The US Justice Department is now claiming that a single high-frequency trading trader (HFT), operating from his house in West London, was either responsible, or a significant contributor to the May 6, 2010, “Flash Crash” on Wall Street.

This comes five years after clearing HFT (a kind of electronic algorithm-based trading) and suggesting that the crash might have been due to the trading activities of a Kansas City broker called Waddell & Reed (HFT traders were the ones skewered by Michael Lewis in his 2014 book, Flash Boys).

So believe it or not,  just one man, operating out of his house in the west London suburb of Hounslow, pushed the entire global market system to the brink of an abyss on the afternoon of May 6, 2010, when the Dow plunged around 600 points in a minute or so, crashing the market’s value by around $1 trillion. That’s if you believe the Justice Department complaint revealed overnight in the US.

The man has been identified as Navinder Singh Sarao. He was arrested in London last night by police on charges of market manipulation, and the Americans will now ask for his extradition.

The Yanks say Sarao engaged in manipulative activity at least 10 times by so-called spoofing and “layering”,  which involves making multiple, bogus orders that are quickly cancelled to trick other market participants. These involved E-Mini S&P 500 futures contracts (E-Minis) on the Chicago Mercantile Exchange (CME). The indictment claims:

“Sarao allegedly employed a ‘dynamic layering’ scheme to affect the price of E-Minis. By allegedly placing multiple, simultaneous, large-volume sell orders at different price points — a technique known as “layering” — Sarao created the appearance of substantial supply in the market. As part of the scheme, Sarao allegedly modified these orders frequently so that they remained close to the market price, and typically canceled the orders without executing them. When prices fell as a result of this activity, Sarao allegedly sold futures contracts only to buy them back at a lower price. Conversely, when the market moved back upward as the market activity ceased, Sarao allegedly bought contracts only to sell them at a higher price.”

So what about the Flash Crash itself? Well, in a joint report released in September, 2010, the Commodities Futures Trading Commission and the Securities and Exchange Commission said that E-mini trading spilled over into the equity market and helped trigger the extreme movements on May 6, 2010.

But the E-Mini trades that the agencies said triggered the big moves were from a large trader, subsequently identified to be Waddell & Reed. The Kansas City broker has always maintained that their trades were not out of the ordinary.

Sarao wasn’t mentioned in that 2010 report. If he was the tipping point, or part of it, what does it say about the policy of the markets, the structure of the futures/physical trading systems in the US and the supposed liquidity in markets? And what about the dozens of larger concerns around the world and, especially in the US, trading in US markets (and allegedly engaging in layering and spoofing)?

The key phrase from the indictment (as far as market cynics are concerned) is, “In other words Defendant’s use of the Layering Algorithm introduced artificial volatility into the E-mini S&P Futures Market and caused artificial prices to exist.” That’s the first admission from US government officials that HFT was to blame for the Flash Crash.

And if you read more of the indictment, you start wondering what has been going on for the past five years, because it is claimed that Sarao engaged in the same sort of activity at least eight times after May 6. This leads to the question: why didn’t that bring the world as we know it, or at least Wall Street, to its knees?

But it gets even more incredible. Sarao’s activities had come to the attention of market overseers — the key market here is the Chicago Mercantile Exchange (CME) — between September 2008 and October 2009, when he placed orders before market opening and then cancelled them, a tactic that influenced the opening price.

The CME contacted Sarao about this in March 2009 and notified him via correspondence dated May 6, 2010, that “all orders entered on Globex (the CME trading platform) during the pre-opening are expected to be entered in good faith for the purpose of executing bona fide transactions”. In other words, stop it unless you are actually buying or selling.

In an email dated May 25, 2010, (as claimed in the indictment): “Sarao wrote to his FCM (Futures Commission Merchant) and told them that he had ‘just called’ the CME ‘and told em to kiss my ass’.”

Are we to believe that the CME and regulators (plus the FBI) sat on that reply for nearly five years before getting round to issuing an indictment and then having Sarao arrested in London last night? And are they seriously claiming that this one man seriously threatened life as we know it —  all the yachts, luxury cars, art, fortunes etc of the rich and not-so-rich  — by taking the Dow to the edge of a financial collapse of a sort never seen before?

Peter Fray

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