Anyone with a sizable stake in the U.S. stock markets probably remembers May 6th, 2010 as a day that will live on in infamy. For a very brief period on this date, the various markets crashed, erasing a staggering $1 trillion only to recover just minutes later. This startling event became known as the “flash crash,” and about five years after the fact, the authorities rounded up one man as largely responsible for the mayhem: a certain London trader living in his parents’ basement named Navinder Singh Sarao.
Flash Crash Culprit?
Sarao was described by his acquaintances as a fairly quiet, miserly young man (despite the incredible sums of money he was accumulating). From the safety of his PC, Sarao was allegedly able to turn the high-frequency trading (HFT) tactic known as “spoofing” into an art form.
Spoofing in this sense must be distinguished from its usual definition in the world of computer networks (when someone up to no good pretends to be a trusted source, like in email phishing). Spoofing in terms of trading on the financial markets entails placing orders or trades on the market only to cancel them.
Provided the trade is sufficiently large, the spoofer can then momentarily manipulate market values and trading patterns without risking anything themselves. Judging by the subsequent action in the affected markets, the spoofer can get other traders (particularly the other automated, computer-controlled trading algorithms) to “show their cards,” so to speak, giving someone in Sarao’s position an even greater opportunity to capitalize on the spoof order. Such a tactic takes advantage of the lightning-fast speed of HFT computer algorithms.
According to investigations, Sarao was able to use this nefarious tool to devastation. He netted as much as $40 million through the illicit tactic, according to USA Today. On the day of the infamous flash crash alone, he is said to have raked in $900,000. (Not a bad day at the office—the rent-free home office, no less.)
In all honesty, Sarao was hardly the only spoofer on the futures and equities markets during his time as a London trader. Nor did he invent this method of gaming the markets. Frankly, the unethical practice surely still goes on today, albeit on a much smaller scale than the flash crash itself. The reason Sarao ultimately got caught was due to the outrageous size—and enormous consequence, however brief—of the flash crash spoof. Moreover, he was going to the well a few too many times, considering how much money he banked off of the use of spoofing.
It’s unfortunate that Mr. Sarao is the “lone wolf” being burned at the stake, as it were, for a crime that so many others are guilty of. To this day, as evidenced by frequent suspicious activity and accusations of fraud and manipulation against HFT traders, the use of spoofing is alive and well. It’s a shame that the authorities are using one particularly young and overconfident man as the scapegoat for an entire industry of fraudsters.
In the aftermath of the 2010 flash crash, regulators of the Chicago Mercantile Exchange (CME) implemented new rules to safeguard against these potentially devastating forms of market manipulation. It remains to be seen whether the smaller-scale types of HFT spoofing still elude regulatory authorities, or what other unfair advantages and illegal forms of trading take place on Wall St.
Despite the short-sighted effort to lay all the blame for one of the stock markets’ most pervasive ills solely at the feet of Sarao, he must still face justice for commodities manipulation and fraud (in addition to spoofing, which is a criminal charge unto itself). A judge in the United Kingdom has determined that, considering his crime impacted futures markets trading in Chicago, Mr. Sarao should be extradited to United States. The judgment now only awaits approval by the U.K.’s Secretary of State. Sarao’s attorneys are expected to appeal the decision, making the case that their client’s trading behavior was within the limits of the law.
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