What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing in today's video we're going to talk about one of the biggest alleged market manipulations in recent history and no we're not talking about gamestop and amc. This market manipulation was a sophisticated and organized operation carried out by a large and powerful organization. The manipulation went on for an astounding seven years and wasn't uncovered by authorities until more than a decade after the practice was started. It affected developed markets in us treasury bonds.

As well as metal commodity futures, the perpetrator was none other than the biggest bank in the us. The blue chip down component jp morgan. As recently as late 2020, they refined a record fine of almost a billion dollars in any other industry, an institution as big as jp morgan being fined. Such a large sum due to illegal market manipulation or a similar crime would be jaw-dropping, but on wall street such penalties for the big banks almost seem commonplace and barely ever make headlines in today's video we're going to shine the spotlight back on jp morgan and its Infamous training activities, so we can understand what wall street tries so hard to cover up market manipulation perpetrated by jp morgan first came to light in late 2019, when it was revealed that the justice department had charged three of jp morgan's traders with spoofing precious metals markets.

Three jp morgan metals traders have been charged with alleged market manipulation. Wilfred you've been digging into this story all day yeah. So two current and one former jp morgan, precious metals traders have each been charged with alleged spoofing market manipulation and fraud between 2008 and 2016.. Spoofing is an advanced market, manipulation technique that can only be effectively implemented by market participants who have a lot of capital and very low latency access to the markets.

In addition, they must have sophisticated trading logic without sophisticated strategies or experienced full-time traders. Just having a lot of capital and quick access to the markets is not enough. In its most general definition. Spoofing is any trading activity where orders are submitted to exchanges which are not intended to be filled.

It was defined in the dodd-frank wall, street reform and consumer protection act and again by the commodity futures trading commission as bidding or offering with the intent to cancel the bidder offer before execution on its face. A reasonable person might have two questions about this definition. One is that just submitting visitor offers, which are just limit orders to buy or sell, seems like a harmless market activity, and the second question is: why would someone even submit such an order if they didn't want it to be filled to answer those questions we have To look at it from the perspective of a huge institution like jp morgan, placing these trades jpmorgan is a financial behemoth whose history goes back more than a hundred years, they've been operating as a money-making machine for all those years and have become one of the top. Few most valuable businesses in the world in the last fiscal year alone, despite the fact that the covent 19 pandemic gripped the entire world.

In a once. In a hundred year, calamity jp morgan was able to bring home about 30 billion dollars of net profit. A non-trivial part of jpmorgan's business is trading activities. These trading activities brought in 18 billion dollars of total revenue last year.

In comparison, that 18 billion dollars of revenue is on the same order of magnitude as the entire assets under management of 0.72, which is one of the world's top hedge funds. So it's safe to say that jp morgan's trading operations are significant on a global level. When jp morgan places a trade on an exchange, the amount of money in each trade can easily be in the millions or even tens of millions of dollars of notional. Whenever huge orders are submitted to an exchange and show up as bids or offers to other market participants, you can bet that other traders will take notice.

For example, hypothetically if company a just released their earnings report in the past 30 seconds, and you then see a huge amount of asks being submitted on the exchange, you might conclude that someone with a lot of money has made a judgment as to whether the earnings Release was positive or negative, given the quick timing of the orders appearing seconds after the earning release, as well as the sheer magnitude of the order. You might think that this market participant is a sophisticated investor, so-called smart money, because the orders were offers rather than bids. You might also conclude that this sophisticated investor thinks the earnings report was negative and thus is trying to sell their shares before the stock price drops in response. It would be natural to not want to buy shares at this time and you might even want to sell some shares if the price hasn't moved.

Yet in this way, the unfilled orders that the mysterious market participants submitted to the exchange affected. The other traders in the market - that's by no means the only way that spoofing can happen and, in fact, usually spoofing takes on much more subtle and sophisticated realizations. Sometimes spoofing can be even carried out by completely automated algorithms without any human ever knowing about it. For example, an area of artificial intelligence and machine learning, called reinforcement, learning allows a computer to take specific actions and receive feedback after each action in the financial markets.

These actions could be submitting orders to an exchange and the feedback could be the profit earned. On each closed trade, over the course of thousands of actions and resulting feedback, the machine learning algorithm learns what actions to take in any given environment to maximize the feedback reward it's very possible for an algorithm like this to eventually learn a spoofing strategy on its own. Without human design or intervention, moreover, reinforcement learning has certainly been used by sophisticated institutions to create automated trading systems. So now we know what spoofing is in at least the eight-year period from july 2007 to august 2016, jp morgan's traders repeatedly engaged in concerted strategies to spoof precious metals markets.

Eventually, the department of justice, with assistance from the fbi, discovered the spoofing and were able to charge a particular trader from within jp morgan with market manipulation. His name was christian trums aged 34. At the time from london, trunks pleaded guilty to one count of spoofing and another count of conspiring to spoof markets for gold, silver, platinum and palladium futures. According to a department of justice, press release, truns learned how to profitably spoof the markets from more senior traders as company and actively engaged in spoofing with the knowledge and consent of the supervisors.

Two days afterwards, the department of justice expanded its target to three other chairs. At jb, morgan, greg smith, michael nowak and christopher jordan, like troons, these traders manipulated the precious metals futures exchanges over the course of at least eight years, racking up thousands of illegal trades. All three of them were charged with conspiracy to conduct the affairs of an enterprise through a pattern of racketeering activity. However, they were also charged with wire fraud, main fraud, commodities, fraud, price manipulation and spoofing.

Three months later, the department of justice expanded its target again to include jeffrey ruffo from new jersey and also a former employee at jp morgan. The charges against ruffo were as wide-ranging as for the previous three traders charged in the department of justice's press release. They described the strategy that ruffo and his co-conspirators use in their spoofing activities, while placing trades for clients on the precious metals desk at jp morgan, they would submit orders to buyers, sell a futures contract at a certain price attempting to get good execution quality on their Order they would then place a large amount of orders on the opposite side of the trade in order to either create the illusion of liquidity in the markets or to mislead other market participants about the true supply demand relationship of the given futures contract. These are called deceptive orders and were used to inject false or misleading information about the true equilibrium market prices of the securities.

According to the department of justice, this misleading information in the form of a spoofed order book was successful in causing other market participants to react to the apparent changes in the supply-demand relationship. This meant that other market participants ended up buying or selling contracts at either quantities, prices or times that they otherwise would have been unlikely to jp morgan did not spoof the markets to directly profit themselves in this case. Instead, they did so on behalf of their hedge fund clients, for example, when a hedge fund client wanted jp morgan to place an order to buy a futures contract on a precious metal on the hedge fund's behalf. The trader at jp morgan would then call up another jp, morgan trader, alerting them of the trade.

The other trader would then place the spoofed orders on the same security driving the price of the security up or down favorably for the hedge fund client by getting good order execution on the trade as a result of jpmorgan spoofing. The hedge fund, clients would continue to do business with jp morgan as opposed to going to a competing prime broker. Hedge fund's placing trades with big banks like this is an important source of revenue for jp morgan and other prime brokers as a source of a large portion of their total trading revenue. Without them, trading operations at large investment banks would likely be unprofitable, perhaps even more blatantly manipulative of markets in a way that directly benefits jpmorgan was through what is called barrier running and barrier defending in this illegal activity.

A hedge fund, client or other institutional investor comes to jb morgan wanting to trade. What is called a barrier option. These are a special type of option that have a binary outcome. In other words, they pay out a set amount if the underlying security exceeds a certain price at expiry and payout.

Nothing if the underlying does not because the difference in payout is so great when the underlying security is near. The barrier price jp morgan engage in using their spoofing strategies to manipulate the securities prices, either up or down, depending on which side of the trade that they took as a result, if the barrier option was on the fence and looking like it could go either way. Jp morgan would manipulate the markets in their favor, for example, if a hedge fund wanted to take a position that the price of gold would be greater than hundred dollars per ounce, they might ask jpmorgan to write a barrier option at a set date. If the price of gold was indeed above seventeen hundred dollars per ounce, the hedge fund would receive an amount of money from jp morgan.

If the price of gold was not above seventeen hundred dollars, the hedge fund would receive nothing to enter into the trade. The hedge fund would pay jp morgan some amount of money up front if leading up to the expiration date of the option. Gold was at, let's say, 1705 dollars. Jp morgan would try to get it down below seventeen hundred dollars, so they would not have to pay the hedge fund, that's where their spoofing expertise comes in this practice of barrier running and barrier, defending directly pitted jp morgan against its own clients.

However, since the clients were trading directly with jp morgan, because so much money was at stake, jp morgan was incentivized to do whatever they could not to lose in the trade. Although the justice department, up until 2018, only charged individual traders at jp morgan was spoofing in september of 2020, they announced that they had successfully settled with the bank itself. Jp morgan had agreed to pay 920 million dollars in connection with its spoofing schemes. The bank also admitted that it engaged in the illicit behavior, which is worth noting, because frequently big banks settled with regulators without either admitting or denying the allegations.

Although the settlement was a record for the commodity futures trading commission in the second biggest civil settlement in american history, it was little more than a drop in the bucket for jp morgan. In the same quarter that the settlement was announced. Jp morgan made an announcement of its own reporting record high corporate profit of 12.1 billion dollars in that quarter alone. Based on that quarterly profit, jp morgan would have been able to pay off the entire record 920 million penalty in less than five trading days.

Another fact that has been largely missed by the sparse media coverage of the jp morgan spoofing scandal is that the traitors indicted by the department of justice were quite high-ranking employees within the company, for example, of the five traders charged over the course of the justice department. Investigation, four of them were executive directors at jpmorgan. The fifth trader, michael nowak, was a managing director and actually ran jp morgan's global precious metals trading desk. Sometimes it seems like the big banks, or the media, or even the regulators themselves, want to pin these market manipulation crimes on a few bad apples within the companies.

The ceos of the companies usually deny that they even knew of the illegal behavior and the companies are quick to condemn the actions of the traders directly placing the trades. Both the person, spoofing, the markets and manipulating futures contract prices is a full-time employee of the company. Is placing trades on behalf of the company and the company has long been the entity benefiting from the illegal profits of the manipulation? Then the crimes are a reflection on the company itself. Michael nowak, one of the traders who pled guilty to the charges had been working at jp morgan for more than 23 years.

He was pretty much in charge of the entirety of jp morgan's, global, precious metals trading operations. In essence, he was the face of the company when it comes to precious metals trading. In the end, the bank itself was the entity that had to pay the fine, not the traders, but the sad thing is that wall street megacorporations have been paying fines like this. One left and right for decades and still engage in illegal activities.

These fines don't seem to have any effect in deterring wall street's heavyweights and unless the magnitude of these fines starts being meaningful on the level of these companies, actual profits or the authorities start really going for those at the top of the organizations. There's no reason to be hopeful that these banks will ever stop alright, guys that wraps it up for this video, if you like, the content, make sure to smash that like button and subscribe for future videos also leave a comment, letting us know what you think. The regulars should do to prevent the banks from continuing their legal profiteering, also check out our second channel, the economic outlook, where we post videos on all sorts of interesting economic topics in the meantime. Thank you so much for watching and we'll see you in the next video wall street millennial, signing out.