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What's the difference between market manipulation and a great trade? A high profile CFTC case that went to trial in 2016 gives us some helpful clues. This is the story of CFTC vs. Don Wilson & DRW:pic.twitter.com/PhIAVFkFu2
Don Wilson began his career in the CME Eurodollar pits in the late 80s. He launched his own firm named after his initials (DRW) in the early 90s & grew to become one of the most influential HFTs in the industry.pic.twitter.com/t0yH91raiK
In 2011, DRW spotted a huge potential trade that traced back to Wilson's early days in interest rates - convexity bias arbitrage. The relationship bw Eurodollars & interest rate swaps became broken, presenting a chance to correct the mispricing. Below video explains the trade:pic.twitter.com/earlPrsYzJ
There was a reason this bias wasn't working on a particular market - they were trading on Nasdaq's small, now defunct swaps market IDCG. DRW accounted for 90% of Nasdaq's swaps activity. They were the only one around to trade away the mispricing.
In 2013 the CFTC sued DRW and Don Wilson personally over these trades, accusing DRW of "banging the close" to manipulate the market. Possible punishment included huge fines & a lifetime ban of Wilson from the industry. The stakes were extremely high.pic.twitter.com/eJUFd5lK4y
Instead of settling, DRW took the case to court in 2016. To win, the CFTC had to overcome a high burden of proof - the hardest of which was an "artificial price" was created in Nasdaq's market. DRW argued it was merely performing necessary arbitrage to keep markets functioning.
After two long years of trial drama, the CFTC's lawsuit was dismissed. DRW and Wilson had overcome the industry's top regulator in court. This priceless quote sums up the verdict pretty well:pic.twitter.com/OQtiuSSTq7
The moral of the story is this - trading in illiquid markets is risky business. There's a fine line between "talking your book" and manipulating the market. Regulators have an extremely high burden of proof when alleging manipulation. In this case, DRW survived.
DRW's history & rise to power in high frequency trading is extremely fascinating. I'll be writing more about them in this Friday's newsletter - sign up below so you don't miss it:https://frontmonth.substack.com/
This was one of my favorite stories the last few years. Hell yeah.
Some times it comes down to good lawyers. Traders without the resources of DRW have settled when regulators offered them fines and penalties less than the legal costs would be to fight. Some of them regret not fighting (often those who also think they had a great trade).
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