Lawsuit: Chicago Futures Market Creates “Guaranteed Winners and Guaranteed Losers”

By Pam Martens: November 6, 2014 

Terrence Duffy of the CME Group Testifying Before the Senate on May 13, 2014

Terrence Duffy of the CME Group Testifying Before the Senate on May 13, 2014

Remember the Senate hearing on June 18 when Senator Elizabeth Warren talked about the high frequency trading firm, Virtu, reporting in its IPO prospectus that it had been trading for 1,238 days and made money on 1,237 of those days. Last week three futures traders told a Federal court in Chicago that it’s not just the high frequency trading firms that are reaping a windfall but the exchanges who are engaged in a conspiracy with them to create “guaranteed winners and guaranteed losers.”

The original lawsuit was filed on April 11 against the CME Group and four of its officials in the U.S. District Court for the Northern District of Illinois. The CME Group owns the Chicago Mercantile Exchange (CME), the largest futures exchange in the world. Terrence (Terry) Duffy, the Executive Chairman and President of the CME Group, a man who has testified before Congress that his exchanges have nothing to do with the charges of rigged markets that are swirling about, is a named defendant in the suit.

Last week lawyers for the plaintiff traders filed a Memorandum of Law to ward off efforts by CME Group’s attorneys to have the case dismissed for lack of specificity. Citing a case known as U.S. v. Snow, the plaintiffs respond that “conspiracy by its very nature is a secretive operation, and it is a rare case where all aspects of a conspiracy can be laid bare in court with … precision.”) Notwithstanding that, many of the charges laid before this court have been quite detailed and named names, such as the following:

“Defendants have entered into clandestine incentive/rebate agreements in established and heavily traded contract markets with favored firms such as DRW Trading Group and Allston Trading, paying up to $750,000.00 per month in one of the most heavily traded futures contracts in the world.  At no time during the Class Period have Defendants voluntarily revealed to the trading public that these material agreements exist in established markets.  Defendants through their lawyers have repeatedly ridiculed the suggestion that clandestine agreements exist.”

The traders bringing the lawsuit, which is filed as a class action, are William Charles Braman, Mark Mendelson and John Simms. Under the law, exchanges must function as quasi regulators, guaranteeing that the exchanges are free of manipulative or discriminatory practices – in other words, that everyone has a level playing field. But what Judge Charles P. Kocoras has been hearing in this case for months are these hair-raising charges of “clandestine” contracts between the futures exchanges and high frequency traders; that the exchange is giving high frequency traders early peeks at data before the rest of the market under a process known as the “Latency Loophole”; and that potentially as much as 50 percent of the trades on the exchange are “wash trades.”

Wash trades are a practice that most people believed was banished as a result of exposure of how Wall Street pool operators used it to rig the 1920s stock market, contributing to the crash from 1929 through 1932 where the market lost 90 percent of its value and ushered in the Great Depression. Wash trades occur when the same beneficial owner is both the buyer and the seller. Wash trades, also known as wash sales, can falsely suggest volume and price movement and suck in unwary traders like a moth to a flame.

Why would exchange officers tolerate such shenanigans and risk the wrath of Federal prosecutors? The lawsuit lays out the motives:

 “The Exchange Defendants profit from the occurrence of wash trades and have a vested interest in not having more robust safeguards against them because they contribute significantly to the Exchange Defendants’ volume numbers and revenue.  Were the volume of wash trades excluded from the Exchange Defendants’ volume and revenue numbers, the radically reduced volume numbers would exert adverse pressure on the CME Group’s stock price, not to mention the revenue to members of CME Group’s governance who have equity interests in participating HFTs [High Frequency Traders] in addition to stock ownership in the CME Group, Inc.”

In the current filing, the plaintiffs’ lawyers explain to the court how the exchange is guaranteeing who the winners are and who the losers are, writing:

“Unlike the stock markets, commodity futures and option trading are ‘zero sum games.’ That is, the market actually has an offsetting loss for every gain in each commodity futures contract. The CME Group sold the foregoing products and exercised its monopoly power so as to enable the HFTs to achieve gains.  For example, HFT firm Virtu Financial, Inc. disclosed in its SEC Form S-1 filed March 10, 2014 that it had experienced only one losing trading day out of the last 1238 trading days.  In the zero sum game of commodity futures trading, the Class unnecessarily lost as a result of the guaranteed revenues.

“These two anticompetitive effects — guaranteed winners and guaranteed losers — represent a severe injury to competition.  The competition in the commodity futures markets previously had been based on equal information.  Here the effect of allowing preferred HFTs to see market information in advance of other market participants was to move prices in small increments in favor of these HFTs while at the same time to ensure that other market participants would lose accordingly.  The final prices then become determined not by successfully predicting future market direction or by other skill or acumen, but by the rigged system created by Defendants’ discriminatory exercise of their monopoly power, agreements in unreasonable restraint of trade, and on-going misrepresentations and non-disclosures.

“The incredible performance of Virtu and other HFTs tracked an equally impressive increase in the Exchange Defendants’ revenues from greatly increased HFT transaction volume. In other words, the HFTs and Exchange Defendants knowingly profited from the losses of Plaintiffs and the Class.”

Lawyers for the plaintiffs are R. Tamara de Silva, who maintains a private practice; Christopher Lovell, Victor E. Stewart, Robert W. Rodriguez, and Christopher Mooney of  Lovell Stewart Halebian Jacobson LLP.

The Civil Docket for the case is #: 1:14-cv-02646.

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