U.S. Questions Whether Futures Markets Can Police Themselves

June 29, 2016 06:42 AM
U.S. Questions Whether Futures Markets Can Police Themselves

A top executive at 3Red Trading LLC reassured his co-founder about the future of the firm, even as federal regulators and two exchanges were investigating them for alleged market manipulation.

“Just finished up with the head honchos,” Edwin Johnson wrote about a meeting with Intercontinental Exchange Inc. executives. “We will do a very basic phone interview next week. Then it will all go away,” he texted his partner in the spring of 2013. “I was given their word last night.”

Likewise, he texted, top brass at CME Group Inc. “are 100 percent behind us.”

The government introduced the messages in court, arguing that exchanges have failed to adequately police trading by Oystacher, one of their biggest customers. Those assertions emerged in a case brought by the Commodity Futures Trading Commission, which is asking the court to immediately halt all trading by Igor Oystacher, 3Red’s co-founder and head trader, until the case accusing him of a type of manipulation called spoofing is decided next year.

The court “cannot rely on the exchanges to stop Oystacher because the evidence has shown that despite their repeated inquiries, concerns, and discipline, exchanges have failed to prevent Oystacher’s continued misconduct,” the CFTC wrote in the 34th footnote to a May 16 court filing. “Multiple texts reveal 3Red’s strategy of attempting to leverage 3Red’s status as a major customer of the exchanges to protect Oystacher from market regulators within the exchanges.”

In its case next year, the CFTC is seeking to do what the exchanges didn’t -- permanently ban Oystacher and 3Red from futures markets. Oystacher has denied he broke the law. Johnson, the 3Red co-founder, wasn’t named in the CFTC suit and has not been accused of wrongdoing.


The government’s criticism of the exchanges is focused on the conflict at the heart of the markets’ role as self-regulators. While the CFTC has previously offered mild criticism of the exchanges in periodic enforcement reviews, the court filing is the harshest rebuke to date of their competence.

Anita Liskey, a CME Group spokeswoman, said any allegation that top executives at the company were soft on Oystacher is false. Kelly Loeffler, a spokeswoman at Intercontinental Exchange, said the credibility of futures markets such as ICE is based on strong enforcement and transparency.

Self-regulation began 157 years ago when the state of Illinois granted the newly formed Chicago Board of Trade the ability to police itself. Starting in the early 2000s, the exchanges began converting to public companies, with shareholders and earnings targets. Profits came from the same customers they were tasked with regulating.

“Self-regulation in the futures market does not work,” said Mark Williams, who teaches finance at Boston University and is a former Federal Reserve bank examiner. “It is hard to provide objective oversight and policing when you are a for-profit entity with an inherent economic incentive to grow the business.”

Vital Role

While CME and ICE aren’t household names, their futures markets -- where products with a face value of about $30 trillion trade -- serve a vital role in global capitalism. They are home to a range of products -- including contracts on commodities like oil and wheat, key interest-rate benchmarks and stock indexes -- that play a role in millions of workers’ retirement accounts and allow industries from agriculture to mining to hedge their commercial risks.

The CFTC used “pretty strong language” in criticizing the exchanges’ oversight, said Dan Berkovitz, who served as the regulator’s general counsel from 2009 to 2013. “This is pretty unusual,” said Berkovitz, now a partner at WilmerHale in Washington. Still, he said the exchanges are vigilant in policing themselves.

While the debate over self-regulation of financial markets isn’t new, the growing dominance of rapid-fire electronic trading has changed the calculus, overwhelming federal agencies while fueling revenue growth for exchange owners charged with regulating it.

Unchecked Spoofing

Spoofing is a kind of computer-driven manipulation that often goes unchecked, traders complain. It involves flooding the market with fake orders to fool other traders into thinking the market is poised to rise or fall. The fake orders are then canceled and the spoofer flips from being a buyer to being a seller, or vice versa. The spoofer profits from earning the difference in price to buy and sell the contracts, and can repeat the practice thousands of times a day.

While there’s nothing wrong with canceling orders, the Dodd-Frank Act passed in 2010 makes it illegal to place orders with no intention of executing them. 

CME Group President and Executive Chairman Terrence Duffy strongly defended his exchange’s record against manipulators.

‘Bad Actors’

“We’ve never, ever supported anybody spoofing in our marketplace, and never would we,” Duffy said on June 9 on Bloomberg Television. “People will always try to do things that are inappropriate, whether it’s trading derivatives or whether it’s selling something on the street. It’s just the way the world works. You have bad actors out there, and there’s not enough cops on every corner to stop everything, but we try our best.”

Asked about the texts, CME Group’s Liskey said, “The suggestion that our executive chairman or any of our senior management are involved with this -- or any regulatory case -- is completely false. Per our regulatory policy, all investigations are maintained within our market regulation division.”

“Futures exchanges have a strong track record of regulatory oversight and governance because they recognize the foundation of market confidence is driven by transparent rules, surveillance and enforcement to fulfill self-regulatory duties under the law,” ICE’s Loeffler said in an e-mailed statement. She defended ICE’s handling of Oystacher, too, saying the exchange “discharged its self-regulatory responsibilities fully and completely in this matter.”

The stiffest punishment Oystacher has received is a one-month trading ban, a punishment meted out by CME in 2014. But the exchange is capable of tougher action. On June 13, for instance, it barred a former Delta Air Lines Inc. employee and his wife for life, fined them $300,000 and ordered them to give back $2.8 million in profits, accusing them of improperly making money from advance knowledge of the airline’s trading.

Chess Champion

Lawyers for Oystacher, a speed-chess champion, have argued that his exceptional reasoning skills and reaction time -- not spoofing -- explain why he is faster than others at executing trades.

“It is a strange turn of events when the CFTC attacks the integrity of a prominent futures exchange,” Tom Becker, a spokesman for Oystacher, said in an e-mailed statement. “3Red remains committed to working with the exchanges and regulators going forward and is grateful to finally have had the opportunity to tell its side of the story in court.”

The CFTC is arguing in the case before U.S. District Judge Amy St. Eve that her Chicago courtroom is the last line of defense to stop Oystacher. It is unprecedented for the CFTC to request a court order to shut down a firm of 3Red’s size. But the final straw was discovering that Oystacher allegedly continued to spoof even after the regulator filed its lawsuit against him, according to a person familiar with the investigation. 3Red’s Becker in February denied that Oystacher was spoofing, and said all his trades were legal and complied with CFTC rules.


The CFTC accuses Oystacher of spoofing on at least 51 trading days between December 2011 and January 2014. Oystacher was the single biggest trader of futures contracts based on copper, natural gas and the S&P 500 stock index during those periods, according to the CFTC, making him one of the biggest exchange customers.

Oystacher and 3Red have been investigated for spoofing eight times by six different futures exchanges since Johnson sent the text messages in 2013. CME Group was the first to sanction him, fining Oystacher $150,000 in 2014 and prohibiting him from trading for 30 days -- during a period of light trading from just after Thanksgiving through the Christmas holiday.

On June 5, 2015, ICE fined Oystacher $125,000 for spoofing on the Russell 2000 Index and ordered him to stop the practice. He was allowed to continue trading. Eurex AG, one of Europe’s largest futures markets, has fined Oystacher twice, including the maximum penalty of 250,000 euros ($275,000), and banned him for trading for 30 days in 2015. Oystacher has agreed to settle, while neither admitting nor denying wrongdoing, all the cases except the one brought by Eurex, which he’s appealing, according to Becker, his spokesman. Heiner Seidel, a Eurex spokesman, declined to comment on the CFTC’s criticism of the ability of futures exchanges to regulate themselves.

Such “trivial fines” aren’t nearly enough, according to Williams.

“The exchanges are not deterring bad actors but sending the wrong message that even if you are caught, the economic upside is much larger than the fines,” he said. “Such inconsequential fines do not penalize bad behavior and make the exchanges look like a watchdog with no bark.”

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Spell Check

DeSmet, SD
6/30/2016 10:28 AM

  The CME has lost it's effectiveness as a risk management tool at least as to the Live and Feeder cattle board. The CME is more focused on it's profits from volume trading and less on it's original purpose as a risk management tool. Unless and until the underlying problems are addressed such as spoofing it will not improve. As much as I oppose additional regulation there may be no other choice .


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