Michael Coscia’s Spoofing Conviction Upheld by the Seventh Circuit

In a move that will have commodities traders on high alert, the Seventh Circuit Court of Appeals has upheld the conviction of Michael Coscia, who was sentenced to three years in prison after a federal jury found the former trader guilty of spoofing and commodities fraud. In its 42-page opinion, a three-judge panel denied Coscia’s argument that the anti-spoofing statute is void for vagueness, finding the provision “provides clear notice and does not allow for arbitrary enforcement.” As a result, Coscia’s first-of-its-kind conviction was affirmed.

Coscia’s trial in October 2015 was followed closely by market participants because Coscia was the first person criminally prosecuted under the anti-spoofing law at issue. After the jury found Coscia guilty, the prosecutor argued that traders such as Coscia, “contemplating sophisticated scams will think twice if they know that there are more significant consequences than a civil lawsuit or a regulatory action.” U.S. District Judge Leinenweber subsequently imposed a three-year sentence with two years’ probation, which put the shocked trading community on notice.

As the former owner of Panther Energy Trading in New Jersey, Coscia practiced in high-frequency trading, a form of automated trading with programmed algorithms that allowed him to place a high volume of orders in a matter of milliseconds. His conviction was based on this automated trading strategy, which the prosecutors successfully characterized as spoofing, in addition to his suspect order-to-fill ratio, and testimony from other traders. Spoofing—a form of disruptive trading where a trader places bids to buy or sell futures contracts with the intent to cancel before execution—was implemented by the Obama administration as part of the 2010 Dodd-Frank financial reform. In creating false demand, a spoofer can artificially move prices for financial gain.

In finding Coscia guilty, the jury concluded that Coscia used computer algorithms to place large orders he never intended to have filled in the markets. Coscia’s trading strategy, as explained in the Seventh Circuit opinion, involved placing small orders to sell higher than current market price, then placing much larger volume orders on the buy side of the market. These large orders created the “illusion of market movement, swelling the perceived value of any given futures contract.” This allowed Coscia to execute his small volume sell orders at a higher price he created with artificial market movement. Once he sold the small volume contracts, he would buy back at a lower price to make a profit. Coscia did this by first placing small buy orders below the price he had created, then placing several large volume orders on the sell side, causing the price to drop in that market. Coscia then bought the small orders at the much lower price, and immediately cancelled the large volume orders. Executing this strategy tens of thousands of times in less than three months resulted in a $1.4 million profit for Coscia, which the prosecution successfully argued was ill-gotten gains.

The Seventh Circuit rejected Coscia’s vagueness argument in part because it found the above-described conduct fell squarely within prohibited spoofing conduct. Coscia’s computer algorithms were designed to “act like a decoy,” automatically placing orders to pump or deflate the market with large orders, which were then cancelled by design if ever at risk of getting filled. His commissioned program would cancel the orders if either a certain amount of time passed, the small orders were filled, or if any one of the large orders was filled. “Read together, these parameters clearly indicate an intent to cancel, which was further supported by his actual trading record.”

Additionally, the Seventh Circuit rejected Coscia’s contention that the evidence of record did not support his spoofing conviction. In doing so, the court pointed to a list of circumstantial evidence: Coscia’s cancellations represented 96% of all Brent futures cancellations on the Intercontinental Exchange, Coscia filled only 0.08% of his large orders on the Chicago Mercantile Exchange, Coscia’s algorithm developer testified that the algorithms were designed to prevent large orders from being filled and that the orders were designed to “pump [the] market,” only 0.57% of Coscia’s large orders were on the market for more than one second, and Coscia’s order-to-trade ratio was 1,592% while the average trader’s ratio ranged from 91% to 264%. Viewing the circumstantial evidence in its totality, the Seventh Circuit found a rational trier of fact could have found Coscia intended to cancel before execution, in violation of the anti-spoofing statute.

In today’s markets, the point-and-click traders are often outpaced by advanced computer algorithms such as those created by Coscia and Panther Energy. However, the decision to uphold Coscia’s spoofing conviction should be a warning to those employing such advanced strategies. Going forward, traders can expect that prosecutors—emboldened by the Seventh Circuit’s ruling—will look for others acting with the intent to cancel bids in order to favorably push the market as potential targets in criminal investigations.

In Action Against Yahoo, the SEC Seeks Emails Without A Warrant

Since 2010, the SEC has abided by the Sixth Circuit’s decision in United States v. Warshak, and has not subpoenaed emails of an individual from third party service providers.   That changed, however, when the SEC decided to test the law by filing a recent action against Yahoo to force compliance with a subpoena for the emails of an individual.

In Warshak, the court held that the use of something less than a warrant, such as a subpoena or court order under the Electronic Communications Privacy Act (ECPA), violates the Fourth Amendment.  Not only had the SEC respected that decision but the DOJ had also changed its policies to comply with Warshak.  While the SEC stayed out of court, it did oppose efforts in Congress to codify the Warshak holding via ECPA reform.  However, when Yahoo refused to comply with an SEC subpoena based on Warshak, the SEC took Yahoo to court, leading to a hearing on the matter on June 30, 2017 in the federal court for the District of Maryland. SEC v. Yahoo, Inc., Case No. 8:15cv1339 (D. Md) (GJH).  While the Judge did not make a decision at the hearing, he did express views on the facts and law that will influence his decision. Continue Reading

Supreme Court to Decide Significant Whistleblower Issue

In granting a petition to review the Ninth Circuit’s decision in Somers v. Digital Realty, the Supreme Court will resolve a circuit court split on the issue of whether Dodd-Frank prohibits retaliation against internal whistleblowers who did not report their concerns about potential securities law violations to the SEC. In March, partners Tony Caliendo, Todd Kerr, and Michael Clyde reported on Somers, which held that internal whistleblowers are protected, joining the Second Circuit on this issue. See Berman v. Neo@Ogilvy LLC, 801 F.3d 145, 155 (2d Cir. 2015). The Fifth Circuit, the first circuit court to address the issue, has taken a different view, holding, “[u]nder Dodd-Frank’s plain language and structure, there is only one category of whistleblowers: individuals who provide information relating to a securities law violation to the SEC.” Asadi v. G.E. Energy (USA), L.L.C., 720 F.3d 620, 621 (5th Cir. 2013).

Both the Ninth and Second Circuits referenced the SEC’s interpretation of the relevant statute, as set forth in Exchange Rule 21F-2: employees who report violations internally are protected regardless of whether they report to the SEC. To the extent the circuit courts’ rulings were based on Chevron deference to the SEC’s interpretation, that could set up an interesting battle at the Supreme Court, where its newest Justice is an outspoken critic of such deference.

Five Criminally Charged in Flint Water Crisis

In an unprecedented move on June 14, 2017, Michigan’s Attorney General, Bill Schuette, charged five state officials with involuntary manslaughter, alleging that each had failed to address the city of Flint’s contaminated water issue that they knew was connected to the poisoning deaths of 12 individuals.  One of the charged officials, Michigan Department of Health and Human Services Director Nick Lyon did not issue any public warning of possibly tainted water until 2016 even though several cases of Legionnaires’ disease that appeared to be linked to the water issue had been reported throughout the previous two years.

Also charged with involuntary manslaughter were Howard Croft, former City of Flint Water Department Manager; Liane Skekter-Smith, Drinking Water Chief for the Michigan Department of Environmental Quality; Stephen Busch, Water Supervisor; and Darnell Earley, who was appointed to be Flint’s Emergency Manager by Michigan Governor Rick Snyder because of the city’s failure to meet its financial obligations. More than 10 other current and former state/local officials face criminal charges other than involuntary manslaughter, including Eden Wells, the Department’s Chief Medical Executive.  Wells was charged with obstruction of justice and lying to a peace officer for allegedly misleading the investigators and attempting to prevent the investigation into the water crisis.

Although Governor Snyder was not charged, he continues to face stiff criticism from state residents for what caused Flint’s water crisis. In early 2014, Flint, at the direction of its former emergency manager Earley, switched its water supply from Detroit Water and Sewerage Department treated water to the Flint River in an effort to save money.  In fact, a $200-a-day solution of anti-corrosion chemicals could have prevented the crisis, but officials failed to take that measure due to cost considerations.  As Attorney General Schuette reports, the state focused entirely on “data, finances and costs, instead of placing the health, safety and welfare of citizens first.”  Since the charges were announced, Governor Snyder has voiced strong support for Lyon and Wells, keeping both in their positions at the Department of Health and Human Services.  Although Governor Snyder does not appear to face personal criminal exposure, the now 17-month long investigation remains ongoing, and Attorney General Schuette declined to comment whether more charges would be filed.

At the center of this involuntary manslaughter case is Robert Skidmore, an 85-year-old former auto industry worker who died after contracting Legionnaires’ disease. The prosecution has focused on Lyon first allegedly receiving notice of a deadly Legionnaires’ disease outbreak in January 2015, but choosing not to advise the public until one year later.  Lyon is alleged to have “deliberately failed to inform the public of a deadly Legionnaires’ disease outbreak, which resulted in the death of Robert Skidmore” and “exhibited gross negligence” in failing to inform the public about the outbreak, even “taking steps to suppress information” relating to the water crisis.  This failure to disclose is alleged to have led to the preventable deaths of several individuals, including Skidmore.

These new charges demonstrate a shift in the criminal investigation’s focus—looking not only at the lead contamination of the water but now at the deaths resulting from that contamination and placing the blame squarely on high-ranking government officials. This aggressive posture poses its own challenges; prosecutors may find it tough to establish a direct link between Flint’s water crisis and the deadly outbreak of Legionnaires’ disease upon which the criminal case rests.  Regardless, even if the charged officials are able to successfully defend the involuntary manslaughter charges, their individual reputations, along with Michigan’s government at large, is in ruins.

The city and state’s responses to the Flint water crisis and ensuing public relations efforts were poorly executed. One of the key takeaways from this case is the importance of opening an investigation the moment an official learns of possible harm, danger, or criminal activity in their jurisdiction.  This lesson extends from the government to the private sector, and is applicable as well to managers and executives at companies, providing a good example of how much emphasis regulators and law enforcement place on ensuring public safety.  Delays in responding to harmful activity or disclosing information about it to potential victims can result in criminal exposure as much as causing the failure or gap would in the first place.  Although there may be changes in or a lessening of environmental regulations under the new Trump administration, failures that result in public harm may still be subject to heightened scrutiny and prosecution.  For example, even if the Environmental Protection Agency eliminated the federal Safe Drinking Water Act, state liability would still be in place.  In this case, the relaxing of environmental protections by the EPA would likely not have had any impact since local officials were charged with violating the state of Michigan’s Safe Drinking Water Act.  Finally, this case again illustrates the value of cooperating with a government investigation rather than obstructing it.

Technological Advances in Food Safety Monitoring Present Enforcement Risks, Compliance Opportunities for the Food Manufacturing Industry

At the annual Food Safety Summit in Rosemont, Illinois, the Department of Justice’s increased focus on food safety enforcement was a key topic of discussion. While it was quite clear that the DOJ’s increased enforcement activity in high-profile food contamination cases involving companies such as Dole Foods and Chipotle Mexican Grill in 2016 caught the attention of the industry, discussion at the Food Safety Summit focused on proactive steps food companies can take to ensure the safety of their products while simultaneously reducing their risk of non-compliance with the Food, Drug, and Cosmetic Act (FDCA) and the Food Safety Modernization Act (FSMA).

The stakes remain high for the food industry, as both companies and individuals may face criminal charges under the strict liability-based Park Doctrine, even if they were unaware of the circumstances that led to contamination.  The key question when assessing potential liability under the Park Doctrine is whether a responsible corporate officer was in a position of authority to prevent or correct the violation.

Within this environment, technological advances in the food safety industry are providing companies and regulators with new compliance and enforcement tools. For example, whole-genome sequencing is a process that determines the complete DNA sequence of an organism.  With whole-genome sequencing, foodborne pathogens, such as Salmonella, Listeria, and E. coli, can be identified more quickly, reliably, and cost-effectively than under previous outbreak surveillance systems.  Regulatory agencies are using whole-genome sequencing technologies to link pathogens to food, manufacturing facilities, and food illnesses.

With the increased use of whole-genome sequencing of samples, food manufacturers should closely monitor facility-related hazards that exist. In one high profile food recall, whole-genome sequencing revealed that the same strain of Listeria existed in samples obtained from sick consumers from 2010-2015, indicating that the bacteria likely existed within the manufacturing facility for five years.  Such a long contamination period raises obvious questions of how the bacteria entered the facility, and how it could have thrived for five years.

In developing the written food safety plan required under the Food Safety Modernization Act and related FDA regulations, companies should address those questions head-on in the following steps:

  • Hazard analysis: identification of hazards, whether they come from upstream suppliers, transportation of goods from those upstream suppliers, or risks unique to the facility, that could enable a contaminant to (1) enter a facility; and (2) survive once introduced to a facility.
  • Preventative Controls: designing measures to minimize or prevent the risk presented by the hazards identified in the first step.
  • Oversight and Management: continuous monitoring, corrective actions, and verification to ensure that the preventative controls are functioning as designed to minimize or prevent identified risks.

While the DOJ’s continued focus on food safety compliance may present enforcement risks, the data available from technological advances in sample testing provide the food industry with an opportunity to proactively design an appropriate food safety plan that identifies and addresses the risks unique to the facility.

9th Circuit Clarifies Elements of Misprision of Felony

A Ninth Circuit panel recently issued a decision in United States v. Olson, affirming the conviction of the former Alaska executive director of the U.S. Department of Agriculture’s (“USDA”) Farm Service Agency for misprision of felony under 18 U.S.C. § 4. Specifically, the panel held that the former director was correctly convicted of misprision of felony “for concealing and failing to notify authorities of her business partner’s submission of false statements” to the USDA’s Rural Development Program in connection with a federal grant application.

In so holding, the Ninth Circuit provided critical clarification of the type of knowledge the government must prove to establish “misprision of felony.” Misprision of felony is one of the oldest federal crimes, and was first enacted in a “functionally identical” version as part of the Crimes Act of 1790.

Elements of “Misprision of Felony”

The panel affirmed the long-established federal rule that “[t]o establish misprision of a felony,” under 18 U.S.C. § 4, “the government must prove beyond a reasonable doubt: ‘(1) that the principal . . . committed and completed the felony alleged; (2) that the defendant had full knowledge of that fact; (3) that he failed to notify the authorities; and (4) that he took affirmative steps to conceal the crime of the principal.”

The panel, however, also provided additional clarification as to the knowledge element. It held for the first time that “the government must prove not only that the defendant knew the principal engaged in conduct that satisfies the essential elements of the underlying felony, but also that the defendant knew that the conduct was a felony.” Continue Reading

Supreme Court Reins In SEC’s Disgorgement Power

This week the Supreme Court trimmed the SEC’s power to seek disgorgement of unlawful gains by securities law violators by unanimously holding in Kokesh v. Securities and Exchange Commission that SEC disgorgement constitutes a penalty and such claims must be brought within five years of their accrual. This decision resolved the circuit split described in a previous post.

SEC Does Not Have Limitless Power to Impose Penalties

Kokesh involved the SEC’s effort to collect $34.9 million in disgorgement for conduct going back as far as 1995, and an additional $18.1 million in prejudgment interest. The Court noted that statutes of limitations are “vital to the welfare of society” and set a fixed date when exposure to Government enforcement efforts end. Continue Reading

U.K. Court Orders Disclosure of Internal Investigation Documents to Criminal Prosecutors

In a controversial ruling, London’s High Court has held that interview notes and other documents created by outside legal counsel and forensic accountants as part of an internal investigation into foreign bribery allegations are not protected by the legal professional privilege.  While the appeals process is already underway, the May 8th decision by the Honourable Mrs Justice Andrews is a noteworthy victory for the U.K.’s Serious Fraud Office (SFO), an agency akin to the U.S. Department of Justice (DOJ).

Eurasian Natural Resources Corporation (ENRC), the U.K. division of a multinational mining conglomerate operating in the Middle East and Africa, is the subject of an ongoing SFO criminal investigation. At times, ENRC appears to have been in a cooperation posture with the SFO; but earlier this year, the SFO filed a petition seeking to force ENRC to produce documents the company claimed were privileged.  The London High Court agreed with the SFO, ruling that almost all of the documents at issue were not privileged and should be disclosed to the SFO. Continue Reading

Investigation into Odebrecht Bribes in Mexico Highlights Need For Prompt Implementation of New National Anti-Corruption System

As Mexico works towards implementing its new National Anti-Corruption System, the largest foreign bribery case in history, arising out of Brazil, serves to highlight historic weaknesses in Mexican anti-corruption efforts and just how necessary the National Anti-Corruption System will be to help combat corruption in Mexico.

The Odebrecht and Braskem Plea Agreement

In December 2016, Brazilian construction conglomerate Odebrecht S.A. (“Odebrecht”) (along with Brazilian petrochemical company, Braskem S.A. (“Braskem”)) pleaded guilty to making hundreds of millions of dollars in corrupt payments to government officials in order to secure business, preferential tax treatment, and other commercial benefits. The companies agreed to pay a combined total penalty of $3.5 billion to resolve charges with authorities in the United States, Brazil, and Switzerland, but admitted that their conduct spanned numerous countries throughout Latin America and the world, including Angola, Argentina, Brazil, Colombia, the Dominican Republic, Ecuador, Guatemala, Mexico, Mozambique, Panama, Peru, and Venezuela. With respect to Mexico, Odebrecht admitted to paying approximately $10.5 million in bribes to Mexican government officials in exchange for public works contracts between 2010 and 2014, and realizing over $39 million in benefits as a result. According to public records, all of Odebrecht’s public works projects in Mexico during that time were commissioned by state-owned oil company Petróleos Mexicanos (“Pemex”). Continue Reading

The First 100 Days: Insider Trading Enforcement to Hold Steady?

In the months leading up to President Trump’s inauguration and even during his first 100 days in office, speculation has persisted on whether white-collar enforcement will continue to be robust and, if so, which areas will be targeted. Although Attorney General Jeff Sessions recently reinforced a general commitment to continue pursuing white-collar criminals in his remarks at the Ethics and Compliance Initiative Annual Conference, details remain sketchy.

In particular, it is unclear whether insider trading prosecutions will remain a priority given the current administration’s pro-business leanings. Although insider trading is considered to be a “bread and butter” type of white-collar prosecution, there has been little guidance whether that will hold steady. Adding to this uncertainty, several key leadership positions are still vacant at two crucial enforcers: the Securities and Exchange Commission (SEC), which is supposed to ensure that material, non-public information is not used for trading; and the U.S. Attorney’s Office for the Southern District of New York (SDNY), which has traditionally acted as a key gatekeeper in deterring insider-trading activity in light of its proximity to the nation’s financial markets. Specifically, the recently-confirmed Chairman of the SEC, Jay Clayton, has not yet appointed a new Enforcement Director, the majority of the SEC’s Commissioners are not in place, and a new SDNY U.S. Attorney has not even been named.

Despite this uncertainty, the SEC and SDNY federal prosecutor’s office have stayed the course in pursuing insider trading cases in these first 100 days. Continue Reading