Federal prosecutors have filed the first-ever indictment of an individual financial professional for manipulating markets through high-speed trading, U.S. Attorney Zachary Fardon announced Thursday.
The Justice Department alleges that a trader named Michael Coscia used the high-tech trading platform at the commodities trading company he runs to place and then cancel dozens of large purchases in less than a second, tricking the electronic marketplaces that determine the commodities prices. Coscia’s alleged trading program allowed him to pocket about $1.6 million over a three month program, according to a press release detailing the charges.
The high-tech market rigging Coscia is accused of is called “spoofing” because it creates the illusion of market activity around a given thing — in this case gold, soybean products, copper, and foreign currency exchange markets — and induces a small shift in the market. That allows someone holding a large quantity of the thing that’s being manipulated to cash in. A wide range of different markets are subject to this kind of manipulation, and recent years have seen formal investigations into market rigging in everything from interest rates to foreign currency markets to oil to electricity. The most famous of those investigations found that a key interest rate known as LIBOR had been rigged by insiders for years, harming anyone with an investment tied to interest rates and costing industry outsiders hundreds of billions of dollars.
Individual accountability has been rare despite all this evidence that financial insiders routinely rig markets in their favor. Banks and traders have paid a number of settlements to resolve accusations without admitting wrongdoing.
This week’s criminal prosecution is the first under a law banning spoofing in American markets, but it’s the second piece of good news for those interested in stiffer penalties for cheating the financial markets. Lloyd’s of London announced on Monday that it had fired eight people and taken back about $5 million in bonuses from those involved in LIBOR rigging.
Outright market rigging like what Coscia is accused of and what Lloyd’s and many other London bankers did with global interest rates is only the most outrageous form of abuse that unsophisticated outside investors may suffer from high-tech, high-frequency trading platforms, however. While some financial professionals insist that the market-smoothing provided by high-frequency trading is beneficial to everyone because it makes markets operate more efficiently, economists have found the opposite.
Even when they’re not cheating, computer-based trading by the millisecond allows sophisticated investors to get ahead of the natural movement of markets, capturing profits and avoiding losses from that movement before everyone else can. Instead of providing a marketplace where capital can find its most efficient purpose and enrich outsiders, high-frequency trading turns the markets into an insider’s game that harms outsiders who participate. One billionaire investor described high-frequency traders as providing “all the social utility of a bunch of rats admitted to a granary.”
The trading programs are also introducing new, hard-to-control forms of risk to the markets where many people invest their retirement funds. The programs were blamed for a so-called “flash crash” in 2010 where the Dow Jones Industrial Average collapsed by 600 points in seconds before bouncing back moments later.
All this risk and potential for abuse has led to somewhat tighter regulation of high-speed trading technology. But setting new rules for a harmful practice may not be enough to protect average investors from the competitive edge that insiders can gain by gaming the rules (or ignoring them).
A cleaner-cut approach to buffering consumers from the damage high-tech traders can cause them would be to place a per-transaction tax on financial trades. A Financial Transactions Tax (FTT) of just one ten-thousandth of a penny per trade would be enough to cancel out the gains that high-speed traders make by frontrunning markets or nudging prices by tiny margins while being too small for traditional investors to be harmed.