Spoofing probe of Chicago firm revealed in founder firing suit

Chicago proprietary trading firm 3Red Trading LLC and co-founders Igor Oystacher and Edwin Johnson were subpoenaed in a market manipulation probe by the Commodity Futures Trading Commission, as U.S. regulators intensify investigations of the practice of “spoofing.”

Spoofing occurs when traders place and immediately cancel orders as a way to illegally move prices in their favor. Regulators and exchanges have been enforcing rules against the practice since passage of the 2010 Dodd-Frank Act. The head of Panther Energy Trading LLC last month became the first person indicted under the law.

3Red, which says on its website that it trades commodities, equities, futures, options and interest rate products, was subpoenaed by the CFTC along with Oystacher and Johnson in 2012, according to filings in Chicago state court. The firm agreed to hand over trading records, and executives were interviewed in 2012 and last year by the regulator's enforcement division, court papers stated.

The filings, and the probe, came to light as part of a lawsuit Johnson filed in June against 3Red's law firm alleging a conflict of interest. As 3Red's former chief risk officer and one-time minority owner, Johnson claimed in his suit that potential investors were being spooked by fears of “spoofing” at the firm.

A CFTC letter referring to the subpoenas was filed in court as part of his lawsuit. The regulator's probe of 3Red remains active, according to a person familiar with the matter who requested anonymity because it isn't public.

Defending Actions

Johnson accused the law firm, Gardiner Koch Weisberg & Wrona, and individual attorneys such as James Koch, of failing to advise him of “the nature and extent of trading violations or their impact on 3Red entities” and himself.

More than a year earlier, Johnson had defended 3Red's actions and criticized the CFTC investigation in e-mails filed as part of his lawsuit.

“Is there any chance the CFTC will stop wasting our time and money?” Johnson said in a message to lawyers including Koch on April 2, 2013. Using a profanity, he said the probe “is costing us a fortune.” He wondered why the CFTC couldn't “realize we are not breaking any laws or rules,” according to the e-mail. “Why are we continuing to aid them in fruitless searches? Can we get tougher?”

Johnson, who owned 10 percent of 3Red, sued Koch and his law firm after he was allegedly pushed out of the trading firm in 2013. He claimed Koch and his law firm had a conflict of interest in representing both him and Oystacher, who held 90 percent of 3Red, at the same time.

Johnson said Koch and the law firm “chose sides and represented Oystacher in contravention” of his interests, and that their actions “interfered” in his agreements with the 3Red entities, and Oystacher, in the law firm's representation of him, Oystacher and the firm.

Johnson claimed the lawyers “conspired to wrongfully terminate” him, and “preclude him from receiving the benefits of the 3Red Group operating agreement.”

He eventually entered into a confidential settlement with Oystacher and 3Red concerning his allegations over his departure from the firm, according to the complaint.

Koch, meanwhile, claimed in an Oct. 6 affidavit filed as part of Johnson's litigation that he had been told by 3Red senior management of an internal investigation into Johnson.

He alleged that Johnson defrauded 3Red by using company money for personal items, that he never made an initial capital contribution to 3Red, and that Johnson “publicly vowed to obtain revenge against 3Red,” including the creation of “a story to embroil 3Red in a CFTC investigation.”

Johnson denied the allegations in an Oct. 27 response filed in state court.

Koch's claim about the CFTC investigation “is untrue,” Johnson said. “Koch is fully aware that 3Red was already embroiled in a multiyear CFTC investigation related solely to Oystacher's trading practices and that 3Red had received a CFTC document preservation letter in November 2011 and a CFTC subpoena in March 2012.”

In that CFTC letter, sent to Oystacher, Johnson and Koch, CFTC Senior Trial Attorney Jon Kramer noted 3Red had already “discussed the requests in the subpoena” with the trading firm's clients, and that the firm had told the CFTC that the clients would produce documents it sought.

When asked in an interview about the subpoenas, Koch said “I don't have answers to those questions.”

Johnson's lawyer, Jeffrey Katz of The Patterson Law Firm LLC in Chicago, said in an e-mail only that his client “is not under investigation,” and declined further comment. Oystacher, who isn't named in the lawsuit, didn't respond to a call or e-mail seeking comment.

Steve Adamske, a spokesman for the CFTC, declined to comment on the probe. Johnson, 3Red, Koch and Oystacher haven't been sued by the CFTC or charged with a crime.

Proprietary trading firms use their own money to buy and sell assets. In the case of 3Red, they also used commercial loans to fund some of their operations, according to Johnson's complaint.

One such loan, for $2 million, came from MF Global Holdings Inc. and ensnared 3Red in that firm's bankruptcy proceedings after it failed in 2011, according to the lawsuit.

3Red received a $5 million capital contribution from Hard Eight Trading LLC in September 2011, according to Johnson.

Representatives of Hard Eight had some qualms before granting the capital contribution, he alleged in the complaint, referring to alleged “spoofing” by 3Red.

“In discussions, the owners of Hard Eight had regulatory related questions regarding Oystacher's trading activities,” according to Johnson's complaint. “Oystacher answered those questions and represented to Hard Eight that he was not involved in 'spoofing.'”

Stephen Lee, chief operating officer of Hard Eight, declined to comment.

Spoofing

It's against the law to spoof, or post requests to buy or sell futures, stocks and other products in financial markets without intending to actually follow through on those orders.

CME Group Inc., operator of the world's largest futures market, instituted a detailed rule against the practice Sept. 15.

Spoofers try to make money by feigning interest in trading at a certain price, creating the illusion of demand in an attempt to get other traders to move prices in a way they can profit from. The spoofer cancels the original trade before it's executed, and buys or sells at the new price.

Michael Coscia, the principal of Panther Energy, was indicted last month in Chicago federal court on six counts of commodities fraud and six counts of spoofing. He's accused of illegally reaping almost $1.6 million as a result of orders placed through CME Group and European futures markets in 2011.

Coscia pleaded not guilty to all 12 counts on Oct. 15 and is free on bail awaiting trial.

In October, the CFTC won a consent order requiring another trader, Eric Moncada, to pay $1.56 million to settle allegations that he entered noncompetitive trades and engaged in spoofing in wheat futures markets.

Moncada, who was barred from trading any wheat contract for five years, didn't admit or deny wrongdoing, according to the court order.