Three Traders Charged with Fraud by Spoofing and Mismarking Option Orders

The SEC charged three traders with (i) mismarking option orders to obtain execution priority and lower fees and (ii) engaging in "spoofing" to generate liquidity rebates from an options exchange.

The SEC Enforcement Division alleges that the defendants violated Section 17(a) of the Securities Act, Sections 9(a)(2) and 10(b) of the Exchange Act and Rule 10b-5. The details of the SEC allegations include:

Mismarking of Options Orders

• Options exchange rules provide that a non-broker-dealer that places more than 390 orders in options per day (on average) during any calendar month in a quarter will be designated as a "professional" and not a "customer" for the next quarter.
• Despite far exceeding this threshold, the traders were able to continually place "customer" orders throughout this time period by alternating their trading on a quarterly basis between accounts.
• When one account was designated as "professional" for an upcoming quarter, they switched their trading to a "customer" account. They then switched back the following quarter.
• The "customer" and "professional" designations are supposed to apply to all accounts beneficially owned by the trader. However, the traders accomplished this back-and-forth scheme through false misrepresentations.

Spoofing

• The spoofing scheme was designed to take advantage of the "maker-taker" program offered by an options exchange. Under the maker-taker program, an order that is sent to an exchange and executes against a subsequently received order generates a "maker" rebate from the exchange. In contrast, an order that immediately executes against a pre-existing order is charged a "take" fee.
• The traders carried out the scheme by using All-Or-None ("AON") options orders - hidden orders that must be executed in their entirety or not at all - and placing smaller, non-bona fide displayed orders in the same option series and price as the AON orders, but on the opposite side of the market.
• The smaller orders were not intended to be executed but instead were placed to alter the option's best bid or offer in order to induce, or spoof, other market participants into placing orders at the same price.
• Those orders from other market participants executed against the traders' hidden AON orders, and any open displayed orders were then canceled.
• Because the executed AON orders existed before the orders sent by the spoofed counterparties, they were deemed to have added liquidity and generated rebates for the traders' accounts.