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December 5, 2008

Spoofing on FINRA Agenda

By Peter Chapman

Spoofing is back. Bad traders are seeking profits by manipulating quotes of illiquid securities through "spoofing," a term that dates back to the early ECN days.

According to Len Amoruso, general counsel at Knight Capital Group, a spoofer will place a large block order at the market's second-best bid price. That spooks sellers, who then raise their offers. Then the gaming begins.

"They are trying to pick off the black boxes," Amoruso said during a forum at this year's Security Traders Association national convention. "They are trying to figure out how a black box will react to that type of activity in the market."

The maneuver harkens to an earlier period when spoofers took advantage of "dumb" automatic-execution systems deployed by some broker-dealers that guaranteed the national best bid or offer to all comers, Amoruso explained. The naughty boys would place a limit order on an ECN that would raise the best bid or lower the best offer. Then they would deluge the broker with sell or buy orders. Profits in hand, they would then cancel their spread-narrowing order.

The Financial Industry Regulatory Authority says it is wise to the game. "We catch a few people. We fine them. We suspend them for a period of time. One by one we put them out of business," Richard Wallace, a vice president and chief counsel in FINRA's market regulation group, said at the convention. "We have a pretty good track record."

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