A New and Easy Method

Streetwise Professor (Craig Pirrong) explained spoofing on electronic exchanges in this post three years ago. Yesterday, he wrote about the US Department of Justice (DOJ) indicting a group of traders for alleged spoofing. The stunning part of the indictment is the DOJ’s estimate of damages:

Market participants that traded futures contracts in these three markets while the spoof orders distorted market prices incurred market losses of over $60 million.

To inflict losses of such magnitude, the spoofers would have had to place a a fake bid and a fake offer in the order of billions of dollars at least, or repeat the spoof thousands of times. Obviously, they did not. According to Prof. Pirrong, the DOJ came up with a charmingly simple method of damage assessment:

The DOJ simply calculated the notional value of the contracts that were traded pursuant to the alleged spoofing scheme. They took the S&P 500 futures price (e.g., 1804.50), multiplied that by the dollar value of a price point ($50), and multiplied that by the “approximate number of fraudulent orders placed” (e.g., 400).

If this is truly the Department’s way of estimating the losses caused by the spoofers, then it’s ridiculously wrong-headed, and would remain so even if it didn’t overstate the losses so egregiously. One doesn’t have to accept Pirrong’s estimate of the losses in order to admit the DOJ’s (alleged) approach is no good.

It reminds me of a peculiar Russian legal innovation. Suppose I’m a purchasing manager and I pay $110 for something worth $100. The supplier then pays me $5 of the $10 “premium.” The direct harm to my employer is $10. It’s harder to measure indirect damage – say, the image of a company run by crooks might prove a long-term handicap. However, Russian courts don’t have to go that far and deep – they take it for granted that the damage equals the value of the deal, that is, $110 in this particular case. Easy! And, apparently, contagious.

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