In the 1980s and 1990s, I was a precious metals trader and ran one of the leading bullion banks with offices in London, the U.S., and Asia. In those days, electronic trading had not yet flourished. The markets changed, and a growing number of traders who did not change with the markets have been punished. From the 1980s through 2001, I worked with or traded with some of the traders now sitting in or heading to federal prison. The rules in the precious metals markets changed in 2010, but some of my former colleagues ignored the regulatory shift and are now paying the price.
Spoofing is an abusive market behavior where a trader moves the price of a financial instrument up or down by placing a significant buy or sell order with no intention of execution. The 2008 global financial crisis was a watershed event leading to the 2010 Dodd-Frank Act that defined spoofing as “the illegal practice of bidding or offering with intent to cancel before execution,” making spoofing a crime.
Precious metals trading became ground zero for spoofing prosecutions, with the U.S. Department of Justice bringing charges and achieving convictions in Federal jury trials. Today, a growing number of former precious metals traders are sitting in Federal prison, with others joining them soon.
J.P. Morgan pays a massive fine for spoofing
In September 2020, the U.S. Commodity Futures Trading Commission ordered JP Morgan Chase, the leading U.S. banking institution, to pay a record $920 million fine for spoofing and manipulating markets.
The case that led to the fine found that:
From at least 2008 through 2016, JPM, through numerous traders on its precious metals and Treasuries trading desks, including the heads of both desks, placed hundreds of thousands of orders to buy or sell certain gold, silver, platinum, palladium, Treasury note, and Treasury bond futures contracts with the intent to cancel those orders prior to execution. Through these spoof orders, the traders intentionally sent false signals of supply or demand designed to deceive market participants into executing against other orders they wanted filled. According to the order, in many instances, JPM traders acted with the intent to manipulate market prices and ultimately did cause artificial prices.
The order also finds that JPMS, a registered futures commission merchant, failed to identify, investigate, and stop the misconduct. The order states that despite numerous red flags, including internal surveillance alerts, inquiries from CME and the CFTC, and internal allegations of misconduct from a JPM trader, JPMS failed to provide supervision to its employees sufficient to enable JPMS to identify, adequately investigate, and put a stop to the misconduct.
The order notes that during the early stages of the Division of Enforcement’s investigation, JPM responded to certain information requests in a manner that resulted in the Division being misled. The order recognizes, however, JPM’s significant cooperation in the later stages of the investigation.
Source: CFTC
The nearly $1 billion fine was a steep price for the misdeeds, but the Department of Justice and regulatory agencies did not stop with the institution. Over the past years, individual traders at JP Morgan and other leading banks were indicted, tried, and convicted of felony-level crimes.
The legal defense for spoofing falls short
While some of the traders the government charged with spoofing, fraud, and other crimes took guilty pleas and testified for the prosecution in other trials, some high-profile offenders offered significant defense. Some of the arguments were:
- Spoofing was legal before 2010, and they only engaged in the activity before it became illegal. However, the government offered more than a bit of evidence the spoofing continued.
- The traders that fought charges also suggested they were always at risk of having the placed buy and/or sell orders executed. The prosecution suggested that their dominant position and access to capital put them at little risk, and their behavior was solely manipulative.
- Another argument was that the advent of high-frequency trading caused them to spoof the computers to even the playing field. Since Dodd-Frank made spoofing illegal, the excuse fell far short of exonerating those charged.
The bottom line is the government put lots of notches in its belt as it has convicted the top traders from at least two banks, Deutsche Bank and JP Morgan. The trials were in Illinois even though the crimes were in New York because Chicago is the home of the Chicago Mercantile Exchange, which runs the gold, silver, and other commodity futures markets.
The traders sitting in Federal Prison
On August 4, 2021, a federal jury in Illinois Northern District convicted Edward Bases and John Pacilio on multiple fraud counts. On March 13, 2023, they were each sentenced to one year and one day in federal prison, and two years of supervised release. In early September 2023, Edward Bases and John Pacilio were inmates at the Federal Correction Institution at Otisville, New York. Both men have a release date of June 5, 2024, as federal inmates must serve at least 85% of the judge’s sentence before being eligible for release.
While others are in prison or have completed sentences for spoofing in the precious metals markets, the two senior traders were the most high-profile cases until the JP Morgan traders went on trial in 2022.
The traders that will join them over the coming months
On August 22, 2023, another Federal Court Judge in Illinois Northern District sentenced Gregg Smith and Michael Nowak to prison after jury trial convictions on multiple fraud, price manipulation, and spoofing charges.
Michael Nowak led JP Morgan’s powerful worldwide precious metals trading business. He received a one year and one day sentence in federal prison, two years supervised release, and was ordered to pay a $35,000 fine.
Gregg Smith, a JP Moran gold trader that an assistant U.S. attorney described as “the most prolific spoofer that the government has prosecuted to date,” was sentenced to two years in the federal lockup, two years of supervised release and was ordered to pay a $50,000 fine. So far, Gregg Smith has received the stiffest sentence. Mr. Smith and Mr. Nowak will report to a federal correctional institution over the coming months. Since both are from the New York metropolitan area, they could join Edward Bases and John Pacilio at FCI Otisville.
A third former JP Morgan precious metals trader, Christopher Jordan, was convicted in a separate trial and is awaiting sentencing.
The markets changed- What was unethical became a crime- Do the crime, do the time
Some of the most powerful traders in the precious metals market are and will be sitting in U.S. correctional institutions. When they get out, their careers are over. Michael Nowak was a managing director at JP Morgan, running the bank’s metals trading and sales business. He was on the London Bullion Market Association board, the trade association that serves as a conduit to U.K. regulators. Gregg Smith, Edward Bases, John Pacilio, Christopher Jordan, and others convicted of similar market crimes will never work for another financial institution. They have paid significant fees for their legal representation over the past years. Their families have greatly suffered from their actions.
Spoofing was never an ethical market behavior, but it was legal before Dodd-Frank. High-powered traders at the world’s leading financial institutions and banks knew the rules changed in 2010, but they decided the law did not apply to them or they could get away with illegal activities. What was unethical became a crime, and a handful of traders are now doing the time.
Will the convictions end spoofing? The answer is a function of the corporate culture that pushes for profits at all costs. JP Morgan and other institutions may have paid a billion dollars and other fines. Still, they retained freedom and banking licenses for the lack of supervision or the culture that bred the behavior. The traders are the pawns in a much broader issue. It is hard to feel sorry for the highly compensated traders. While they have lost their freedom, the institutions can conduct business as usual. Time will tell if the culture changes.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
