw.com
Regulatory Focus on Market Structure
and Trading Issues
The SEC and CFTC have increased their focus on market structure
and trading issues since the “Flash Crash.” Among the issues of
focus are:
 Disruptive trading practices
• Focus of enforcement from the SEC and CFTC
• CFTC proposal concerning disruptive trading practices
 Controls for algorithms and automated trading strategies
• Focus of regulatory inquiries and possible rulemaking from both the
SEC and CFTC
 Market access controls
• New SEC Rule 15c3-5
• Possible rulemaking from the CFTC
Disruptive Trading Practices
Focus of SEC Enforcement
 SEC Chairman Mary Schapiro has announced that SEC
Enforcement staff is focusing on whether certain trading practices
potentially give rise to federal securities law violations. Such
practices include
• layering or spoofing
• improper order cancellation activities or "quote stuffing"
• the use of order anticipation and momentum ignition strategies
undertaken for a manipulative purpose
• passive market making practices that incentivize possible
manipulative quoting activity
• abusive co-location and data latency arbitrage activity in potential
violation of Regulation NMS
• use of direct market access arrangements to conceal manipulative
trading activity
Securities: Spoofing, Layering and Quote
Stuffing
 “Spoofing” is generally a reference to the practice of entering orders
to drive the price of a security up (or down) without any intention of
receiving an execution
 “Layering” is a form of spoofing where a participant enters multiple
orders at different prices on one side (or both sides) of the market
for the purpose of creating a false appearance of trading activity
 “Quote Stuffing” is often described as entering large number of
orders and canceling those orders immediately for the purpose of
slowing down quoting networks responsible for updating the NBBO
 Statements in electronic communications often are used by
regulators to establish intent
Trillium Settlement with FINRA
 Trillium Brokerage Services and several individuals settled with
FINRA for a total of $2,300,000 in September 2010
 FINRA found that the traders were using an improper trading
strategy which used orders that were immediately cancelled to
create a false appearance of trading activity
 Traders entered numerous layered, non-bona fide market moving
orders to generate selling or buying interest in specific stocks
 The trading strategy induced other market participants to enter
orders to execute against limit orders previously entered by the
Trillium traders
 FINRA fined nine Trillium proprietary traders, the head trader and
the head of compliance
Trillium (Continued)
 FINRA alleged that traders at Trillium engaged in a “repeated pattern of
layering conduct to take advantage of trading, including algorithmic trading
by other firms”
 After entering a buy (sell) limit order into Nasdaq, a Trillium trader would
repeatedly enter numerous layered, non-bona fide, market moving sell
(buy) orders through Nasdaq on the opposite side of the market from the
limit order at prices primarily outside of the Nasdaq BBO
 The trader would then buy (sell) shares at prices that were lower (higher)
than he would otherwise have been able to buy (sell) shares but for his
entry of the numerous non-bona fide sell (buy) orders into Nasdaq
 Within seconds of receiving the executions of the buy (sell) limit orders, the
trader would cancel the non-bona fide orders in Nasdaq
 The trader would typically repeat this pattern on the opposite side of the
market, beginning with the entry of a sell (buy) limit order for the same
security, followed by the placement of numerous non-bona fide buy (sell)
orders
Trillium (Continued)
 Fines and Sanctions for the Firm
• Fine of $1,000,000
• Disgorgement of $173,357
 Fines and Sanctions for Individuals
• Total of 11 individuals paid fines and/or disgorgement
• Individual fines ranged from $220,000 to $12,000
• Disgorgement ranged from $78,000 to $7,000
• Suspensions for individuals ranged from two years to 6 months
• Four individuals charged with failure to supervise
Total:
$2,300,000
Securities: Momentum Ignition
 Entering a series of orders and trades in an attempt to
ignite a rapid price move either up or down
 Rapid submission and cancellation of many orders,
along with the execution of some trades, will trigger the
algorithms of other traders and cause them to buy (sell)
more aggressively
 Alternatively, a trader may intend to trigger standing stop
loss orders that would help cause a price decline
Securities: Manipulation
 Marking the Close (Open)
• Marking the close is a manipulative device whereby the
manipulator tries to influence the closing price of a stock by
executing purchase or sale orders at or near the close of the
market
 Painting the Tape
• Painting the tape signifies creating an appearance of trading
activity without an actual beneficial ownership
 Wash Trade
• A wash trade is a transaction made without an intent to take a
genuine, bona fide position in the market, such as a
simultaneous purchase and sale designed to negate each other
so that there is no change in financial position
Disruptive Trading In Futures Markets
 CFTC proposed an Interpretive Order issued on March 18,
2011 concerning definitions of disruptive and manipulative
conduct in the futures market:
• Violating Bids and Offers
• Order Execution of Transaction During Closing Period
• Spoofing
Futures: Orderly Execution of Transactions
During Closing Period
 CFTC proposed that violations will occur where a trader acted recklessly.
This attempts to ensure that legitimate trading activity and individuals
acting in good faith do not become violations
 “Closing period” proposed to mean “the period in the contract or trade when
the daily settlement price is determined under the rules of that trading
facility”
 Sample Disciplinary Matter - In the Matter of Moore Capital Management,
LP, Moore Capital Advisors, LLC, and Moore Advisors, Ltd., CFTC Docket
No. 10-09 (Apr. 29, 2010): $25 million civil monetary penalty, joint and
several liability; all defendants attempted to manipulate the settlement
prices of platinum and palladium futures contract on NYMEX by “banging
the close”
• Moore Capital Management, LP manager agreed to pay a $1 million
civil penalty to settle charges that he attempted to manipulate prices of
palladium and platinum futures contracts
• Manager permanently barred from trading futures at the close
Futures: Spoofing
 Under the proposed rules, “spoofing . . . includes, but is not limited to:
i. Submitting or cancelling bids or offers to overload the quotation system of
a registered entity;
ii. Submitting or cancelling bids or offers to delay another person’s execution
of trades; and
iii. Submitting or cancelling multiple bids or offers to create an appearance of
false market depth”
 Intent is required
 Sample Disciplinary Matter - In the Matter of Bunge Global Markets, Inc.,
CFTC Docket No. 11-10 (Mar. 22, 2011): $550,000 civil monetary penalty;
Bunge entered orders to purchase or sell soybean futures contracts in preopening trading sessions on Globex that Bunge had no intention of having
executed. The CFTC alleged that these orders caused prices to be
reported that were not true and bona fide, and that the soybean futures
orders also constituted false, misleading or knowingly inaccurate reports
concerning soybean market information that affected or tended to affect
the price of soybeans, in violation of the CEA
Futures: Manipulation
 The Commodity Exchange Act as amended by Dodd-Frank
expands the CFTC’s anti-manipulation enforcement powers
 CFTC is attempting to prohibit practices “that are intended to
mislead investors by artificially affecting market activity”
 Intent is required
 Sample Disciplinary Matter - CFTC v. Energy Transfer Partners, LP,
Case No. 3:07-cv-01301 (N.D. Tex. 2008): $10 million civil
monetary penalty; Energy Transfer Partners, L.P., Energy Transfer
Co., Houston Pipeline Co., and ETC Marketing, Ltd. attempted to
manipulate the price of natural gas for delivery at the HSC by
selling on the ICE massive quantities of natural gas at HSC to place
downward pressure on natural gas prices at the HSC and reported
those transactions in an attempt to manipulate the index price of
natural gas at the HSC