CRA Insights

Layered orders and spoofing allegations

September 2, 2022
Financial stock exchange market display screen board on the street

Spoofing charges made headlines recently when jurors in an Illinois court convicted two former JP Morgan precious metals traders, Gregg Smith and Michael Nowak, of wire fraud, attempted price manipulation and spoofing.[1] JP Morgan itself paid a record potential spoofing penalty of $920 million in 2020 in a separate resolution with the US Department of Justice (DoJ).[2] The manipulation of financial markets via spoofing typically involves allegations of placing non-bona fide orders (alleged ‘spoof’ orders) which a trader intends to cancel on one side of the market, to facilitate the execution of alleged ‘genuine’ orders on the opposite side. Alleged spoof orders can be classified into two groups: large orders and layered orders.

The two JP Morgan traders, Smith and Nowak, were alleged by prosecutors to have primarily engaged in a layering strategy.[3] Layered orders refer to multiple orders placed by a trader, on the same side of the market, within a short period of time at multiple price levels.[4] Placement of both individual large orders and a layered group of orders reflects an increase in supply on the buy or sell side of the market. Therefore, authorities can allege that a layered group of orders constitutes spoofing by claiming that the intent of the orders was to create a false impression of market depth.[5]

This Insights is a follow-up to an earlier article, a primer on futures markets and spoofing allegations.[6] In this piece, we continue the discussion on spoofing with a focus on layered orders in the futures markets.

We first provide an overview of recent spoofing allegations made by the DoJ and the Commodity Futures Trading Commission (CFTC) involving layered orders, and show that orders even as small as two lots can be flagged by the authorities as alleged spoof orders. Then, we analyze the execution probability of layered orders during episodes of sudden market movements (sweeps) in different futures markets. In our sample, we find that 17% of trades happen when at least two prices are executed at the same millisecond in the gold futures market. Furthermore, at least two prices are executed at the same millisecond once in every 12 seconds in the gold futures market. This shows that a layered order at the first two levels of the order book carries the risk of being completely executed. Execution probabilities differ across futures markets depending on thickness (or depth) of the markets, with sudden market movements less likely to occur in thicker markets.

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