U.S. regulators' $14 million settlement with high-frequency trading firm Optiver over oil price manipulation in 2007 is a "milestone" victory in their toughening stance on market malfeasance which is being closely watched by traders.
In its first major case against an algorithmic trader, the Commodity Futures Trading Commission said late on Thursday that a court settlement required the Amsterdam-based firm to disgorge $1 million in profits and pay $13 million over allegations it used a rapid-fire tool nicknamed "The Hammer" to influence U.S. oil prices in 2007.
The settlement came two days after U.S. President Barack Obama proposed a renewed campaign against illegal oil trading schemes. But the case dates back to the Bush administration's effort to crack down on surging oil prices in late 2007 and 2008 as crude soared toward a record of nearly $150 a barrel.
The CFTC alleged that traders in Optiver's Chicago office engaged in a practice called "banging the close", in which the firm attempted to move U.S. crude, gasoline and heating oil prices by executing a large volume of deals during the final moments of trading, when exchanges set "settlement" prices.
The regulatory agency also alleged that an Optiver official lied to cover up the purported scheme.
The case was viewed as a litmus test of the CFTC's efforts to get more aggressive over market manipulation, a charge that has historically been difficult to prove despite mounting political pressure to take rogue traders to task. Financial reforms have given it even more leeway to pursue malfeasance.
"It's definitely meant as a warning shot from the CFTC to the industry," said Howard Tai, senior analyst at market research firm Aite Group.
"Will others step out of bounds in the future? Almost certainly. (But) they need to show that they are trying to get on top of things to make traders think twice about stepping out of line."
The CFTC launched a major investigation into oil prices in 2008. The Optiver case, announced in July of that year, was the first to emerge from that effort.
"The CFTC will not tolerate traders who try to gain an unlawful advantage by using sophisticated means to drive oil and gas futures prices in their favor," David Meister, the CFTC's enforcement chief, said in a statement.
"Manipulative schemes like ‘banging the close' harm market integrity, and false and misleading statements to exchange officials to cover tracks obstruct the investigative process," he said.
Optiver, which neither admitted nor denied the CFTC's allegations as is common in such settlement cases, said it was "pleased to put this matter behind it".
The settlement barred Christopher Dowson from trading commodities for eight years, Randal Meijer for four years and Bastiaan van Kempen for two years.
The company itself was barred for two years from trading U.S. oil futures in the three minutes before the market closes.
The fine was less than the $19.3 million that Optiver had set aside for the case in its 2010 annual report.
High-frequency and algorithmic traders have been watching the Optiver case closely amid worries that other automated trading programs could be deemed manipulative, though most firms define themselves as market makers and liquidity providers rather than proprietary trading shops.
Yusuke Seta, a commodity sales manager at brokerage Newedge in Japan, said he backed a crackdown, though tougher regulation was a concern for all traders.
"CFTC has reached a milestone, that is what matters," Seta said.
"(But) sometimes it is hard to distinguish the line that separates manipulation and usual trading."
"YOU NEVER KNOW HOW LONG IT'S GOING TO LAST"
Optiver, founded as a one-man operation by options trader Johann Kaemingk in Amsterdam in 1986, was considered a pioneer in the closely knit high-frequency and algorithmic trading communities of Amsterdam and Chicago.
It has more than 600 employees worldwide, including offices in Sydney, and says on its website it has "never had a loss-making year". The firm trades only with its own capital, and has no clients.
The CFTC case revealed emails and phone recordings showing efforts by traders at Optiver's Chicago branch to "move", "whack" and "bully" oil prices.
According to a CFTC background sheet, van Kempen told an Optiver trader on March 19, 2007: "You should milk it for right now because you never know how long it's going to last."
The CFTC complaint said Optiver and van Kempen made false statements to New York Mercantile Exchange compliance officials in an effort to conceal the alleged scheme.
The defendants had attempted to manipulate NYMEX U.S. crude oil, gasoline and heating oil contracts 19 separate times during 11 days in March 2007, according to the complaint.
"Those who seek to manipulate oil or other commodity markets should know we aren't messing around," CFTC Commissioner Bart Chilton said. "You manipulate, we are going after you."
In a copy of the private company's 2010 annual report obtained by Reuters last year, the firm reported trading income of 551.1 million euros (about $800 million) in 2007 and 710.6 million euros in 2008.
But trading income fell to 263.7 million euros in 2009 and 377.5 million euros in 2010.
LONG TIME COMING
Obama on Tuesday called on lawmakers to raise civil and criminal penalties on individuals and companies involved in manipulative practices.
The CFTC was keen to trumpet the Optiver settlement on Thursday, but the long wait between the alleged manipulation and a settlement illustrates the difficulties faced by regulators.
The agency had been criticized after the number of enforcement cases slumped between 2006 and 2008, just as commodity markets were attracting more attention from investors and the public as oil prices soared.
But since then the agency has made progress, successfully lowering the legal bar for what constitutes commodity market manipulation while winning some important backers.
Obama asked lawmakers for more money to fund the agency, saying they needed to hire "more cops" for market oversight.
Last year enforcement cases filed by the CFTC surged 74 percent to its highest level in history. The number of cases has climbed each year since 2008.
In 2010, the CFTC won a $25 million fine from hedge fund Moore Capital Management for attempting to manipulate settlement prices of platinum and palladium futures, and for "banging the close".
A major suit against London-based oil trader Arcadia and its U.S. unit is pending in court.
The regulator obtained orders imposing more than $290 million in civil monetary penalties in 2011, and directed the payment of more than $160 million in restitution and disgorgement, more than double the prior year.
The CFTC is expected to review HFT trading this year and is seeking more money to update monitoring technology, following fierce criticism in the wake of the equity market "flash crash" in May 2010.
"As reflected by the court's order, we will seek significant financial penalties from violators and limitations on their privileges to trade on markets in the United States," Meister at the CFTC said in the Optiver statement.
(Additional reporting by Karey Wutkowski, Sarah Lynch and Alexandra Alper in Washington, D.C., Florence Tan in Singapore; Editing by Bernard Orr, Robert Birsel and Dale Hudson)