Spoofing.

A small provision in the Dodd-Frank Act outlawing something called “spoofing” has generated the latest round of criminal charges against eight traders along with civil settlements by Deutsche Bank, HSBC, and UBS. All for doing something that happens every second of the trading day: entering and then canceling orders.

The law makes it illegal to engage in “bidding or offering with the intent to cancel the bid or offer before execution.”

The federal appeals court in Chicago upheld the first criminal conviction for spoofing last year in United States v. Coscia, in which the judges rejected the argument that no one was deceived by orders placed and then quickly canceled because other traders do that routinely. “His scheme was deceitful because, at the time he placed the large orders, he intended to cancel the orders.”

Apparently, the only requirement to prove spoofing is that the defendant enters orders without any real hope they will be filled to pull the market in one direction so that other orders can be filled, generating a small profit. Proving the case requires showing multiple orders were used and not just isolated transactions, such as one defendant who engaged in what the government claims was 36,000 different instances of spoofing.

And it wouldn’t be a case involving traders if there weren’t the usual messages showing how they were gladly abusing the market. In one chat, a trader wrote “so glad I could help . . . got that up 2 bucks . . . that does show u how easy it is to manipulate it.” Describing something as manipulation sure does help prove intent.

Who is fooled by the spoofing? It turns out that most of the time it is competing computer algorithms of other high-frequency trading firms. So this isn’t a case in which mom-and-pop investors are taking it on the chin.

— Peter J. Henning