The Commodity Futures Trading Commission (CFTC) lost a case that was expected to help define the boundaries of market manipulation, when prominent HFT/derivatives trader Don Wilson was cleared of market rigging allegations this week by a judge in New York. To make matters worse, the judge also turned on the CFTC in his ruling for "bringing the misbegotten market manipulation case" in the first place, according to the Financial Times.
Judge Richard Sullivan dismissed all charges against Wilson and his company, DRW, two years after hearing the case. It comes as a major blow to the CFTC, which had sought cash penalties and a lifetime ban on trading for Wilson and his firm which employs more than 900 people. They were seeking this relief after alleging that $20 million in ill-gotten gains were netted by Mr. Wilson’s firm after he manipulated the interest futures market by painting the tape, in a sense, to mark up an already existing position.
Some more specifics:
The CFTC sued Wilson and DRW in 2013, saying they broke the law by placing orders only to move prices in their favor. The trades were for a new type of interest-rate derivative offered by a futures exchange owned by Nasdaq Inc. The CFTC alleged that DRW bid on contracts during two daily 15-minute windows when prices are set but never intended to buy the assets. That benefited a $350 million position DRW had already established, according to the regulator.
But the judge had another take on the matter. In his ruling, he claimed that Wilson’s trading strategy wasn't manipulation, but rather was based on his "superior knowledge" of the futures market. In his ruling, the judge wrote: "It is not illegal to be smarter than your counterparties in a swap transaction, nor is it improper to understand a financial product better than the people who invented that product."
The lawsuit was filed back in November 2013 when the CTFC alleged that DRW submitted manipulative bids more than 1000 times, costing counterparties like Jefferies and - wait for it - MF Global, to bear the losses.
Many such cases, similar to those brought by the SEC, are often settled. However, Wilson refused to do so and testified during a bench trial that took over a week, attempting to explain his bids. The CTFC's argument was that it could show that DRW sought to "affect prices" to prove manipulation. However, the judge thought that the CFTC needed to prove that the intent was to create artificial prices, and not just affect them.
In the end, the judge said that the CFTC used "nonsensical" logic in their allegations. As will happen in landmark cases, many parties, including exchanges and trade groups had filed amicus briefs also challenging the CFTC’s interpretation of manipulation. The CFTC has a similar action against food giants Kraft and Mondelez, alleging similar types of manipulation in the wheat futures market. But ultimately on Monday when the judge handed down his ruling, he didn’t mince words.
He wrote: “Here, the CFTC offered no evidence or explanation demonstrating that [contract] settlement prices were artificially high. It is only the CFTC's Enforcement Division that has persisted in its cry of market manipulation, based on little more than an ‘earth is flat’-style conviction that such manipulation must have happened because the market remained illiquid."
And there you have it: the next time you are sued for "banging the close", all you have to prove is not that you are manipulating the market, but that you are smarter than everyone else who is not manipulating the market and thus losing money.