On November 6, 2013, the Commodity Futures Trading Commission filed suit against Donald R. Wilson and his company, DRW Investments, for “banging the close” and “spoofing” the IDEX USD Three-Month Interest Rate Swap Futures Contract (the “Three-Month Contract”) from January 2011 through August 2011. See CFTC Banging the Close and Spoofing pdf.
DRW Investments took a $350 million bilateral position in the Three-Month Contract. In taking that position, they believed that the contract was undervalued—that its value would rise. It did not. At that point, according to the suit, Wilson and DRW “took matters into their own hands.” CFTC Suit at 3
Understanding the alleged manipulative conduct, requires understanding that (1) the method for valuing the Three Month Contract was dependent on bids during a pre-set 15-Minute PM Settlement Period [between 2:45 p.m. and 3:00 p.m. ET] and (2) in the absence of activity during this Settlement Period, values would default to prevailing interest rates, so-called Corresponding Rates. According to the suit, “the methodology [for determining value] was dependent upon various data including bids and offers for the Three-Month Contract that were electronically placed by market participants on the NFX [NASDAQ OMX Futures Exchange] to the extent that any [bids or offers] were placed or pending during preset 15-minute, PM Settlement Period each day….If no bids or offers were electronically placed or pending during the time period, then, for many of the contracts it listed, IDCH [International Derivatives Clearinghouse] would generally default to setting its daily settlement rates, i.e., the IDEX curve [the daily settlement rates of the Three-Month Contract for various maturities] to be same as the prevailing interest rates in corresponding bilateral interest markets specified in the IDCH’s [International Derivatives Clearinghouse] (“Corresponding Rate(s)”). CFTC Suit at 2-3.
According to the CFTC, to prevent prices from defaulting to the Corresponding Rates (and to increase their profits from values higher than the Corresponding Rates), Wilson and DRW “banged the close” and “spoofed” the 15-minute PM Settlement Period from January 2011 to August 2011. They “banged the close” by repeatedly placing bids [nearly 60% of the bids and on 13 days all their bids] during the Settlement Period.
They “spoofed” by entering into those bids with no intent of consummating those transactions. According to the CFTC, DRW cancelled those bids after prices were set during the Settlement Period so that “DRW would [not] have to actually enter into a futures contract and pay the higher rates that it bid.” Id. “In fact,” according to the CFTC, “none of DRW’s electronic bids were accepted or “hit” to consummate an actual transaction. Yet, all of its bids during the PM Settlement Period pushed the Three-Month Contract settlement prices higher than they would have been in the absence of DRW’s bids.” Id.
At least two red flags got the attention of the CFTC.
- An illiquid market. According to one DRW trader, the Three Month Contract was the “ultimate of illiquid products.” CFTC Suit at 20.
- Activity inconsistent with a prior period. According to the CFTC, DRW did not have the capacity to place the bids on the NFX directly and so on January 21, 2011, they hired Sky Road LLC. According to the CFTC suit, DRW “had no business purpose for retaining Sky Road other than to carry out the manipulative scheme.” CFTC Suit at 16.
In commenting on the suit, acting CFTC Enforcement Director Gretchen Lowe, said, “Traders cannot engage in manipulative acts to affect the price of futures contracts to achieve their desired profits, regardless of the so-called motive [apparently a reference to DRW protecting a position.] Today’s action demonstrates that the Commission [the CFTC] will vigorously prosecute such cases to protect the integrity of the markets.”