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 The U.S. has asked UK authorities to hand over Navinder Singh Sarao,
36, after his arrest this week on charges that he manipulated
markets over several years in a fraudulent scheme that helped cause
the stock market rout.
The U.S. Department of Justice alleges that Sarao used souped-up,
off-the-shelf software to trick other market participants into
thinking massive sell orders were about to hit, causing the
so-called E-mini S&P futures prices to drop so he could buy at
cheaper levels. In doing so, he made $40 million in profits, U.S.
authorities allege.
But traders doubt that Sarao could have had the upper hand in a
market dominated by Wall Street firms with powerful computer trading
programs and huge technology budgets.
The charges against Sarao, operating far from the center of U.S.
markets and engaging in activity some believe occurs every day among
larger firms, show that regulators may not shy away from publicity,
even if their case may be legally solid.
Linking Sarao to the flash crash "smacks of sensationalism," said
Manoj Narang, founder of Tradeworx, a firm that supplies data for
regulators. "Maybe they felt that would get the story in the papers.
Mission accomplished, I guess."
In Britain, a petition has been started opposing Sarao's extradition
to the United States. So far, at least 194 people have signed up to
an online message saying "One man with a single broadband connection
cannot bring down an entire market."
Sarao, who court documents show pushed around millions of dollars
between banks in the Caribbean, Switzerland and the Middle East, has
been granted bail in London on conditions including a 5
million-pound ($7.5 million) bond.
His lawyer, Joel Smith, declined to comment on whether Sarao had yet
raised the bail and been released, but said he opposes extradition
to the United States.
CANCEL IF CLOSE
The view held by some in the market that Sarao is a scapegoat for
the flash crash may not help his case much.
The complaint from the Justice Department, and the civil charges
from the market regulator, the U.S. Commodity Futures Trading
Commission, stop short of blaming Sarao outright for causing the
2010 turmoil, instead referring to him as a "contributing" factor.
Moreover, the trading activity that the authorities say was illegal
occurred on many days over a multi-year period, not just on May 6,
2010, when the flash crash happened.
That means that even without the flash crash, much of the substance
of the complaint would still stand, experts said.
The software Sarao allegedly used to execute his trades allowed him
to position himself just above or under the market while being
certain the bids will never be taken up.
He did this using so-called 'cancel if close' orders, which people
in the market said can easily be suspect. It means that as the
market price moved close to where Sarao put in his orders, they
would automatically be canceled.
Michael Friedman, chief compliance officer at electronic trading
firm Trillium in New York, said that market-makers, firms that
smooth trading by guaranteeing prices, could legitimately do similar
things.
But if people consistently cancel their orders, the case for
manipulation can be made, he said.
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"So was there a connection between what he did and the flash crash?
There certainly isn't an obvious connection if there is one at all,"
Friedman told Reuters.
Trillium itself was fined in 2010 for similar activity by the
Financial Industry Regulatory Authority. Friedman at the time was
the firm's outside counsel; he said the firm "paid a fine and got
rid of the offending traders."
MOST OF THE MODIFICATIONS
In its complaint, the CFTC focuses on 12 days of Sarao's trading. It
shows that on those days, he accounted for more than 60 percent of
the order modifications in the E-mini contracts on the CME Group Inc
futures exchange.
That was "more than one and a half times that of the rest of the
market," the complaint says. But the documents also suggest that
Sarao may not have caused volatility himself, but only benefited
from wild swings that already existed.
Sarao "isn't a criminal. He is a hero. He is the sort of guy who
makes the market safe for ordinary investors," John Hempton of the
Australian hedge fund Bronte Capital said on a blog post, saying
that Sarao's trading disrupts the trading of high frequency trading
firms, which Hempton referred to as "front running computers."
"The Department of Justice has been played into bringing the full
force of the U.S. legal system onto an irrelevant trader - just to
make the world safer for the real rip-off merchants," Hempton wrote
on his blog.
Of the 12 days the CFTC looked at in great detail, Sarao only
executed trades on four. A Reuters analysis of those 12 days show
those to be more volatile and with higher volume than on average in
the April 2010 to August 2011 period, which encompasses all but one
of the days the CFTC cited most closely.
For most of the period covered in the complaint, spoofing was not
specifically banned.
That is why the authorities charged Sarao with market manipulation,
a wider concept, and harder to prove.
Some say spoofing shouldn't be illegal at all.
"If that's what Sarao did, he should be punished accordingly for
breaking the rules," said Tradeworx founder Narang. "However, an
entirely different question is whether this activity should be
outlawed. I believe it should not be."
(Reporting by Douwe Miedema, Additional reporting by Herb Lash and
Rodrigo Campos in New York and Sarah N. Lynch in Washington. Editing
by David Gaffen and John Pickering.)
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