Spoofing, Market Manipulation, and the Limit-Order Book

Abstract

This article provides an overview of recent legal developments related to spoofing in financial markets and an analysis of economic issues related to spoofing. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 defines spoofing as “bidding or offering with the intent to cancel the bid or offer before execution.” As one of three “disruptive practices” proscribed by the Act for futures markets, spoofing is distinct from, though related to, market manipulation, which is covered by other statutory and regulatory language for financial markets. Recent spoofing cases include a criminal conviction for spoofing in futures markets, several settlements, and at least two prominent ongoing actions. Turning to economic issues, this article explains the operation of the limit-order book, which is the basis for most futures and equity markets. A build-up of orders on one side of a limit-order book can induce market movements, and spoofing might work through this mechanism. However, the presence of spoofing may improve market liquidity and enable informed traders to profit from their information. An economic analysis of alleged spoofing strategies may provide evidence relevant to courts’ assessment of traders’ intentions. This analysis could include an investigation of both expected returns and risks of the trading strategies.