Futures Trader Arrested For Causing 2010 'Flash Crash'

New submitter dfsmith writes: Apparently the "Flash Crash" of the stock market in May 2010 was perpetrated by a futures trader in the UK. The US Justice Department alleges that he used a "dynamic layering scheme" of large-volume sell orders to confuse other buyers, hence winning big in his futures trades. "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."

Comments

So was it illegal?

[Irate Engineer]

So was it illegal to do this? They use the word "scheme" hoping people will mentally prefix it with "Ponzi" in their minds to make it sound illegal, but was it? Sounds like he was being clever and making money - ain't that the whole point of trading?

Re:So was it illegal?

[NicBenjamin]

You can buy a penny stock. You have a First Amendment right to talk it up on penny stock forums. You can then sell for a profit. No single step is illegal. But if the police prove you intended to pump and dump it you have committed a crime. The whole process, taken together, is a crime if they prove you were trying to convince a bunch of idiots to do something stupid (ie: buy your $.05 penny stock for $0.25) that a) cost them money while b) earning you money. You manipulated the market for your personal gain, and that's bad.

This guy made a series of perfectly legal moves that had the effect of a) costing a bunch of idiots to lose money in the Flash Crash while b) he gained money.

Re:So?

[NicBenjamin]

How do you know a guy who wrote 30 checks on an account with $0 in it didn't intend to deposit enough to cover the difference?

You don't really. But in the US Legal system enough circumstantial evidence will overcome reasonable doubt every time. And if this guy made loads of money off a crash caused by these tactics, and then continued to use the same damn tactics for years and years, it's really hard to believe it was an accident.

Re:So?

[AuMatar]

So lets say I have a standing order to buy FooBar stock at $50 a share. Its current price is $55. So basically I'm looking to buy on dips.

Tonight it comes out that the CEO has been falsifying all financial reports, and instead of making money for the last 3 years they've lost millions. You don't think I should be able to cancel that buy order due to the new information?

Re:Allegedly

[Anonymous Coward]

Because the complaint is ridiculous, that's why.

It describes actions that are common practice among Wall Street's biggest banks and trading desks.

Let's remember that to date, no one has done jail time for rigging LIBOR. A crime that is exponentially more serious than this one.

When you're committing crimes for a megabank, your chances of seeing a prison cell are essentially zero.

Re:So?

[Giant Electronic Bra]

Yeah, but I work in this field, and I can tell you that MOST bids and offers aren't acted on, and MOST of them are far 'off the money'. HOWEVER, every single bid or offer placed upon the market, and the CME surely counts, is financed. You simply cannot put a bogus order onto the CME, the NYSE, or even the most rinky-dink ECN. So, the question remains "so what?", the man's money was where his mouth was, and its up to other people to decide what to buy or not buy.

The real point is, there's no clean line here. Normal market activity consists of trying to get other people to buy high and sell low so you can do the opposite. Its a zero-sum game and you cannot point to one bid or offer and say "that's fraudulent" and another essentially identical one and say it isn't. I mean I've literally traded the E-Mini on the CME, just like this guy did. Our algos put in multiple orders at multiple price levels and pegged them a few pips off the BBO. How is it that my order flow is legal, but his almost indistinguishable one isn't? I think there's about a snowball's chance in hell they can show he did anything criminal. I mean its possible, there could have been other activities that crossed certain lines, having insider information of some sort, etc, but just placing orders on a market? I defy any prosecutor to make a case that such a thing is criminal.

You cannot do that

[Giant Electronic Bra]

The CME, and EVERY SINGLE OTHER trading venue in existence, requires guaranteed credit before you trade. You simply CANNOT place an order for E-Mini on CME and not be able to make good on it if your bid/offer is accepted. Thus there is no such thing as 'kiting'. Broken trades are VERY rare and if you do break one, there's an investigation and serious penalties are in order. Generally speaking there's someone with the available credit to make the counterparty whole.

So, this Sarao guy for instance, would have been going through someone, say RCG, who is an FCM (Futures Commission Merchant) where he would have say $1 million on deposit. RCG would offer him say 100:1 margin, so he'd make positions as large as $100 million, and if at any point his unrealized P&L grew to close to his $1 million they would call his position and he'd be busted out. At the end of the day he pays RCG some interest on whatever margin he actually used and keeps his profits on whatever he made trading his $100 million in buying power. At NO POINT will RCG ever allow him to be in excess of his credit limit or underwater, and they are regulated and thus guaranteed to have sufficient risk capital to cover any shortfall with the counterparty to any trade on CME. ALL Sarao's trades will be 'given up' to them, or else placed directly through their platform (Onyx 2 I believe currently) and placed by RCG on its omnibus accounts.

The point is, you can't place trades you can't back up, its simply impossible.