It’s hard to believe that one trader could have such an outsized impact on the stock market, but that’s what the Justice Department is claiming. It arrested a lone U.K. trader for alleged cheating the markets and amplifying the flash crash of 2010.
Silla Brush, Tom Schoenberg and Nick Baker had these details about the arrest in a story for Bloomberg:
U.S. authorities accused a lone trader based in a house under the flight path of London’s Heathrow Airport for intensifying the 2010 global markets shock known as the flash crash, part of an alleged pattern of cheating dating back as far as 2009.
The trader, 36-year-old Navinder Singh Sarao, was arrested in the U.K. on Tuesday, and the U.S. is seeking his extradition, the Justice Department said in a statement. He earned almost $900,000 trading futures on the Standard & Poor’s 500 Index on May 6, 2010 — when investors saw nearly $1 trillion of value erased from U.S. stocks in just minutes — and a total of $40 million from 2010 to 2014 buying and selling the contracts, according to the U.S. government.
Although the U.S. says Sarao’s illegal activities spanned from at least June 2009 through April 2014, the government gave special attention to what happened during the flash crash, which damaged perceptions about the safety of global markets. The trades by Sarao, a resident of Hounslow, England, took place on an exchange run by Chicago-based CME Group Inc. He was charged on Feb. 11 with wire and commodities fraud in a criminal complaint filed in federal court in Illinois.
CNN Money’s Ben Rooney had details about how Sarao manipulated the markets in order to drive down prices:
According to the criminal complaint, Sarao flooded the market with multiple, large sell orders for futures contracts called E-Minis, which traders use to speculate on the direction of the S&P 500 index.
This created the appearance of heavy supply in the market and drove prices down. Sarao allegedly canceled most of the orders before they were executed.
Prosecutors say Sarao then profited when the market fell and also when it rebounded by buying and selling futures contracts.
On the day of the Flash Crash, the complaint says Sarao made nearly $9 million trading E-Minis. From 2010 to 2014, he allegedly made about $40 million.
Sarao traded primarily through his own company, Nav Sarao Futures Limited, on the Chicago Mercantile Exchange.
The Commodities Futures Trading Commission also filed a civil complaint against Sarao.
Steve Goldstein wrote for MarketWatch that it will be tough to pin the crash on Sarao:
So what is at issue — with respect to the flash crash, at least — is whether he set off the avalanche in the E-mini market. The Justice Department, in the criminal complaint, says that his “manipulative activity contributed to the flash crash.”
Between 1:33 p.m. and 2:45 p.m., Sarao placed 135 sell orders for a total of 32,046 contracts, and canceled 132 of them, the complaints state. The government says this created persistent downward pressure on the E-mini.
Even so, pitting the entire E-mini collapse on Sarao is at least debatable. It’s worth pointing out that the Justice Department says Sarao’s “dynamic layering” program ended at 2:40 p.m. — so, just before the nosedive. The CFTC, in its complaint, says his actions contributed to an extreme order-book imbalance in the E-mini market.
With respect to the flash crash, then, what Sarao can be accused of is knocking the futures market to a point where it was ready to be tipped over. And he acted incredibly aggressively. He modified more than 20 million lots on May 6, 2010 — and the entire rest of the market modified less than 19 million. His offers accounted for as much as 29% of the sell-side book in the E-mini.
Nathaniel Popper wrote for The New York Times that some would call his trading smart instead of criminal:
A trader involved in spoofing puts in orders with the intention of moving the price of a financial asset — in the flash crash case, it was a futures contract betting on the direction of the Standard & Poor’s 500-stock index. When the price moves, that trader quickly cancels the orders and takes advantage of the price change
There are few in the industry who are willing to defend spoofing and other deceptive strategies with names like layering and quote stuffing. But there is also much debate about how common spoofing and similar strategies have become. And it has been difficult to find firm evidence as to whether such strategies are directly harming ordinary long-term investors.
Spoofing is an evolution of older strategies used by traders in the physical pits, who tried to cajole competitors into offering slightly better or worse prices, sometimes through crafty hand signals.
“Technically it is market manipulation, but some people would call that clever,” said Matt Samelson, the chief executive of the consulting firm Woodbine Associates.
The large high-frequency trading firms have generally argued that spoofing is a strategy used by mostly fringe or nefarious actors. And although it is illegal, spoofing does not usually play a significant role in influencing stock prices, the firms say.
It’s hard to imagine that one person is responsible for the mayhem of five years ago, and it looks like many in the media doubt the claims as well. While there must be something on which to base the case, this seems like another case of officials going after the easy headlines instead of getting to the root of the cause.
