The Trader who took on the Regulator

When Daniel Schlaepfer and his day trading firm Select Vantage Inc. sued the Australian Securities and Investments Commission for defamation in 2016, few thought he would find any vindication – 5 years down the line, he has been pronounced the moral victor

Since the onset of the pandemic, the otherwise seldom reported on world of day-trading has featured increasingly prominently in the global news agenda. The combination of severe market volatility, people being deprived of regular income and confined to their homes has tempted millions of amateur traders to try their hand at the markets. This trend reached its crescendo in January of this year when thousands of amateurs conspired on Reddit to send GameStop share prices through the roof, and many hedge funds into the ground in the process. As such the industry’s hot topic of recent months has been the proper regulation of amateur day trading.

Meanwhile, an important precedent has been set in the sphere of the proper regulation of professional day trading. For the last five years Daniel Schlaepfer, the founder and CEO of Select Vantage Inc (SVI), a Cayman Islands-based day trading firm and one of the largest liquidity providers in the world (engaging over 2,000 traders in 264 offices in 39 countries around the world) has been suing the Australian Securities and Investments Commission (ASIC) and its head of market supervision, Greg Yanco, for defamation.

The list of market players volunteering to take on national regulators is not a long one. In 2014, Stewart Ford, founder of failed investment firm Keydata, unsuccessfully attempted to sue the UK’s Financial Conduct Authority (FCA) for £371m, claiming a “politically motivated” abuse of power led to his firm being investigated and subsequently placed under administration. The case against the regulator was dismissed in 2016 at London’s High Court, with the claims described as ‘deficient and embarrassing’. In the same year, Hinton Associates tried to sue the FCA for libel. But the regulator’s immunity was deemed ‘sacrosanct’ and the claimants had to abandon their case.

Mr. Schlaepfer’s case was years in the making and an understanding of its motivation requires some broader context. His firm was born out of a company called Swift Trade, the firm at which Schlaepfer gained his training and began his career, which was owned and run by Canadian share trader Peter Beck. In 2010, the FCA alleged that Swift Trade had between 2007-2008 been engaged in a trading scam known as "layering".

Layering involves traders entering relatively large orders to buy or sell shares without ever intending to follow through on those orders. This gives a false impression of demand for a stock, prompting a move in the price (either upwards in the case of an apparent abundance of big buyers, or downwards when there appear to be lots of heavy sellers). The bluff orders were deleted within seconds, but not before a small shift in price had allowed Swift’s traders to intervene, buying or selling equity derivatives at prices that would not otherwise have been possible.

Following proceedings, the FCA fined Swift Trade $100,000 in 2012 and Beck was subsequently barred from membership of the Financial Industry Regulatory Authority (FINRA) indefinitely. However, the trading business was, subject to certain conditions, permitted to continue operating.

Founded in 1997, Swift was an early success story of the emerging day-trading phenomenon, giving rise to a number of competitors and a community often disparagingly referred to as “arcade traders”. The burgeoning sector had a reputation for amateurism and opportunism - and the regulatory landscape in which it operated over the course of a decade remained something of a Wild West. Rules were vaguely formulated, poorly understood and rarely enforced. The concept of ‘layering’ had multiple competing definitions, and some market participants even argued that the practice was fair game. As a result, many in the trading sector saw Beck as the fall guy in a climate of regulatory pushback.

When Swift Trade fell Schlaepfer saw an opportunity. He struck a deal with Beck to salvage the company’s assets and attempted to professionalize the operation to meet regulatory standards. The newly formed ‘Select Vantage Inc.’ invested heavily in centralized surveillance, risk management processes and order entry controls. Aspiring traders were made to undergo prolonged training and testing through simulation software before they were hired to trade the firm’s capital, and active traders would be closed out of the system for the day if specific loss thresholds were breached. Unusual order activity would be flagged to a compliance team and comprehensively reviewed. If it was to stay in business, SVI had to eliminate all the loopholes that led to the downfall of Swift Trade.

It is against this backdrop that, in 2016, Schlaepfer heard from an industry contact that two years prior, in November 2014, a high ranking official at ASIC called Greg Yanco had warned multiple brokerages against doing business with his firm, effectively telling the likes of UBS, Bank of America Merrill Lynch, Credit Suisse and Deutsche that Schlaepfer and SVI had engaged in criminal conduct by “layering” the stock market, causing SVI to “vanish overnight” from the Australian market.

Neither Schlaepfer nor anyone at SVI were ever made aware of the allegations or presented with evidence of layering activity - let alone provided with an opportunity to respond to ASIC’s suspicions. Now Schlaepfer knew why none of the brokers Down Under had been willing to do business with his firm for the past two years, so he took ASIC to court.

A three-week trial in Sydney in 2019 was wholly unsuccessful. In a brutal judgment, New South Wales Supreme Court Justice Desmond Fagan dismissed Schlaepfer’s case as “misconceived”, upholding ASIC’s defence of truth in asserting that SVI traders had been engaged in misconduct - whether or not Schlaepfer had been knowingly concerned - as well as its defence of ‘qualified privilege’, stating that the regulator was merely responding under its market integrity rules when airing its concerns to major stockbrokers.

Three years and many millions of dollars later, Schlaepfer might have left it there. Instead he chose to appeal. Schlaepfer’s lawyers argued that Justice Fagan had failed to engage with their case on truth, making little to no reference to their expert witness evidence surrounding the question of layering and arguing that the judge had thereby “worked a miscarriage of justice and produced a mistrial.”

More pertinent was the matter of ‘identification’. Core to Schlaepfer’s case for slander was that he had been personally identified, though not specifically named, in Yanco’s communications, and thereby implicated in criminal activity which had a material impact on his business.

Fagan had found that Yanco’s wording was not sufficient to identify Schlaepfer, a claim the plaintiff’s lawyers stated “demonstrates a disregard for natural human curiosity.” In his communications, Mr. Yanco had referred to a firm run by ‘a trader formerly of Swift Trade’. Only one individual fit that description.

Most egregious from Schlaepfer’s perspective was the fact of not having been made aware of ASIC’s concerns. His firm had been found guilty without the opportunity to prove its innocence. Simply put, ASIC might have asked SVI to explain its traders’ behaviour before invoking its legal duty to inform major market players that it suspected illegal conduct. Ironically, at the time of the trial, ASIC’s then chair James Shipton had been on the conference circuit to promote the regulator’s newly established ‘Fairness Imperative’, espousing the precept that a regulator should only take action if certain that the law had been broken.

The judgment returned on the appeal last month found that ASIC had not followed its own code on this occasion. The judge highlighted “the fact that Mr. Yanco’s communications were made without any opportunity for Mr. Schlaepfer to respond was fatal to the element of reasonableness required to be established in order to make out the statutory defence.”

While the appeal was not won overall, the judgment’s conclusion underscored a striking reversal of the original verdict, finding that Schlaepfer had been found “successful on most issues including the defence of truth, which occupied a substantial portion of the proceedings. That success has achieved what was said to be an important outcome of the appeal, namely, the vindication of Mr. Schlaepfer’s reputation. Although ASIC has succeeded in establishing the defence of qualified privilege at common law, that is a defence of confession and avoidance. To put the matter another way, Mr Schlaepfer has established in the appeal that he was defamed, but defensibly so.”

In a statement issued after the verdict, Schlaepfer said he was glad the issue was resolved. However, he added that “the fact that ASIC’s defence of qualified privilege was upheld is worrying and could set a dangerous precedent for financial regulation,” allowing ASIC to act “with impunity”. In spite of this, ASIC has been ordered to pay two-thirds of its costs arising from the proceedings - a highly unusual outcome in Australia, where the loser typically pays the winner’s costs. The regulator sought leave to appeal the decision - but was refused. Having been fought through both the regional and national courts in Australia, these costs won’t be cheap. But then again there’s no such thing as a free lunch, especially in the finance industry.

This article does not necessarily reflect the opinions of the editors or the management of EconoTimes