/ Market Manipulation Investigations Articles / Market Manipulation Under US Federal Law
At the federal level, the key market manipulation regulations are in the 1933 Securities Act, 1934 Exchange Act, 1936 Commodity Exchange Act, and Title 18 of the U.S. Code. While this primer does not address them, each of the states has its own set of laws that can also reach manipulation and fraud in financial markets (e.g., New York State’s Martin Act). There are also various private companies (e.g., FINRA, NYMEX, CME, ICE) that independently police behaviour on the markets they control through their own rules and procedures. Depending on the type of trading at issue in any given case, the overlapping regulations from each of these different sources may need to be considered.
Indeed, manipulation investigations often begin at the private level. For example, the CME Group, which runs the world’s largest futures exchange, has its own team of in-house investigators who pore over trade data for signs of misconduct. When something raises a red flag, investigators will generally solicit an explanation from the trader responsible. If that explanation is insufficient, the CME has the option to impose its own sanctions and/or refer the matter to federal law enforcement for further scrutiny.
The serial investigations into Michael Coscia, the first person to be criminally charged with “spoofing,” followed this exact sequence. After Coscia settled enforcement actions brought by the CME and ICE (two private exchange operators), Coscia was sued by the CFTC. In July 2013, Coscia reached a settlement with the CFTC requiring him to pay over $4.5 million in financial penalties and serve a oneyear suspension from trading. A year later, he was indicted by the DOJ for the same conduct. At trial, Coscia’s representations to the other regulators—and especially his CFTC deposition testimony—were used as key pieces of evidence against him. He was eventually found guilty and sentenced to three years in federal prison.8
Following Wall Street’s stock market crash in October 1929 and the ensuing global economic meltdown, Congress realised that economic recovery necessitated restoration of public faith in the securities markets. As legal commentators noted at the time, “It was inevitable that some type of measure should be taken to correct the evils of over-speculation and financial racketeering occurring on organized security exchanges, and to prevent as far as possible another major stock market crash with its attendant grief and destruction.10
To this end, two major pieces of federal legislation were passed during the height of the Great Depression in the early 1930s: the Securities Act of 1933 and the Securities Exchange Act of 1934.11 The ‘33 Act has relatively limited scope in that it deals primarily with the process by which companies can register, market, and issue new securities.12 The ‘34 Act, on the other hand, was designed to broadly regulate the purchase or sale of securities13 on secondary U.S. markets. In other words, the statute focuses on what happens after a security’s initial issuance. In addition to creating a civil securities regulator, the SEC, the ’34 Act made it unlawful for anyone involved in the securities industry—investors, brokers, dealers, and traders—to act dishonestly. As stated in the ’34 Act’s introductory section, the law was intended to be a comprehensive legal framework for essentially all securities transactions in the U.S.:
“[T]ransactions in securities as commonly conducted upon securities exchanges and overthe-counter markets are effected with a national public interest which makes it necessary to provide for regulation and control of such transactions and of practices and matters related thereto, including . . . requirements necessary to make such regulation and control reasonably complete and effective, in order to protect interstate commerce, the national credit, the Federal taxing power, to protect and make more effective the national banking system and Federal Reserve System, and to insure the maintenance of fair and honest markets in such transactions.”14
With respect to market manipulation, the key provisions of the ’34 Act are Section 9(a) and Section 10(b). There are a range of potential penalties that can be applied to violations of these provisions. The SEC can, for example, seek injunctive relief and civil monetary penalties in federal court or through its own administrative procedures.15 Criminal penalties can be imposed by the DOJ for “willful” ’34 Act violations.16 Individuals found guilty of a criminal market manipulation offense under the ’34 Act are subject to a maximum of 20 years in prison and fines of up to $5 million.17
Section 9(a) was designed by Congress to “prevent rigging of the market and to permit operation of the natural law of supply and demand.18 What exactly constitutes “the natural law of supply and demand” has never been definitively pinned down by the courts, but, broadly speaking, Section 9(a) makes it unlawful to:
Matched orders and wash sales are two of the most basic means of manipulating the market, and they are explicitly prohibited by Exchange Act § 9(a)(1). In these transactions, a manipulator acts as both the buyer and the seller in order to give the false appearance of arms’-length trades without assuming any actual risk.19 Alternatively, the manipulator can act in concert with other conspirators to give the false appearance that trades are disinterested transactions between independent actors.20
In order to establish a § 9(a)(1) violation, regulators must prove the “existence of (1) a wash sale or matched orders in a security, (2) done with scienter, and (3) for the purpose of creating a false or misleading appearance of active trading in that security . . . .”21 Certain courts have held that when wash sales/matched orders are shown to have been done intentionally (i.e. not by mistake), manipulative intent can be inferred.22
One of the more notable “matched trading” cases in recent years was the 2015 parallel DOJ/SEC action against Benjamin Wey, CEO of New York Global Group, a private equity firm. The authorities alleged that Wey secretly obtained shares of one of his firm’s clients (CleanTech) through foreign nominees and then sought to sell those shares through prearranged transactions at inflated values.23 He then purportedly talked up the stock to other investors to increase its price further before dumping it for a large profit. Yet, in a fortunate twist for Wey, the criminal case against him was ultimately dismissed after SDNY Judge Nathan took the extraordinary step of suppressing all of the evidence obtained during the FBI’s execution of search warrants on Wey’s office and apartment. In a lengthy opinion examining the Fourth Amendment’s particularity requirements, Judge Nathan concluded that the warrants were deficient because: (1) they lacked particularity; (2) were overbroad; and (3) were not saved by the good-faith exception to the exclusionary rule.
After the DOJ terminated its case against Wey, the SEC dismissed their parallel claims and issued a press release acknowledging that it “had relied on evidence that was later suppressed in a parallel criminal proceeding and determined that its ability to rely on the suppressed evidence may also be affected.24
The price of most publicly traded securities and derivatives fluctuate throughout each trading day. The two prices that are given most attention by investors are the opening price and the closing price. The closing price is particularly significant because it is the primary reference point for determining an asset’s performance over a given time period.
Because of this, the securities laws include specific prohibitions on activity—variously referred to as “marking the close,” “banging the close,” or “painting the tape”—meant to artificially affect prices or trading activity in the time period just before market close. “[M]arking the close . . . is a form of market manipulation that involve[s] attempting to influence the closing price of a publicly traded share by executing purchase or sale orders at or near the close of normal trading hours. Such activity can artificially inflate or depress the closing price for that security and can affect the price of the market on close orders, which are orders submitted to purchase shares at or near as possible to the closing price.25
The purpose of marking the close is to influence the trading decisions of other market participants by creating “actual or apparent active trading in such security.26 Note that although the § 9(a)(2) refers only to “transactions,” courts have held that this term includes not only completed purchases or sales but also bids and offers to purchase or sell securities.27 The SEC has taken the same position.28 This expansive interpretation allows regulators to sanction traders for manipulation even when they have not actually consummated a transaction. The criteria used to differentiate legal bids and offers and those that “paint the tape” is unclear, but the SEC will often focus on situations involving rapidly placed orders near the top of the order book (or at staggered price levels).29
So-called “pump and dump” schemes are a relatively unsophisticated form of market manipulation involving three basic steps: (1) large purchases of a particular stock (usually ones that are thinly traded and/or have low market capitalisation); (2) “pumping up” of the asset’s price by the promoter through a fraudulent sales campaign based on misinformation; and (3) dumping of the asset back into the market by the promoter at an inflated price.30 But regulators have also brought pump and dump charges against defendants engaging in more complicated manipulative practices.
In SEC v. Diversified Corp., for example, a major holder of a thinly traded, over-the-counter stock sought to inflate the price of his shares.31 Rather than follow the typical pump and dump playbook, the stockholder conspired with the company’s board to first authorize the issuance of millions of facially unrestricted shares. He then instructed that these shares be issued to several other individuals, who were in on the scheme. Next, he “pumped up” the share price by raising his bid price for shares to indicate that there was a demand for the stock at higher prices—“even when it was higher than the bid price announced by other market makers and there was no demand for the stock.” According to the SEC, this practice “distorted the market” because he was essentially bidding against himself and was thereby sending a false signal to investors—“false in the sense that he was not raising his bid to meet a genuine demand for [the company’s] shares.” Id. To further inflate the stock price, the defendant and his co-conspirators also issued press releases that falsely portrayed the stock as a good investment. After the stock had increased by over 2000% within a few months, the shares were dumped on the market.
This method of manipulation has often been employed at boiler room-type operations involving high pressure sales calls placed to vulnerable victims.32 It can also be done electronically via “cyber” boiler rooms:
“The new ‘cyber’ boiler rooms allow scam artists to conduct sophisticated market manipulations at almost no cost over the Internet from the comfort of their own homes. In four easy steps, a manipulator can consummate the entire fraud. The first step is to set up a site or home page where potential investors can find out about the issuer. In step two, the manipulator, using bulk e-mail or a spamming program, personally contacts potential investors regarding an investment opportunity. In step three, the manipulator begins a ‘buzz’ about the issuer and its shares by posting false information to bulletin boards, newsgroups, and discussion forums. Finally, in step four, the manipulator strengthens the buzz by employing an Internet investment newsletter. It is that easy to hype the stock, and easier still to sell the stock back into the exchanges or over-the-counter markets at a profit and reap the financial rewards of having inflated the stock price.33
By “short selling” a stock or other instrument, trader’s are able to make a bet that its price will decline. A short sale transaction typically takes place in three stages: first, the short seller borrows the security from a third-party and promises to return it at an agreed-upon date; second, the short seller sells the borrowed security in the market; third, at or around the date the short seller needs to return the security to the lender, she buys it back from the market; and lastly, it is returned to the lender. In a successful short sale, the price at which the short seller buys the security back in step three is less than the price it was sold for in step two (with the short seller pocketing the difference).34
“Naked” short selling is when a seller sells a security without first borrowing it in the hopes that it can be bought for less than the sale price before it must be delivered to the buyer, which is generally a matter of days. If the seller fails to do so, they will generally be liable for a “failure to deliver” and be forced to pay the purchaser cash compensation. Naked short selling is not illegal per se, but the practice is subject to heavy regulation by the SEC because it can be used to improperly drive down a stock’s market price.35 Although various attempts have been made to characterize naked short selling as inherently manipulative, such efforts have largely failed. Rather, courts have determined that naked short selling are is only unlawful when combined with some other manipulative act.
As the Seventh Circuit stated in ATSI Comm., Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99-105 (2d Cir. 2007), “[S]hort selling—even in high volumes—is not, by itself, manipulative. Aside from providing market liquidity, short selling enhances pricing efficiency by helping to move prices of overvalued securities toward their intrinsic values. In essence, taking a short position is no different than taking a long position. To be actionable 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.” No precise definition has been given to exactly what the “something more” must be, but caselaw suggests that in order to be manipulative, short selling must be combined with some sort of misinformation transmitted to the market.36
Section 10(b) makes it unlawful to “use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” Through this loosely worded provision, Congress granted the SEC broad powers “to combat manipulative abuses in whatever form they might take, including anti-fraud, prophylactic, and general rulemaking authority.37
Eight years after the passage of the ’34 Act, the SEC adopted Rule 10b-5 (17 C.F.R. § 240.10b-5) to refine Section 10(b)’s prohibitions. As stated in an accompanying SEC press release, Rule 10b-5 was designed to “close a loophole in the protections against fraud administered by the [SEC] by prohibiting individuals or companies from buying securities if they engage in fraud in their purchase.38 As interpreted by the Supreme Court, 10b-5 fits within Section 10(b) such that “Rule 10b-5 encompasses only conduct already prohibited by § 10(b).39 Although Rule 10b-5 was adopted with little fanfare, it has become one of the best-known provisions in American law.40 The rule makes it “unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
Unlike the § 9 prohibitions which target specific types of trading activity, §10b and Rule 10b-5 were intended to be catchall measures to cover a broad spectrum of imprecisely-defined misconduct. By keeping their contours somewhat fuzzy, Congress and the SEC designed the regulations to be adaptable enough to “reach the unanticipated schemes of clever” market participants.41
Thus, although § 10(b) and Rule 10b-5 only prohibit “conduct involving manipulation or deception,” the means by which such manipulation or deception are accomplished are essentially irrelevant insofar as the regulations’ scope is concerned. Rather, what matters is the intent behind the market conduct at issue.42 Further, the Supreme Court has held that “[c]onduct itself can be deceptive,” and so liability under § 10(b) and Rule 10b-5 does not necessarily require “a specific oral or written statement.43
While the prohibitions contained in § 10(b) and Rule 10b-5 are broader than those in § 9,44 the statutes overlap, and conduct that violates § 9 may also violate § 10(b) and Rule 10b-5 if done with "scienter".45 The Supreme Court defines “scienter” as “a mental state embracing intent to deceive, manipulate, or defraud.46 In most Circuits, reckless conduct—i.e. “conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care”—satisfies the scienter requirement.47 Because of the focus on scienter, § 10(b) and Rule 10b-5 can arguably be violated based on the defendant’s intent alone.48 That is, an otherwise legal transaction can be treated as illegal if it was motivated by criminal intent.
This is in contrast with § 9 violations, where there must be evidence that a defendant’s actions fell into certain categories or affected the market in specific ways.49 Manipulation under § 10(b) and Rule 10b-5 therefore “connotes intentional or wilful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.” But since virtually all market activity affects prices in some way, the “critical question then becomes what activity ‘artificially’ affects a security’s price in a deceptive manner.50 The majority approach requires a showing that an alleged manipulator engaged in market activity aimed at deceiving investors into believing “that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators.51
To identify “activity that is outside the ‘natural interplay of supply and demand,’ courts generally ask whether a transaction sends a false pricing signal to the market. For example, the Seventh Circuit recognizes that one of the fundamental goals of the federal securities laws is “to prevent practices that impair the function of stock markets in enabling people to buy and sell securities at prices that reflect undistorted (though not necessarily accurate) estimates of the underlying economic value of the securities traded, and thus looks to the charged activity's effect on capital market efficiency.52 To prevent this “deleterious effect” on the capital markets, certain courts have distinguished manipulative from legal conduct by asking whether the manipulator “inject[ed] inaccurate information into the marketplace or creat[ed] a false impression of supply and demand for the security . . . for the purpose of artificially depressing or inflating the price of the security.53 This approach has not been universally accepted, however, and a key issue that is as yet unresolved by the Supreme Court is whether manipulative intent alone is enough to make so-called “open market” transactions manipulative and in violation of the securities laws (as discussed in the next section).
Manipulative conduct is generally characterized as either “traditional manipulation” or “open market manipulation.” Traditional manipulation involves one of the specifically prohibited trading practices listed in Exchange Act § 9(a)(1) or some type of explicitly fraudulent conduct under § 10(b). In open market manipulation, the trading activity is not objectively fraudulent, but may nevertheless constitute illegal manipulation when taken in context. In other words, open market transactions are ones that are facially legitimate in all respects—“the transaction is real, . . . beneficial ownership is changing, and the volume of trading is reflective of market activity.54 “The difficulty in such cases, where the activity in question is not expressly prohibited, is to ‘distinguish between legitimate trading strategies intended to anticipate and respond to prevailing market forces and those designed to manipulate prices and deceive purchasers and sellers.’55
In GFL Advantage, the Third Circuit was reluctant to find that otherwise legal conduct could violate securities laws based only on manipulative intent. Rather, it determined that the law required evidence of certain types of activity in addition to malintent—e.g. unauthorized placements and parking of stock, secret sales without disclosing the real party in interest, guaranteeing profits to encourage short selling by others, fraudulently low appraisals, painting the tape.56 This determination “may be explained by the fact that it is unusual in American law to impose liability based solely on the intent of the actor. There may also be a concern that because of the ambiguity and difficult in establishing intent, prohibition of otherwise legal conduct based only on an actor’s intent might chill and deter socially desirable conduct.57
In contrast, the D.C. Circuit accepted that open-market transactions can constitute market manipulation if done with manipulative intent. In Markowski v. SEC, for example, “defendants argued that they could not be convicted of market manipulation based on otherwise legal transactions involving ‘(1) maintaining high bid prices . . . and (2) absorbing all unwanted securities into inventory’ because their bids and trades were ‘real.’58 In rejecting this argument, the D.C. Circuit cited “Congress’s determination that ‘manipulation’ can be illegal solely because of the actor’s purpose.59
In New York’s Second Circuit, the law on open-market manipulation is not yet settled.60 But in United States v. Mulheren, the Second Circuit suggested in dicta that a trader could be convicted of market manipulation for an open market transaction where the sole intent of such transaction was to artificially affect the price of a security.61 Lower courts in the Second Circuit have generally followed the reasoning in Mulheren and rejected the approach in GFL Advantage.62
While spoofing in the commodities markets was explicitly made illegal in the CEA following the enactment of Dodd-Frank (see Section D.2 below), the same conduct in other markets is prohibited by § 10(b) and Rule 10b-5.63 In general, spoofing refers to placing and quickly cancelling orders that are never intended to be executed. Such orders can induce trading by other market participants (e.g., highspeed algorithmic traders) who seek to take advantage of changes to supply and demand in the order book. “Layering” is a type of spoofing that involves a series of spoof orders placed at different price levels increasingly far from the prevailing best price.
In SEC v. Lek Sec. Corp., for example, the defendants were charged with § 10(b) violations for engaging in a layering scheme involving the placing of allegedly “non-bona fide orders”—i.e. ones they did not “intend to execute and had no legitimate economic reason—with the “intent of injecting false information into the market about supply or demand” for certain stocks.64 The alleged purpose of this scheme was to “trick and induce other market participants to execute against orders that [defendants] did intend to execute for the same stock on the opposite side of the market, which the complaint describes as its bona fide orders. Through this scheme, [defendants allegedly sought] more favorable prices on the executions of its bona fide orders than otherwise would have been available.65
Lek Securities and the other defendants moved to dismiss the SEC’s complaint in its entirety on various grounds. In an opinion addressing the applicability of § 10(b) to spoofing/layering, the Southern District of New York accepted the SEC’s theory and denied defendants’ motion:
[Market manipulation] broadly includes those practices “that are intended to mislead investors by artificially affecting market activity.” In considering whether an act injects false pricing signals into the market, courts recognize that one of the fundamental goals of the federal securities laws is . . . “to prevent practices that impair the function of stock markets in enabling people to buy and sell securities at prices that reflect undistorted (though not necessarily accurate) estimates of the underlying economic value of the securities traded. . . . Market manipulation can be accomplished through otherwise legal means. As the Second Circuit has noted, “in some cases scienter is the only factor that distinguishes legitimate trading from improper manipulation.66
Several other courts have also concluded that spoofing can violate § 10(b) and Rule 10b-5.67 Sam Lek and his company settled the SEC’s claims before in exchange for a $1.42 million penalty, disgorgement of $525,892, and a compliance monitor for three years. The remaining defendants were found guilty after trial in November 2019. In March 2020, a final judgment was issued that imposed a nearly $20 million combined penalty (that is currently being appealed).68
Congress’s overarching purpose in passing the ’33 Act was to “provide investors with full disclosure of material information concerning public offerings of securities in commerce, to protect investors against fraud and, through the imposition of specified civil liabilities, to promote ethical standards of honesty and fair dealing.69 The statute’s key anti-fraud provision is Section 17(a) (15 U.S.C. § 77q), which provides:
It shall be unlawful for any person in the offer or sale of any securities or any security-based swap agreement by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly—
While the structure of § 17(a) is similar to Exchange Act § 10(b) and Rule 10b-5, § 17(a) is broader because civil claims brought by the SEC under § 17(a)(2) and (a)(3) may be based on negligent conduct, while such claims under § 10(b) require proof of scienter.70 But the possible penalties for § 17(a) violations are lower—any person found guilty of a “wilful” violation is subject to a maximum fine $10,000 and/or five years in prison.71
In several recent cases, the SEC has taken the position that spoofing violates § 17(a). In its 2020 DPA with JP Morgan, for example, the SEC alleged a violation of § 17(a)(3) in light of a long-running scheme to spoof the U.S. Treasuries market.72 Likewise, in SEC v. Chen, the SEC charged dozens of mainly China-based traders with violations of §§ 17(a)(1) and (a)(3) for engaging in a coordinated scheme to artificially influence the prices of various publicly traded securities in the US through nominee trading accounts.73 Other cases where the SEC alleged § 17(a) violations for spoofing or spoofing-like conduct include Behruz Afshar, et al., Securities Act Release No. 9983 (SEC Dec. 3, 20150), Briargate Trading LLC, et al., Securities Act Release No. 9959 (SEC Oct. 8, 2015), SEC v. Milrud, 15-cv-00237 (D.N.J.), and SEC v. Pomper, 01-cv-07391 (E.D.N.Y.).
In addition to combatting manipulation and fraud on stock exchanges, during the Great Depression the U.S. government was concerned with perceived wrongdoing in the commodities markets.74 To address this issue, Congress passed the Commodity Exchange Act (CEA) in 1936. As the Second Circuit described the law, “[T]he CEA is a remedial statute that serves the crucial purpose of protecting the innocent individual investor—who may know little about the intricacies and complexities of the commodities market—from being misled or deceived.” Loginovskaya v. Batratchenko, 764 F.3d 266, 270 (2d Cir. 2014). Like stock exchanges, futures exchanges were deemed to be of national importance and in need of more stringent regulation: “The transactions and prices of commodities on such boards of trade are susceptible to excessive speculation and can be manipulated, controlled, cornered or squeezed . . . rendering regulation of such transactions imperative for the protection of such commerce and the national public interest.75
In 1974, the CEA was substantially amended by the Commodity Futures Trading Commission Act which, among other things, created the CFTC to assume responsibility for the CEA’s regulation and enforcement.76 The CFTC’s anti-manipulation authority extends to spot and forward physical commodity transactions, as well as exchange-traded and over-the-counter derivatives (futures contracts and options). A knowing violation of the CEA’s anti-manipulation provisions, contained in CEA §§ 4(c) and 9(a), is a felony punishable by up to 10 years in prison and a fine of not more than $1,000,000.77
In the first few decades of the CFTC’s existence, a generally accepted four-part test for manipulation under the CEA developed: (1) intent to manipulate prices; (2) the ability to influence prices; (3) existence of an artificial price; and (4) causation of the artificial price.78 This standard proved exceedingly difficult for the CFTC to satisfy when challenged.79 In fact, since 1974 the CFTC has only won a single market manipulation case decided in a contested proceeding.80 It was reportedly for this reason that legislation was introduced in 2010 to ease the CFTC’s burden in enforcement actions (see below).81
CEA §§ 4(c)(a)(2) prohibits commodities futures transactions that are “of the character of” “wash” sales, “cross” trades, “accommodation” trades or “fictitious” sales. It also prohibits any transaction that “is used to cause any price to be reported, registered, or recorded that is not a true and bona fide price.” The CEA’s prohibitions against “wash sales” and matched orders have been interpreted essentially the same way as the Exchange Act’s.82 The elements of such a claim are: (1) a purchase and sale of any commodity for future delivery; (2) of the same delivery month of the same futures contract; (3) at the same or similar price; and (4) with the intent of not making a bona fide transaction.83 Both the CFTC and courts interpreted these provisions to require proof of a specific intent to manipulate.84 As the Second Circuit noted, “One cannot have an ‘accommodation’ sale or a ‘fictitious’ transaction if one in fact believes he is bargaining faithfully and intends to effect a bona fide trade.85
Following the 2008/2009 financial crisis, Congress expanded Section 4(c) through a provision in 2010’s Dodd-Frank Wall Street Reform and Consumer Protection Act.86 Specifically, § 747 of DoddFrank added prohibitions on “disruptive practices” to CEA § 4(c). The new section (7 U.S.C. § 6c(a)(5)) states that it “shall be unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—(A) violates bids or offers; (B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; (C) is, is of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).”
Of these additions, the anti-spoofing provision (“ASP”) has generated the most controversy. From the beginning, it was attacked as vague and overbroad. Commentators noted in particular that the ASP has no drafting or legislative history—it “simply materialized with no public discussion, [and so] there is literally nothing in the legislative record to illuminate the provision’s meaning or reach.87 Market professional were also dismayed at the inclusion of the word “spoofing” in the statute since “spoofing” had no accepted meaning in the futures and derivatives markets.
During a December 2010 roundtable discussion hosted by the CFTC, for example, Kenneth Raisler, former General Counsel of the CFTC, noted “It is hard to imagine how [spoofing] even applies to the futures world or how it should be applied.88 The CEO of the CME Group—one of the world’s major exchange operators—similarly stated that “[t]he statute’s definition of ‘spoofing’ . . . is too broad and does not differentiate legitimate market conduct from manipulative conduct that should be prohibited.89
Following these criticisms, the CFTC issued interpretative guidance in May 2013 “to provide market participants and the public with guidance on the manner in which it intends to apply the statutory prohibitions set forth in section 4c(a)(5).” In pertinent part, the guidance states:
As to spoofing, the CFTC’s guidance went on to state that “a spoofing violation will not occur when the person’s intent when cancelling a bid or offer before execution was . . . part of a legitimate, good-faith attempt to consummate a trade.” It further stated that the CFTC “does not interpret reckless trading, practices, or conduct as constituting a ‘spoofing’ violation,” nor does it interpret the ASP as “reaching accidental or negligent trading, practices, or conduct.” “When distinguishing between legitimate trading (such as trading involving partial executions) and ‘spoofing,’” the CFTC explained that it would “evaluate the market context, the person’s pattern of trading activity (including fill characteristics), and other relevant facts and circumstances.91 Even with this guidance, the ASP continues to be attacked as inherently vague. So far, courts have been largely unreceptive to these arguments.92
As noted above, spoofing generally refers to the placing of “trick” orders—i.e., orders intended to be cancelled—on one side of the market in order to deceptively induce other market participants into filling “real” orders lying in wait on the other side. In a typical spoofing scheme, a trader will place one or more relatively small, genuine orders on the opposite side of the market from larger, non-bona fide orders in order to take advantage of how other traders react to large changes in supply and demand.
In its 2015 criminal spoofing trial against Michael Coscia, for example, DOJ introduced an exhibit93 showing the following sequence in Coscia’s trade data:
DOJ used this data as circumstantial evidence that the Buy orders were “trick” orders that Coscia’s trading algorithm entered in order to push the market towards his “real” Sell orders. To show that the Buy orders were not intended to trade, DOJ pointed to the fact that they were immediately cancelled after the Sell orders were filled (after being left open for just a fraction of a second).
Coscia was eventually convicted and sentenced to three years in prison. In upholding his conviction and sentence on appeal, the Seventh Circuit described the conduct prohibited by the ASP:
“In practice, spoofing, like legitimate high-frequency trading, utilizes extremely fast trading strategies. It differs from legitimate trading, however, in that it can be employed to artificially move the market price of a stock or commodity up and down, instead of taking advantage of natural market events . . . . This artificial movement is accomplished in a number of ways, although it is most simply realized by placing large and small orders on opposite sides of the market. The small order is placed at a desired price, which is either above or below the current market price, depending on whether the trader wants to buy or sell. If the trader wants to buy, the price on the small batch will be lower than the market price; if the trader wants to sell, the price on the small batch will be higher. Large orders are then placed on the opposite side of the market at prices designed to shift the market toward the price at which the small order was listed.94
While the trading sequence described by the Seventh Circuit has come to typify the conduct that law enforcement generally focuses on in spoofing actions, it made clear that all the ASP requires the government to prove in such cases is an intent to cancel an order at the time it is placed.95
The Coscia case was the first criminal prosecution alleging violations of the ASP. But perhaps to hedge against constitutional vagueness challenges to the then-untested law, the DOJ also charged him with commodities fraud under 18 U.S.C. § 1348(1). Section 1348(1) makes it a crime to “defraud any person in connection with any commodity for future delivery.” The elements of this crime are (1) fraudulent intent, (2) a scheme or artifice to defraud, and (3) a nexus with a security. “False representations or material omissions are not required” for conviction under this provision.96
In his appeal, Coscia argued that because all of “his orders were fully executable and subject to legitimate market risk,” they could not, as a matter of law, be fraudulent or otherwise violate Section 1348(1). But the Seventh Circuit disagreed, finding that his argument “confused illusory orders with an illusion of market movement.” The court noted that the evidence supported the conclusion that Coscia “designed a scheme to pump and deflate the market through the placement of large orders. His scheme was deceitful because, at the time he placed the large orders, he intended to cancel the large orders . . . and thus sought to manipulate the market for his own financial gain.97
Following Coscia’s conviction and the Seventh Circuit’s favorable interpretation of the ASP and Section 1348(1), the DOJ and CFTC have brought dozens of additional spoofing cases in the last five years (most often in the Northern District of Illinois, a court bound by decisions of the Seventh Circuit Court of Appeals). While the fundamental conduct at issue in these cases is largely the same as that in Coscia, prosecutors’ theories of liability have evolved beyond the ASP and Section 1348(1).
In United States v. Vorley, for example, DOJ did not allege violations of the ASP at all (even though the alleged wrongdoing was clearly spoofing). Instead, prosecutors opted to charge the defendants, both former precious metals traders, with wire fraud in violation of 18 U.S.C. § 1343. In a motion to dismiss the indictment, the defendants argued that the wire fraud statute requires allegations of an affirmative “false statement” and that the case against them failed to do so, since all that was alleged was that they put certain orders into the order book.
The district court judge disagreed, however: “The wire fraud statute proscribes not only false statements and affirmative representations but also ‘the omission or concealment of material information, even absent an affirmative duty to disclose, if the omission was intended to induce a false belief and action to the advantage of the scheme and the disadvantage of the victim.’ And that is precisely what the indictment alleges here: that the defendants did not disclose, at the time they placed their Spoofing Orders, their intent to cancel the orders before they could be executed, inducing by the placement of those orders a false belief about the supply or demand for a commodity, so that the market would move in a direction that favored the Primary Orders, to their benefit and to the detriment of traders in the market who were not privy to the fact that the defendants intended to cancel the Spoofing Orders before they were accepted.98
In United States v. Smith, DOJ used an even more aggressive charging theory. There, prosecutors alleged that four former JP Morgan employees violated the ASP in addition to four alternate substantive offenses: attempted price manipulation, bank fraud (18 U.S.C. § 1344(1), wire fraud affecting a financial institution (18 U.S.C. § 1343), and commodities fraud (18 U.S.C. § 1348(1)). In addition, prosecutors alleged that the defendants had participated in a racketeering conspiracy in violation of the RICO statute (18 U.S.C. §§ 1961-1968).99 Defendants’ motion to dismiss this indictment is currently pending before the court. To date, DOJ has brought criminal spoofing actions against twenty-one individuals alleging violations of various different statutes:
Defendant | Alleged Statute Violated | Disposition |
---|---|---|
Michael Coscia 14-cr-00551 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Commodities Fraud (18 U.S.C. § 1348) |
Guilty after trial Sentence: 36 months |
Navinder Sarao 15-cr-00075 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Wire Fraud (18 U.S.C. § 1343) Commodities Fraud (18 U.S.C. § 1348) |
Guilty plea with cooperation Sentence: 12 months home confinement |
David Liew 17-cr-00001 (N.D. Ill.) |
Conspiracy (18 U.S.C. § 371) | Guilty plea with cooperation Sentence: pending |
Andre Flotron 17-cr-00220 (D. Conn.) |
Conspiracy (18 U.S.C. § 1349) Commodities Fraud (18 U.S.C. § 1348) Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) Aiding and Abetting (18 U.S.C. § 2) 100 |
Not guilty after trial |
Jiongsheng Zhao 18-cr-00024 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) |
Guilty plea with cooperation Sentence: time served |
John Edmonds 18-cr-00239 (D. Conn.) |
Conspiracy (18 U.S.C. § 371) Commodities Fraud (18 U.S.C. § 1348) |
Guilty plea with cooperation Sentence: pending |
Kamaldeep Gandhi 18-cr-00609 (S.D. Tex.) |
Conspiracy (18 U.S.C. § 371) | Guilty plea with cooperation Sentence: pending |
18-cr-00610 (S.D. Tex.)> | Conspiracy (18 U.S.C. § 371) | Guilty plea with cooperation Sentence: pending |
Edward Bases 18-cr-00048 (N.D. Ill.) |
Wire Fraud (18 U.S.C. § 1343) Commodities Fraud (18 U.S.C. § 1348) Conspiracy (18 U.S.C. § 1349) |
Trial scheduled for September 2021 |
John Pacilio 18-cr-00048 (N.D. Ill.) |
Wire Fraud (18 U.S.C. § 1343) Commodities Fraud (18 U.S.C. § 1348) Conspiracy (18 U.S.C. § 1349) Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) |
Trial scheduled for September 2021 |
Jitesh Thakkar 18-cr-00036 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) Conspiracy (18 U.S.C. § 371) Aiding and Abetting (18 U.S.C. § 2) |
Charges dismissed after mistrial |
James Vorley 18-cr-00035 (N.D. Ill.) |
Wire Fraud (18 U.S.C. § 1343) Conspiracy (18 U.S.C. § 1349) |
Guilty after trial Sentence: pending |
Cedric Chanu 18-cr-00035 (N.D. Ill.) |
Wire Fraud (18 U.S.C. § 1343) Conspiracy (18 U.S.C. § 1349) |
Guilty after trial Sentence: pending |
Corey Flaum 19-cr-00338 (E.D.N.Y.) |
Manipulation (7 U.S.C. § 13(a)(2)) | Guilty plea with cooperation Sentence: pending |
Christian Trunz 19-cr-00375 (E.D.N.Y.) |
Manipulation (7 U.S.C. § 13(a)(2)) | Guilty plea with cooperation Sentence: pending |
Xiasong Wang 19-mj-06485 (D. Mass.) |
Conspiracy (18 U.S.C. § 371) | Pending (no trial date set) |
Jiali Wang 19-mj-06485 (D. Mass.) |
Conspiracy (18 U.S.C. § 371) | Pending (no trial date set) |
Gregg Smith 19-cr-00669 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) Conspiracy (18 U.S.C. § 371) Wire Fraud (18 U.S.C. § 1343) Commodities Fraud (18 U.S.C. § 1348) Racketeering Conspiracy (18 U.S.C. § 1962(d)) |
Trial scheduled for October 2021 |
Michael Nowak 19-cr-00669 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) Conspiracy (18 U.S.C. § 371) Wire Fraud (18 U.S.C. § 1343) Commodities Fraud (18 U.S.C. § 1348) Racketeering Conspiracy (18 U.S.C. § 1962(d)) |
Trial scheduled for October 2021 |
Christopher Jordan 19-cr-00669 (N.D. Ill.) |
Spoofing (7 U.S.C. § 6c(a)(5)(C)) Manipulation (7 U.S.C. § 13(a)(2)) Conspiracy (18 U.S.C. § 371) Wire Fraud (18 U.S.C. § 1343) Commodities Fraud (18 U.S.C. § 1348) Racketeering Conspiracy (18 U.S.C. § 1962(d)) |
Trial scheduled for October 2021 |
Jeffrey Ruffo 19-cr-00669 (N.D. Ill.) |
Racketeering Conspiracy (18 U.S.C. § 1962(d)) | Trial scheduled for October 2021 |
Dodd-Frank also added a general anti-manipulation provision in Section 6(c)(1) to the CEA. The new section makes it “unlawful for any person, directly or indirectly, to use or employ, or attempt to use or employ, in connection with any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, any manipulative device or contrivance, in contravention of such rules and regulations as the [CFTC] shall promulgate by not later than 1 year after July 21, 2010 . . . .”
The language of this new section is “virtually identical101 to Exchange Act § 10 (b), and its legislative history shows that Congress designed it to give the CFTC anti-manipulation powers equivalent to the SEC.102 Given the CFTC’s difficulties in proving manipulation before this law, it was apparently designed to lower the legal hurdles the CFTC needed to overcome in such cases. In introducing the legislation, its sponsor, Senator Cantwell, specifically highlighted that “[i]n the 35 years of its history, the CFTC has only successfully prosecuted one single case of manipulation."103
To implement § 6(c)(1)’s provisions, the CFTC issued an analogue to Rule 10b-5, Rule 180.1, in 2011. Rule 180.1 makes it unlawful to “intentionally or recklessly . . . use or employ, or attempt to use or employ, any manipulative device, scheme, or artifice to defraud.” Despite the close similarities with Rule 10b-5, the CFTC stated that “judicial precedent should guide, but not control, application of the scienter standard under subsection 6(c)(1) and the CFTC’s implementing rule.104 As such, the CFTC has taken the position that a mere showing of “recklessness” is sufficient to prove a § 6(c)(1) violation,105 which it defines as “an act or omission that departs so far from the standards of ordinary care that it is very difficult to believe the actor was not aware of what he or she was doing.106
On November 6, 2013, the CFTC flexed it’s new anti-manipulation authority in a complaint failed against Donald R. Wilson and his company, DRW Investments LLC.107 The CFTC alleged Wilson violated CEA §§ 6(c) and 9(a)(2) by placing inflated bids “for certain futures contracts with the intent to move the prices of the contracts in their favor” and “to increase the value of the futures contract positions they held in their portfolio.108 Following a denial of defendants’ motion to dismiss, the case proceeded to a four-day bench trial before Judge Sullivan in December 2016.
In 2018, Judge Sullivan issued a decision concluding that the CFTC had failed to prove its case under the four part Frey standard. While Judge Sullivan found that the CFTC established the first element—ability to influence price—he concluded that “its case founders on its abject failure to produce evidence—or even a coherent theory—supporting the existence of an artificial price.” Citing an earlier CFTC case, Judge Sullivan noted that “a price is artificial when it has been set by some mechanism which has the effect of ‘distort[ing] those prices’ and ‘preventing the determination of those prices by free competition alone.’” On that point, the CFTC “offered no evidence or explanation demonstrating” artificial prices, but rather introduced testimony from a single expert who opined that prices were artificial because they were influenced by “DRW’s self-serving actions.”
Judge Sullivan flatly rejected this theory. “The inescapable conclusion from the evidence introduced at trial is that DRW’s bids, and the consequent settlement prices, were the result of free competition, since sophisticated market participants would surely have accepted Defendant’s open bids if they thought they were above market value. . . . That, after all, is how markets work, and the CFTC’s failure to articulate any theory as to why the market was inefficient, or why would-be counterparties were prevented from enforcing market discipline by hitting DRW’s allegedly inflated bids, is ultimately fatal to its claim.”
Judge Sullivan went on to criticize the CFTC’s conflation of “artificial prices with the mere intent to affect prices.” “Relying on dictum in its own thirty-five year-old administrative decision, the CFTC essentially argues that any price influenced by Defendants’ bids was ‘illegitimate,’ and by definition ‘artificial,’ because Defendants understood and intended that the bids would have an effect on the settlement prices. . . . This theory, which take to its logical conclusions would effectively bar market participants with open positions from ever making additional bids to pursue future transactions, finds no basis in law.”
The CFTC’s attempted market manipulation allegations were similarly dispensed with. “Unlike market manipulation, attempted market manipulation does not require proof of an artificial price—only that Defendants ‘acted (or failed to act) with the purpose or conscious object of causing or effecting a price or price trend in the market that did not reflect the legitimate forces of supply and demand.’ But again the mere intent to affect prices is not enough; rather, the CFTC must show that Defendants intended to cause artificial prices—i.e., prices that they understood to be unreflective of the forces of supply and demand.”
Soon after its loss in Wilson, the CFTC quietly settled CFTC v. Kraft Foods Grp., Inc., 15-cv-02881 (N.D. Ill.), one of the handful of litigated enforcement actions brought under Section 6(c)(1). There, the CFTC took the position that § 6(c)(1) and Rule 180.1 do not require proof of specific intent or the existence of an artificial price (in contradiction to Judge Sullivan’s findings). In other words, the CFTC argued that it could allege a scheme to defraud involving otherwise legal, open market transactions. In a ruling on defendant’s motion to dismiss, the court rejected the CFTC’s claim and determined that § 6(c)(1) and Rule 180.1 “prohibit only fraudulent conduct.109 But in light of the result in Wilson, the CFTC resolved the case before be addressed on the merits. And in an unusual move, this settlement was reached without any public findings of fact or conclusions of law.110 In fact, the CFTC included in the settlement agreement a provision preventing it from making any public statements about the case in the future. Because the CFTC’s negotiated silence on the Kraft settlement leaves “the industry without any intelligible guidance” on what manipulative conduct Section 6(c)(1) and Rule 180.1 prohibit, the CFTC is currently the subject of a Freedom of Information Act lawsuit that seeks to reveal the legal and factual bases for the settlement.111
Section 9(a)(2) makes it unlawful for “any person to manipulate or attempt to manipulate the price of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, or of any swap, or to corner or attempt to corner any such commodity . . . .” Section 9(a)(4) makes it unlawful for “any person willfully to falsify, conceal, or cover up by any trick, scheme, or artifice a material fact, make any false, fictitious, or fraudulent statements or representations, or make or use any false writing or document knowing the same to contain any false, fictitious, or fraudulent statement or entry to a registered entity, board of trade, swap data repository, or futures association.”
Like Exchange Act § 10(b), these provisions in the CEA were designed to be a broad catchall for deceptive or manipulative behavior.112 Courts have generally held that manipulation under the CEA does not necessarily involve an “explicit misrepresentation.113
Regulation of cryptocurrencies in the U.S. is still evolving, and whether they fall within the jurisdiction of the SEC, CFTC, or another regulator is generally determined on a case-by-case basis.129 Thus, “[u]ntil Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency.130 Federal criminal cases involving cryptocurrencies are within the exclusive jurisdiction of the DOJ.131 Cryptocurrencies are also regulated by the Treasury Department’s Financial Enforcement Network (FinCEN), the IRS, and state regulators.132
The SEC’s position is that its regulatory authority extends to any digital asset that constitutes a “security,” defined by the Supreme Court as “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.133 To determine whether a cryptocurrency falls within this definition, courts examine their underlying substance (rather than their form). If a digital asset is determined to be a security, it must be registered with the SEC and offered pursuant to the SEC’s registration requirements.134
If a particular cryptocurrency is deemed to be a commodity, on the other hand, it falls under the CEA and the jurisdiction of the CFTC,135 and “[l]anguage in 7 U.S.C. § 9(1) ad 17 C.F.R. § 180.1 establish the CFTC’s regulatory authority over manipulative schemes, fraud, and misleading statements” involving cryptocurrencies.136 Heath Tarbert, the outgoing CFTC Chairman, specifically identified two cryptocurrencies—Bitcoin and Ether—as commodities under the CFTC’s jurisdiction: “We’ve been very clear on bitcoin: bitcoin is a commodity under the [CEA]. We haven’t said anything about Ether – until now. It is my view as Chairman of the CFTC that Ether is a commodity, and therefore will be regulated under the CEA.137
In 2018, it was reported that the CFTC and DOJ had launched an investigation into possible manipulation in the crypto market. According to the Wall Street Journal, the investigation was prompted by the launch of Bitcoin (BTC) Futures by CME Group in December 2017. The price of CME’s BTC Futures are based on data from four major crypto exchanges (Bitstamp, Coinbase, itBit and Kraken). It was speculated that authorities were probing whether prices on these exchanges were being manipulated through spoofing, wash sales, or other means in order to artificially influence BTC Futures. On August 5, 2018, the Journal published a report that found that “dozens of trading groups are manipulating the price of cryptocurrencies on some of the largest online exchanges, generating at least $825 million in trading activity over the past six months—and hundreds of million in losses for those caught on the wrong side.138 The report identified 175 “pump and dump” crypto schemes involving anonymous online chat groups with names like “Big Pump Signal.”
To date, no enforcement action stemming from the Journal report has been made public, but the CFTC has since filed a number of unrelated lawsuits involving cryptocurrencies, as has the SEC.139
“Absent clearly expressed congressional intent to the contrary, federal laws will be construed to have only domestic application.140 Put simply, “[w]hen a statute gives no clear indication of extraterritorial application it has none.141 To determine whether this presumption is rebutted, courts analyze federal statutes under a “two-step framework” that begins with consideration of “whether the statute gives a clear, affirmative indication that it applies extraterritorially.142
Because none of the anti-manipulation statutes above explicitly apply to conduct overseas, the extent of their extraterritorial reach turns on a step-two analysis which asks “whether the case involves a domestic application of the statute.” This question is answered by determining the statute’s “focus.” “The focus of a statute is ‘the object of its solicitude,’ which can include the conduct it ‘seeks to regulate’ as well as the parties and interests it ‘seeks to protect’ or vindicate.143 “If the conduct [at issue] relevant to the statute’s focus occurred in the United States, then the case involves a permissible domestic application of the statute, even if other conduct occurred abroad. . . . But if the relevant conduct occurred in another country, then the case involves an impermissible extraterritorial application regardless of any other conduct that occurred in U.S. territory.144 Since a “market manipulation claim . . . cannot be based solely upon misrepresentations or omissions,” the “focus” of illegal manipulation is the market activity itself.145
As described in detail below, the presumption against extraterritoriality acts as a limited check on U.S. law enforcement’s ability to bring cases involving foreign conduct. Even minimal contact with the U.S., such as communications or transactions within or through the U.S., is generally sufficient to bring otherwise foreign conduct within the purview of U.S. law. In practice, this makes traders situated anywhere in the world potentially subject to U.S. law enforcement’s essentially global jurisdiction. In fact, a large percentage of recent market manipulation and spoofing cases have involved defendants in London, Hong Kong, Singapore, Sydney, Dubai, and elsewhere who traded on one of the major U.S. exchanges.
Exchange Act § 10(b) and Rule 10b-5
In its 2010 Morrison decision, the Supreme Court concluded that § 10(b) and Rule 10b-5 have only a domestic reach, and therefore apply only to one of two types of transactions: (1) “transactions in securities listed on domestic exchanges,” and (2) “domestic transactions in other securities.146 Days after this ruling, however, Congress inserted a provision, Section 929P(b) (15 U.S.C. § 78aa(b)), into Dodd-Frank that appeared to nullify Morrison in the context of SEC and DOJ actions under the Exchange Act. Section 929P(b) states:
The district courts of the United States . . . shall have jurisdiction of an action or proceeding brought or instituted by the [SEC or DOJ] alleging a violation of the antifraud provisions of [the Exchange Act] involving—
While the intended effect of Section 929P(b) seems clear, it has generated confusion in the lower courts because it addresses extraterritoriality as a jurisdictional issue, whereas Morrison clearly held it be a merits question.147 As the Northern District of Illinois stated, for example, “The plain language of Section 929P(b) and its placement in the jurisdictional section of the Exchange Act indicate that it may be jurisdictional. It is unclear, however, whether the Court’s analysis should stop there because it is possible that this interpretation would create superfluity or contradict the legislative intent.148
In 2019, the Tenth Circuit became the first court of appeals to hold that Section 929P(b) did in fact abrogate Morrision, and that the Exchange Act’s substantive anti-fraud provisions should apply outside the U.S. as long as the conduct had either a foreseeable effect in the U.S. or on U.S. citizens, or occurred in the U.S.149
Outside the Tenth Circuit, courts continue to apply the test in Morrison in both civil and criminal fraud cases.150 For example, in 2014, the Second Circuit considered whether this test’s first prong allowed suits involving foreign investors, foreign defendants, and shares purchased on a foreign exchange.151 Even though the shares at issue were cross-listed on the NYSE, the court held that Morrison precluded application of U.S. law unless the shares were actually purchased on a U.S. exchange. As to the second prong, another Second Circuit decision concluded a transaction will be considered “domestic” if “irrevocable liability is incurred or title passes within the United States.152 “Irrevocable liability” attaches “when the parties to the transaction are committed to one another,” or, “in the classic contractual sense, there was a meeting of the minds of the parties.153
How this formula applies to complex cross-border transactions involving quasi-domestic instruments like American depositary receipts remains an open question.154
Commodity Exchange Act
The Morrison decision and Section 929P(b) applied only to the federal securities laws (the 1933 Securities Act and 1934 Exchange Act). The extraterritorial reach of enforcement actions brought under the CEA continue to be assessed under the pre-Morrison “conduct and effects” test, which asked: (i) “whether the wrongful conduct had a substantial effect in the U.S. or upon U.S. citizens,” and (ii) “whether the wrongful conduct occurred in the U.S.155 Because of this, the CFTC has asserted that they can bring enforcement actions against manipulation that has some effect on U.S. commodities markets and prices, even if the defendant did not actually transact through a U.S. exchange.156
The Second Circuit, however, has pushed back on this expansive interpretation. In the 2019 Prime Int’l Trading decision, the Second Circuit concluded that the CEA’s antifraud and antimanipulation provisions have no extraterritorial application.157 Plaintiffs in that case were traders of crude oil futures and derivatives contracts on NYMEX who sued companies who produce crude oil in the North Sea. Plaintiffs claimed that defendants had traded physical crude in Europe in order to manipulate related benchmark and futures prices in the U.S. In affirming the district court’s dismissal of the complaint, the Second Circuit concluded that the CEA requires not only domestic transactions, “but also domestic— not extraterritorial—conduct by defendants that is violative of a substantive provision of the CEA."158
While Prime Int’l Trading involved private plaintiffs, it is likely that, at least in the Second Circuit, the same analysis would be applied to DOJ and CEA enforcement actions. This could make it more difficult for regulators to pursue CEA violations involving manipulative conduct occurring entirely overseas and/or predominantly affecting futures and derivatives traded abroad.
A Primer on Market Manipulation Regulations in the U.S. and U.K." by author Rahman Ravelli.
Chapter.1 - What is Market Manipulation?
Chapter.2 - Market Manipulation under Federal US Law.
Chapter.3 - Market Manipulation in the UK.
Download the complete PDF guide
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Aziz Rahman is Senior Partner at Rahman Ravelli and its founder. His ability to coordinate national, international and multi-agency defences has led to success in some of the most significant corporate crime cases of this century and top rankings in international legal guides. He is recognised worldwide as one of the most capable legal experts regarding top-level, high-value commercial and financial disputes.