Metals Trading: It's a Racket

The Racketeer Influenced and Corrupt Organizations Act, better known as “RICO,” is a federal law which provides for extended penalties and a civil cause of action for acts performed as part of an ongoing criminal organization.[1] The law was part of the Organized Crime Control Act of 1970, signed into law by President Nixon, which was intended to provide prosecutors with a tool to combat the Mafia as well as other groups engaged in organized crime.

Under RICO, a person who commits two or more acts of racketeering activity—which include 35 crimes—within a ten-year period can be charged with racketeering if the acts are related to an “enterprise.” Among those 35 crimes the statute enumerates are wire fraud and financial fraud.

The penalties are steep. Those found guilty of racketeering can be fined up to $25,000 and sentenced to 20 years in prison for each RICO violation. The racketeer must also forfeit ill-gotten gains and an interest in a business connected with a pattern of racketeering activity.

The government has not limited its RICO prosecutions to defendants we ordinarily think of as organized crime figures. In a recent indictment,[2] prosecutors charged two former and one current JP Morgan metals traders with engaging in racketeering, as well as bank fraud, wire fraud, market manipulation, attempted manipulation, commodities fraud and spoofing as a result of their activities in metals futures market.

The indictment is surprising not only because the three are pretty far removed from organized crime, but also because of the government’s decidedly mixed success in convicting defendants under less aggressive indictments. For example, in April of this year, the trial of Jitesh Thakkar, who was the alleged programmer for Navinder Sarao, the supposed “Flash Crash” spoofer, resulted in a mistrial. Andre Flotron, a former UBS trader indicted for conspiracy to defraud in connection with alleged spoofing in the precious metals futures market, was acquitted by the jury in August 2019.

The indictment is quite lengthy, but this is essentially what the government charges: Between March 2008 and August 2016, the three JP Morgan traders named in the indictment—Gregg Smith, an executive director and trader; Michael Nowak, a managing director and Global Head of Precious and Base Metals Trading; and Christopher Jordan, a former trader—and others placed thousands of sizable bids or offers on one side of the metals futures markets without intending to execute those orders. On the other side of the market, the three placed smaller genuine orders, which were often “iceberg” orders, meaning they exposed only a portion of their total orders to the market.

According to the indictment, the three intended that the larger orders that would never be executed would affect market prices in a way what would benefit their genuine orders. The indictment describes scores of these thousands of orders in minute detail. Here is just one of the trading sequences the government detailed:

On May 27, 2008, at 8:39:56.313 a.m., SMITH placed a Genuine Order to sell 7 silver futures contracts at $17.575. Beginning at 8:40:06.041 a.m., SMITH placed 13 layered Deceptive Orders to buy seven contracts each (91 contracts total) from $17.55 to $17.565. Beginning at 8:40:09.266a.m., all seven contracts in SMITH’s Genuine Order were filled. Beginning at 8:40:09.935 a.m., SMITH cancelled his Deceptive Orders.

One of the things the indictment describes is a crime commonly known as “spoofing,” bidding and offering with the intent, at the time the bid was placed, to cancel the bid and offer prior to execution. Spoofing is explicitly mentioned, and prohibited, in the United States Code.[3]

There appears to be substance to the government’s charges. Two other former JP Morgan traders, John Edmonds and Christian Trunz have already pleaded guilty to commodities fraud and spoofing, among other things, for their participation in the same metals trading scheme.

The two testified that the manipulation technique was routine, sanctioned by higher-ups at the bank and carried out over the years. At an October 2018 hearing, Edmunds said, “While at JP Morgan I was instructed by supervisors and more senior traders to trade in a certain fashion, namely to place orders that I intended to cancel before execution.” Trunz told a federal judge in Manhattan in August 2019 that the spoofing trades were commonplace at the bank and that he had learned the technique from other traders at Bear Sterns, where he previously worked, and at JP Morgan. Recall that JP Morgan bought the then failing Bear Stearns in 2008 at the height of the financial crisis.

So it appears that the government will have more than bare numbers on a page to prove its case. These two participants in this scheme, and likely others, are likely to testify. Perhaps because the prosecution believes the case to be a winner, it has decided to up the ante in spoofing cases, despite its recent mixed success.

And if Edmonds’s and Trunz’s testimony is true, it’s hard to avoid the question: What about the bank?

[1] 18 U.S.C. §§1961 et seq.

[2] United States of America v. Gregg Smith, Michael Nowak and Christopher Jordan, No. 19 CR 669 (N.D. Ill., filed August 22, 2019).

[3] 7 U.S.C. §§6c(a)(5)(C) and 7 U.S.C. §13(a)(2).