& Co.’s precious-metals traders consistently manipulated the gold and silver market over a period of seven years and lied about their conduct to regulators who investigated them, federal prosecutors said Friday.
The bank built a formidable franchise trading precious metals, but some of it was based on deception, prosecutors said at the start of a trial of two former traders and a co-worker who dealt with important hedge-fund clients. They said the traders engaged in a price-rigging strategy known as spoofing, which involved sending large, deceptive orders that fooled other traders about the state of supply and demand. The orders were often canceled before others could trade with them.
The criminal trial in Chicago is the climax of a seven-year Justice Department campaign to punish alleged spoofing in the futures markets. Prosecutors have alleged the former members of
JPMorgan’s
JPM -0.31%
precious-metals desk constituted a sort of criminal gang that carried out a yearslong conspiracy that racked up big profits for the bank.
“Day in, day out for seven years, the defendants manipulated the market so that they could make more money,” U.S. Justice Department prosecutor Lucy Jennings said. “And then they lied to cover it up.”
JPMorgan paid $920 million in 2020 to resolve regulatory and criminal charges over the conduct, which involved nine futures traders and at least two salespeople who dealt with clients such as hedge funds, according to court records. Three former traders cooperated with the Justice Department’s investigation and will testify against the three defendants: Gregg Smith and Michael Nowak, who traded precious metals; and Jeffrey Ruffo, who was their liaison to big hedge funds whose trades earned money for the bank.
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Attorneys for Messrs. Smith, Nowak and Ruffo told jurors Friday that prosecutors cherry-picked a handful of trades to concoct a misleading theory of how the men traded.
Mr. Smith canceled many orders but never used them as a ruse, defense attorney Jonathan Cogan said. He often canceled orders after he realized that high-speed trading firms, which made decisions faster than he could, jumped ahead of his orders and moved the price up or down, Mr. Cogan said.
“He did not place orders with the intent to manipulate the market, not during the snippets of time the prosecutors will focus on in this case—not ever,” Mr. Cogan said.
An attorney for Mr. Nowak, who led the precious-metals desk, said his client was a gold-options trader during the years under scrutiny. Mr. Nowak used futures mostly to limit the risk of his large options positions, attorney David Meister said, so his pay wasn’t linked to making more or less money on a futures trade.
“The stuff he’s charged with here couldn’t move the needle for Mike’s pay,” Mr. Meister said.
Mr. Smith had worked at Bear Stearns before joining JPMorgan in 2008 when the bank acquired Bear in a fire sale precipitated by the financial crisis. Mr. Nowak traded for JPMorgan in both London and New York. Mr. Ruffo worked at the bank for a decade, communicating with hedge funds that were brokerage clients and providing the desk with important market intelligence, according to prosecutors. All three have pleaded not guilty.
Prosecutors have alleged the pattern of spoofing was continuous, a claim that allowed them to charge the three men with racketeering in addition to conspiracy, attempted price manipulation, fraud, and spoofing. The conduct allegedly spanned from 2008 to 2016.
Racketeering is a charge typically reserved for criminal enterprises such as the mafia and violent gangs, although eight soybean-futures traders in Chicago were convicted of racketeering in a crackdown on cheating in the early 1990s.
U.S. District Judge Edmond E. Chang has reserved up to six weeks for the trial, although prosecutors said Friday that they could be finished presenting their case within two weeks. Judge Chang last year dismissed part of the case—several counts of bank fraud—against the defendants. Prosecutors also recently moved to drop allegations related to options trading that authorities claimed had been manipulative.
Prosecutors have alleged that JPMorgan employees already were spoofing when Mr. Smith got to the bank. They say Mr. Smith and another trader from Bear brought a new style of spoofing that was more aggressive than the simpler approach people at JPMorgan had been using, according to court records.
Spoofing became an important way to successfully execute trades for hedge-fund clients whose fees were critical to the trading desk, prosecutors said. “It was key to get the best prices for those clients, so that they keep coming back to the precious-metals desk at JPMorgan, and not another bank,” Ms. Jennings said.
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Guy Petrillo, an attorney for Mr. Ruffo, said Friday his client was a reliable and honest salesman whose only role was to communicate with clients and pass their orders to traders such as Messrs. Smith and Nowak.
“There will be no reliable evidence that Jeff knew that traders were using trading tactics that he understood at the time were unlawful,” Mr. Petrillo said.
Federal prosecutors have honed a formula for going after spoofing defendants during their multiyear strike on the practice. In addition to using cooperating witnesses who said they knew the conduct was wrong, prosecutors have deployed trading charts and electronic chats to depict a sequence of trades intended to deceive others in the market. While the charts show a pattern of allegedly deceptive trading, prosecutors said the incriminating chats reveal the intent of the traders placing the orders.
Former traders at
Deutsche Bank AG
and
Bank of America Corp.
were convicted of spoofing-related crimes in 2020 and 2021, respectively.
Those trials featured chats in which some defendants boasted about spoofing.
Lawyers for Messrs. Smith, Nowak and Ruffo said there are no chats in which their clients talked about spoofing because the men didn’t engage in it.
Spoofing is a form of market manipulation outlawed by Congress in 2010. Spoofers send orders priced above or below the best prices, so they don’t immediately execute. Those orders create a false appearance of supply and demand, prosecutors say. The tactic is designed to move prices toward a level where the spoofer has placed another order he wants to trade. Once the bona fide order is filled, the spoofer cancels the deceptive orders, often causing prices to move back to where they were before the maneuver started.
Mr. Smith’s style of spoofing involved layering multiple deceptive orders at different prices and in rapid succession, according to the settlement agreement that JPMorgan struck with prosecutors two years ago. It was harder to pull off but also harder to detect, and other JPMorgan traders adopted his mode of trading, court records say.
In the earlier trials, prosecutors successfully defended their theory that spoofing constitutes a type of fraud. Some traders have argued spoofing doesn’t involve making false statements—usually a precondition for fraud—because electronic orders don’t convey any intent or promises.
The tactic can impose losses on those tricked by spoofing patterns. The government has portrayed some of Wall Street’s most sophisticated trading firms, such as Citadel Securities and Quantlab Financial, as the past victims of spoofers. In the latest trial, prosecutors also plan to call individual traders who traded for their own accounts and were harmed by spoofing.
Write to Dave Michaels at dave.michaels@wsj.com
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