The Flash Crash, Interactive Brokers, Two Hedge Funds, John Does, and Homer Simpson's Appetite for Donuts

July 6, 2022

The 2015 Flash Crash is the Wall Street gift that keeps on giving. In today's blog we got a FINRA arbitration and two federal lawsuits. Then we got spoofing. Is spoofing illegal? Is it fraudulent? Or, as a federal court muses, is it just a byproduct of things getting faster to the point that it's all pretty much a blur and, spoofing or not, we're all moving close to the speed of light on Wall Street. 

The 2015 Flash Crash

By way of prelude to the lawsuits to follow, remember that on August 24, 2015, the stock market opened down sharply (over 5%), which delayed the trading of many stocks and promptly acted in accordance with what is popularly known as a "Flash Crash." During the first 20 or minutes of trading, many S&P options lacked the ability to generate and publish Bid/Ask information.

2019 FINRA Arbitration Award

In a FINRA Arbitration Statement of Claim filed in March 2017, customer Kessev Tov LLC asserted breach of contract and promissory estoppel; violation of state securities statutes; claims under common law; and vicarious liability against FINRA member firm Interactive Brokers LLC. Claimant Kessev Tov south $10 million in compensatory damages, punitive damages, interest, and costs. The FINRA Arbitration Award asserts that the "causes of action relate to investments in VXX shares, exchange traded notes and SPX options." 
In the Matter of the Arbitration Between Kessev Tov LLC, Claimant, v. Interactive Brokers LLC, Respondent (FINRA Arbitration Award 17-00770 / August 28, 2019)

Respondent Interactive Brokers denied the allegations, asserted affirmative defense, and filed a Counter-Claim asserting failure to maintain sufficient equity to meet margin requirements, which resulted in Claimant's failure to pay a deficit in its account. Ultimately, the parties demanded the following:

During the hearing, Claimant requested compensatory damages ranging from $2,470,902.78 to $6,686,681.77, attorneys' fees ranging from $815,397.92 to $2,273,303.91, and expert witness fees and expenses in the amount of $67,300.40.

During the hearing, Respondent requested compensatory damages in the amount of
$666,578.25, attorneys' fees in the amount of $425,122.35, legal expenses in the
amount of $46,443.49, and expert witness fees and expenses in the amount of

at Page 2 of the FINRA Arbitration Award

2019 FINRA Arbitration Award

The FINRA Arbitration Panel denied Claimant's claims. The Panel found Claimant Kessev Tov liable to and ordered it to pay to Respondent Interactive Brokers on the latter's Counter-Claim $666,578.25 in compensatory damages plus interest, $212,561.18 in attorneys fees; $23,221.75 in costs, and $32,375.35 in expert witness fees. 

NDIL: Kessev Tov and Pajoje Sue "John Does"

Moving forward in time in 2020, we got two -- count 'em -- two different lawsuits before the United States District Court for the Northern District of Illinois ("NDIL").

(Memorandum Opinion and Order, NDIL / June 30, 2022)

Plaintiffs Kessev Tov and Pajoje are each hedge funds that traded S&P options on the Chicago Board Options Exchange ("CBOE") on August 24, 2015; and Plaintiffs allege that various "John Doe" Defendants manipulated the market via spoofing -- the placing of Deceptive Orders that were placed with no intention of executing. As pointedly alleged by Plaintiffs, the Deceptive Orders created false "market midpoints" (the price between the Best Bid and the Best Ask) that induced market participants to close out positions in response to artificially inflated prices. More specifically, Plaintiffs further alleged that [Ed: footnote omitted]:

Kessev Tov alleges that Defendant John Doe B's spoofing bids caused it to receive a "margin call" that morning. Specifically, Kessev Tov alleges that pricing signals sent by John Doe B's spoofing bids signaled that Kessev Tov's portfolio was suddenly worth dramatically less. Kessev Tov alleges that, because it maintained a margin balance in its account, the decrease in value created by the spoofing bids caused Kessev Tov to fall into a margin deficiency, and Kessev Tov received a margin call at 8:30:34 a.m. Kessev Tov alleges that Defendant John Doe B's spoofing bids were the only bids in the market for the positions held by Kessev Tov prior to the margin call. To correct the margin deficiency, Kessev Tov alleges that it was then forced to enter orders to close its options. In the process of closing out its positions by placing market midpoint orders, Kessev Tov claims it fell victim to two additional spoofing bidders, John Does A and D. Kessev Tov alleges that those defendants' spoofing bids caused it to execute orders "at values highly distorted from the rational market." (Case No. 20-cv-04947, Dkt. 25 at 10, ¶ 28.) Pajoje alleges that John Does A and D's spoofing bids also caused it to purchase contracts to close its positions at prices "far in excess of the rational prices for the option contracts at issue based upon their fundamental characteristics, and also in excess of the prices that prevailed following the cessation of Defendants' spoofing activity." (Case No. 20-cv-04948, Dkt. 24 at 24, ¶ 53.) 

at Page 3 of the NDIL Opinion

Kessev Tov and Pajoje each filed  original complaints on August 23, 2020, and a two-count amended complaint against certain John Doe defendants on May 7, 2021, and on February 22, 2021, respectively, alleging violations of Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b) and Rules 10b-5(a) and (c) promulgated thereunder, as well as the Illinois Securities Law of 1953 ("ISL"), 815 ILCS § 5/12. Kessev Tov and Pajoje alleged that John Does A and D carried out the manipulation scheme alleged in their complaints. Kessev Tov has also sued a third defendant, John Doe B. 

Plaintiffs ultimately filed suit in two cases-one brought by Kessev Tov (20-cv-04947) and the other brought by Pajoje (20-cv-04948). The following month, Pajoje moved for expedited discovery, seeking to serve a subpoena to identify the John Doe bidders involved in the market manipulation alleged in the lawsuits. The Court granted the motion, and the Chicago Board Options Exchange, Inc. ("CBOEI"), which operates the CBOE, agreed to produce the data with the bidders' identities masked. In analyzing the data, Plaintiffs determined that three bidding firms- John Does A, B, and D-had placed the alleged spoofing orders. Plaintiffs requested that the CBOEI reveal the firms' identities, and the CBOEI advised that it wanted to first notify the firms and give them an opportunity to appear and object. Thereafter, counsel for John Does A and D, as well as separate counsel representing John Doe B, contacted counsel representing both Kessev Tov and Pajoje, and the parties ultimately agreed that Defendants could proceed anonymously until the instant motions were decided.

 at Page 4 of the NDIL Opinion

Motions to Dismiss

As to the motions noted in the last sentence of the above-quote, Defendant John Does A and D filed identical motions to dismiss the amended complaints, asserting in part that:
  1. Plaintiffs' claims are untimely; 
  2. Plaintiffs failed to state a claim for market manipulation; and 
  3. Plaintiffs' ISL claims fail for additional reasons, including that Plaintiffs do not allege that they purchased any securities from the defendants and are therefore ineligible for the ISL's remedies. 
Defendant John Doe B's Motion to Dismiss asserted that Kessev Tov failed to state a manipulation claim based on largely the same arguments as those put forth by the other defendants. 

Two-Year Federal and Three-Year State Statutes of Limitation

Initially, NDIL tackles Defendants' assertion that Plaintiff's Section 10(b) and ISL claims are barred by applicable statutes of limitation:

[T]he two-year period for bringing a Section 10(b) claim is triggered once the plaintiff "discovers, or could have discovered with reasonable diligence, the facts underlying the violation," whichever comes first. CP Stone Fort Holdings, LLC v. John Doe(s), Case No. 16 C 4991, 2016 WL 5934096, at *3 (N.D. Ill. Oct. 11, 2016) (Gettleman, J.) (hereinafter, "CP Stone I") (citing Merck, 559 U.S. at 633, 646-48)). Plaintiffs' securities claims under the ISL carry a three-year statute of limitations, beginning on the date of the security's sale. 815 ILCS § 5/13(D). "But if the party suing neither knew nor in the exercise of reasonable diligence should have known of any alleged violation of the Illinois securities law, the three-year period to sue for Illinois securities law claims begins to run [on] the earlier of: (1) the date upon which the party bringing the action has actual knowledge of the alleged violation of this Act; or (2) the date upon which the party bringing the action has notice of facts which in the exercise of reasonable diligence would lead to actual knowledge of the alleged violation of this Act." Orgone Cap. III, LLC v. Daubenspeck, 912 F.3d 1039, 1046 (7th Cir. 2019) (quoting 815 ILCS § 5/13(D)(1)-(2)) (emphasis omitted).

at Page 7 of the NDIL Opinion

Defendants John Does A and D argue that with reasonable diligence Plaintiffs would have discovered the alleged spoofing on August 24, 2015; and, as such, the filing of the Complaints after some five years had transpired violated the statutes of limitations. Further, Defendants assert that, in fact, Plaintiffs:  

knew virtually all of the information on which their claims are based, including that: (1) unknown market participants had submitted bids and asks at prices that Plaintiffs believed to be far in excess of rational prices and higher than prices at any other time that day; and (2) Plaintiffs had purchased options at prices they believed were artificially inflated by spoofing trades. Defendant John Does A and D contend that only the identity of the alleged culprits was unavailable in August 2015, and that was not a legitimate reason to delay the filing of the complaints until after the limitations periods had expired

at Page 8 of the NDIL Opinion

Plaintiffs denied their awareness of the spoofing in August 2015, and, in part, Kessev Tov cited its 2017 FINRA arbitration against its brokerage firm, Interactive Broker, as confirming that the hedge fund had believed that its damages had been caused by flaws in the broker's trading platform. Only after the arbitration award was rendered against it did Kessev Tov examine trading data that raised the prospect of spoofing:

[T]he bids were effectively invisible because they were only in the market for a matter of milliseconds. Beyond the short duration of the bids, Plaintiffs note that the bids did not show up on their trade confirmations or statements because they had exited the market by the time that Plaintiffs' trades were executed. While Plaintiffs recognize that they were aware of their losses in August 2015, they maintain that the cause was unknown to them. In support, Plaintiffs note that Kessev Tov initially brought a FINRA arbitration against Plaintiffs' broker, because Plaintiffs thought that their damages had been caused by flaws in the broker's trading platform. It was only after the arbitration concluded that Plaintiffs realized other market participants could have been responsible, and thereafter obtained the "tick-by-tick" trading data revealing the alleged spoofing bids. (Case No. 20-cv-04947, Dkt. 34 at 10-11; Case No. 20-cv-04948, Dkt. 39 at 10-11.) Plaintiffs deny that a reasonable market participant (1) could have known in August 2015 that unknown market participants were submitting bids and asks at irrational prices; or (2) should be expected, absent knowledge of fraud, to have obtained and scoured the "tick-by-tick" trading data to determine whether unknown market participants had defrauded them.

at Pages 7 - 8 of the NDIL Opinion

Statutes of Limitation: Motion to Dismiss Denied

After consideration of the parties' arguments, NDIL found that:

[T]he allegations in the amended complaints do not create an "ironclad" limitations defense warranting dismissal. That Plaintiffs were aware of their losses in the aftermath of the August 24, 2015 trading activity does not establish that Plaintiffs were aware, or should have been aware through reasonable diligence, that those losses stemmed from the alleged market manipulation of other market participants. It is simply not clear from the complaints that the applicable statutes of limitations are a bar to these suits. Defendant John Does A and D's motion to dismiss on this ground is denied

at Page 9 of the NDIL Opinion

Failure to State a Claim: Motion to Dismiss Granted

A more formidable obstacle for Plaintiffs was found in Defendants' arguments that the Complaints failed to alleged any manipulative conduct. Upon review, NDIL repeatedly found that much of the Complaints was riddled by conclusory allegations. Pointedly, the pleadings failed to assert what the S&P options' "prevailing market price" on August 24th would have been but for Defendants' purported spoofing. As NDIL observed:

[P]laintiffs ostensibly ask the Court to conclude that purchasing an option at the highest price for a given day-while in the midst of an admitted "flash crash"-is an irrational price. Merely labeling prices "irrational" because they were higher during a period of volatility does not make them irrational. . . .

at Pages 19 - 20 of the NDIL Opinion

In elucidating its position, in part the Court offered this analysis:

At bottom, Plaintiffs have alleged that Defendants engaged in market manipulation because they entered-and quickly cancelled-orders to buy and sell. The complaints allege that Defendants' manipulation is evident in the "well-defined pattern and speed of placing these bids" and the "frequency, speed, and precision with which the bidding took place evidences a highly orchestrated plan to deceive." (Case No. 20-cv-04947, Dkt. 25 at 6-7, ¶ 16; Case No. 20-cv-04948, Dkt. 24 at 6-7, ¶ 15.) In the case of John Does A and D, the complaints place the volumes of simultaneous bids and asks in a range of 12 to 83, while for John Doe B, the range was 3 to 7. (See generally Case No. 20-cv-04947, Dkt. 25; Case No. 20-cv-04948, Dkt. 24.) The only "pattern" apparent from the face of the complaints is that of rapidly placed and subsequently cancelled orders. 

But placing rapid orders and cancelling them does not necessarily evince illegal market activity. Other courts have recognized the ubiquity of rapid trading across securities platforms. For example, in United States v. Coscia, 866 F.3d 782, 785 (7th Cir. 2017), the Seventh Circuit described this "new trading environment" in the commodities markets, in which "trading takes place on digital markets where the participants utilize computers to execute hyper-fast trading strategies at speeds, and in volumes, that far surpass those common in the past." None of the parties contend that rapidly cancelling orders, in and of itself, is illegal.

at Pages 17 - 18 of the NDIL Opinion


NDIL granted without prejudice Defendants John Does A, B, and D's motions to dismiss; and ordered that Plaintiffs replead within 30 days if they can cure the cited deficiencies.

Bill Singer's Comment

Geez . . . even at this late date, even after writing the blog, I'm still not sure about this one. The Court may have gotten it right. Maybe not. Like I said, I'm just not sure either way with this. 

NDIL holds that spoofing, in and of itself, "does not necessarily evince illegal market activity." Okay -- I agree with that. Many savvy traders will test market depth and conviction by entering orders for an intentionally short time just to see if someone out there is willing to bite and for how much size. So, okay, I'm not going to quibble with NDIL as to whether what looks like spoofing or even spoofing itself is, absent more, illegal. 

Where I step out onto thin ice, see the cracks forming, and hear the ice breaking is when the Court goes further and asserts that a "new trading environment" exists, such, that "hyper-fast trading" may have altered the trading paradigm (I hate that last word) to the extent that it may be impossible to discern between intentional spoofing and so-called hyper-fast trading. Almost like promulgating a version of  Heisenberg's Uncertainty Principle for Trading: The size of a trade and the velocity of an entered Bid/Offer cannot both be measured simultaneously. 

Again, not saying the Court got it right. Not saying the Court got it wrong. I am saying that I need a large iced coffee and a couple of donuts, and then I need to dunk and sip and ponder -- maybe get a refill but not tell my wife that the two donuts that I swore to her were all that I ate were actually four donuts and one was filled with custard and two were filled with jelly and one had icing on it. 

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