Stocks: Was One Man Responsible For the 2010 "Flash Crash"?

By Markets Fool.com

Stocks are roughly flat on Wednesday, with the Dow Jones Industrials Average and the broader S&P 500 both up about 0.2% at noon EDT. Even as Dow components Boeing , McDonald's , and Coca-Cola all announced better than expected earnings before the opening bell, another Dow stock, Visa , is posting the biggest move this morning -- shares were up 5.4%, down slightly after hitting a new 52-week high earlier in trading. Visa and rival MasterCard are rising on a report that China will open up its market for clearing domestic bank card transactions, a market valued at $6.8 trillion last year.

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Speaking of big moves, equity investors can finally rest easy: U.S. authorities have identified a U.K. futures trader who contributed to the May 2010 "flash crash" that caused the Dow to fall 600 points in the space of five minutes. While high-frequency trading firms and investment banks use co-located servers and employ battalions of technologists, Navinder Singh Sarao, 36, allegedly managed this feat from a semidetached house on the outskirts of London.

The U.S. Department of Justice has charged Sarao with one count of wire fraud, 10 counts of commodities fraud, 10 counts of commodities manipulation, and one count of "spoofing"(entering orders with the intent of cancelling them before they are executed), all in relation to his trading of E-Mini S&P 500 futures contracts, which track the benchmark S&P 500 index. The DOJ is seeking his extradition so that he can stand trial in Illinois.

"Financial keystone cop-ery"
Or, as Paul Murphy of the Financial Times' FT Alphaville blog writes:

Except you know, instinctively, that this is nonsense. It's pure financial keystone cop-ery. This is a laughable piece of regulatory grand-standing from the Americans, which the British authorities look like fools for going along with.

I wouldn't necessarily go that far, but the story -- as reported -- seems wildly improbable. U.S. authorities believe Sarao earned $40 million in illicit trading profits from 2010 to 2014. Given how competitive futures markets are, that figure seems out of all proportion with reports of Sarao's resources.

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I've read reliable reports of a few individual futures traders earning comparable sums, but they were "locals" who acted as market makers on the floor of the exchanges, back in antiquity (the days of open outcry trading). In other words, they had a natural edge -- and they were at the very top of their game.

I don't think this bizarre development will do much to repair the reputational harm the U.S. equity markets suffered in the wake of the "flash crash" -- if anything, it adds to the confusion. In fact, the Justice Department's action lends weight to this week's call from former Federal Reserve Chairman Paul Volcker for a merger of the Commodities Futures Trading Commission and the Securities and Exchange Commission (the former regulates futures markets, while the latter oversees cash equity markets).

The article Stocks: Was One Man Responsible For the 2010 "Flash Crash"? originally appeared on Fool.com.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, MasterCard, McDonald's, and Visa. The Motley Fool owns shares of MasterCard and Visa and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.