By David Sheppard
NEW YORK (Reuters) - U.S. regulators' $14 million settlement with high-frequency trading firm Optiver over oil price manipulation in 2007 is a "milestone" victory in their toughening stance on market malfeasance which is being closely watched by traders.
In its first major case against an algorithmic trader and the biggest financial penalty involving manipulation in the oil futures market, the Commodity Futures Trading Commission said late Thursday that a court settlement required the Amsterdam-based company to disgorge $1 million in profits and pay $13 million over allegations it used a rapid-fire tool nicknamed "The Hammer" to influence U.S. oil prices in 2007.
The ruling came just two days after U.S. President Barack Obama proposed a renewed campaign against illegal oil trading schemes. But the case dates back to the Bush administration's effort to crack down on surging oil prices in late 2007 and 2008 as crude soared toward a record of nearly $150 a barrel.
The CFTC alleged that traders in Optiver's Chicago office engaged in a practice called "banging the close," in which the firm attempted to move U.S. crude, gasoline and heating oil prices by executing a large volume of deals during the final moments of trading, when exchanges set "settlement" prices.
The regulatory agency also alleged that an Optiver official lied to cover up the scheme.
The case was viewed as a litmus test of the CFTC's efforts to get more aggressive over market manipulation, a charge that has historically been difficult to prove, despite mounting political pressure to take rogue traders to task. Financial reforms have given it even more leeway to pursue malfeasance.
"CFTC has reached a milestone, that is what matters," said Yusuke Seta, a commodity sales manager at brokerage Newedge in Japan. "Tougher regulation will always be tough for traders. I am concerned that it could cause a loss of liquidity. Sometimes it is hard to distinguish the line that separates manipulation and usual trading."
The CFTC launched a major investigation into oil prices in 2008. The Optiver case, announced in July of that year, was the first to emerge from that effort.
"The CFTC will not tolerate traders who try to gain an unlawful advantage by using sophisticated means to drive oil and gas futures prices in their favor," David Meister, the CFTC's enforcement chief, said in a statement.
"Manipulative schemes like ‘banging the close' harm market integrity, and false and misleading statements to exchange officials to cover tracks obstruct the investigative process," he said.
Optiver, which neither admitted nor denied the CFTC's allegations as is common in such settlement cases, said it was "pleased to put this matter behind it."
The settlement barred Christopher Dowson from trading commodities for eight years, Randal Meijer for four years and Bastiaan van Kempen for two years.
Two of the three defendants, Meijer and van Kempen, have since left the firm.
The company itself was barred from trading U.S. oil futures in the three minutes before the market closes for two years.
The fine was less than the $19.3 million that Optiver had set aside for the case in its 2010 annual report.
High-frequency and algorithmic traders have been watching the Optiver case closely amid worries that other automated trading programs could be deemed manipulative, though most firms define themselves as market makers and liquidity providers rather than proprietary trading shops.
"YOU NEVER KNOW HOW LONG IT'S GOING TO LAST"
Optiver, founded as a one-man operation by options trader Johann Kaemingk in Amsterdam in 1986, was considered a pioneer in the closely knit high-frequency and algorithmic trading communities of Amsterdam and Chicago.
It has more than 600 employees worldwide, including offices in Sydney, and says on its website it has "never had a loss-making year." The firm trades only with its own capital, and has no clients.
The CFTC case revealed emails and phone recordings showing efforts by traders at Optiver's Chicago branch to "move," "whack" and "bully" oil prices.
According to a CFTC background sheet, van Kempen told an Optiver trader on March 19, 2007: "You should milk it for right now because you never know how long it's going to last."
The CFTC complaint said Optiver and van Kempen made false statements to New York Mercantile Exchange compliance officials in an effort to conceal the manipulative scheme.
The defendants had attempted to manipulate NYMEX U.S. crude oil, gasoline and heating oil contracts 19 separate times during 11 days in March 2007, according to the complaint.
"Those who seek to manipulate oil or other commodity markets should know we aren't messing around," said CFTC Commissioner Bart Chilton. "You manipulate, we are going after you."
In a copy of the private company's 2010 annual report obtained by Reuters last year, the firm reported trading income of 551.1 million euros (about US$800 million) in 2007 and 710.6 million euros in 2008.
But trading income fell to 263.7 million euros in 2009 and 377.5 million euros in 2010.
LONG TIME COMING
President Obama on Tuesday called on lawmakers to raise civil and criminal penalties on individuals and companies involved in manipulative practices.
But while the CFTC was keen to trumpet the Optiver settlement on Thursday, the long wait between the alleged manipulation and a settlement illustrates the difficulties faced by regulators.
High-frequency trading has come under scrutiny in commodity markets in recent years following a series of violent and seemingly inexplicable price moves that many traders have blamed on its growth. But most of the CFTC's outright manipulation cases still revolve around human trades.
In 2010 the CFTC won a $25 million fine from renowned hedge fund Moore Capital Management for attempting to manipulate settlement prices of platinum and palladium futures, also for "banging the close." Another major suit against London-based oil trader Arcadia and its U.S. unit is pending in court.
The CFTC is expected to review high frequency trading, which has come in for fierce criticism since the equity market "flash crash" in May 2010.
The settlement was approved on Thursday by Chief Judge Loretta Preska of the U.S. District Court in Manhattan.
The case is CFTC v. Optiver US LLC et al, U.S. District court, Southern District of New York, No. 08-06560.
(Additional reporting by Karey Wutkowski, Sarah Lynch and Alexandra Alper in Washington, D.C., Florence Tan in Singapore; Editing by Bernard Orr and Robert Birsel)