No oasis for “direct electronic access” clients

On July 21, the Capital Markets Tribunal released its decision in Oasis World Trading Inc. (Re)¹. Oasis was a proprietary day trading firm which did business through hundreds of overseas traders. These traders accessed securities markets using direct electronic access (DEA) to place trades through Oasis’s accounts. The Tribunal found that Oasis contravened Ontario securities laws in multiple ways, including by engaging in market manipulation and failing to maintain an adequate system of control and supervision.

What you need to know

• Clarity on spoofing. The Tribunal clarified the components of spoofing beyond the basic elements of placing a non–bona fide order to influence the market and then subsequently cancelling it, including that actual or subjective knowledge that a trader’s orders were intended to manipulate the market is not required to prove the offence. Rather, constructive knowledge imputed by the Tribunal, based on the available evidence that the trader ought to have known that misconduct was occurring, is sufficient.
• Reliance on circumstantial evidence. Direct evidence of misconduct is not required to establish market manipulation. The Tribunal relied exclusively on circumstantial evidence in finding that Oasis engaged in market manipulation. While there are no prescribed categories of evidence required to prove market manipulation, the types of evidence considered by the Tribunal provide helpful guidance for future cases.  
• DEA obligations. To date, most enforcement activity involving DEA market participants has focused on dealers. This decision confirms that DEA clients—even if not required to register under the Securities Act— have independent obligations, including the obligation to prevent market manipulation and maintain adequate systems of control and supervision.

Background

Oasis World Trading Inc. (Oasis) was a proprietary day trading firm. It had hundreds of traders located in China who conducted a high volume of day trading. The traders used Oasis’s trading platform to place trades on Canadian and Australian markets through Oasis’s accounts. The Ontario Securities Commission (OSC) alleged that Oasis engaged in unregistered trading and market manipulation, and that it failed to establish and maintain systems of control and supervision.

While the Tribunal concluded that Oasis was not required to register under the Securities Act (the Act)², it found that Oasis engaged in market manipulation in the form of spoofing, engaged in conduct contrary to the public interest by failing to establish and maintain adequate systems of control and supervisions, and breached National Instrument 23-103 by providing DEA to unauthorized persons.

Spoofing as a form of market manipulation

As part of its allegation of market manipulation, the OSC alleged that Oasis engaged in 643 instances of spoofing. The allegations included trading involving one trader acting on both sides of the market, multiple traders in the same office coordinating trades, and traders in different offices coordinating trades.

The definition of spoofing is often debated and misunderstood, in part because there are many forms of spoofing. The Tribunal clarified that a common form of spoofing has three elements: (1) an individual places a non–bona fide order on one side of the marketplace to “bait” other market participants; (2) another order is completed on the opposite side of the marketplace for the same security; and (3) the initial non–bona fide order is cancelled. This was the form of spoofing that the OSC alleged that Oasis had engaged in.

The non–bona fide order element entails proving that the traders who entered the orders did not intend to execute them. The market manipulation aspect of spoofing requires proof that the course of conduct contributed to a misleading appearance of trading activity or an artificial price—that is, a false impression about the price or value of, or level of interest in, a security. Proof that the trader subjectively intended to manipulate the market is not required; rather, constructive knowledge based on the available evidence may be imputed to the trader, through a finding that the trader ought to have known that their conduct would result in manipulation. 

Reliance on circumstantial evidence

It can be difficult to prove spoofing. This type of market manipulation requires proof that there was no intention to execute an initial order, despite many potentially lawful reasons for cancelling an order. Nevertheless, the OSC relied exclusively on circumstantial evidence to prove that Oasis engaged in spoofing, including by relying on trading data and internal correspondence in which traders were warned not to place orders they did not intend to fulfil.

Oasis argued that circumstantial evidence was insufficient to prove a breach under the Act. It pointed to prior cases where additional contextual evidence was required to make a finding of market manipulation, such as evidence of trading by other market participants. The Tribunal rejected this argument. While the Tribunal found that several factors from prior decisions were present—such as a high rate of order cancellation, instances of rapid cancellation, and price changes triggered by orders entered and cancelled—this case was distinguishable because it involved day trading, which involves contextual factors that may not be relevant to other forms of trading.

In concluding that Oasis engaged in market manipulation, the Tribunal relied on circumstantial evidence of (i) the number of instances of trading, (ii) repeated trading patterns, (iii) the involvement of a small group of traders, and (iv) a message implicitly recognizing that improper trading activities had occurred. In the Tribunal’s view, the evidence overwhelmed any possible theoretical innocent explanation for the trading. While the onus was on the Commission to prove the elements of market manipulation (which it did), the Tribunal noted that Oasis’s failure to justify any of the individual trades was “unhelpful”.

DEA clients have supervision responsibilities

In addition to complying with regulatory requirements, the Tribunal’s decision confirms that DEA clients must maintain adequate systems of control and supervision. While a DEA client’s responsibilities may overlap with that of the dealer who provided them with market access, a DEA client is responsible for discharging its own obligations.

What constitutes an adequate system of control and supervision will depend on the size and complexity of the DEA client’s business. Although there are no specific requirements for entities that are not required to be registered under the Act (such as Oasis), this did not obviate the need for Oasis to have an adequate system of control and supervision.

The Tribunal ultimately concluded that Oasis failed to establish and maintain adequate systems of control and supervision. In coming to this conclusion, the Tribunal relied on the lack of written policies, historical records, audits, and evidence (such as the use of emojis), which suggested that compliance was not taken seriously. While this conduct did not contravene the Act, the Tribunal nevertheless found that it amounted to conduct contrary to the public interest.