U.K. Trader Tied to 2010 ‘Flash Crash’ Charged & Arrested: CFTC

A high-frequency trader was arrested Tuesday in England for allegedly manipulating the market for a popular S&P 500 futures contract in a scheme that contributed to the May 2010 “Flash Crash” when the Dow Jones Industrial average fell 1,000 points in five minutes.

Navinder Singh Sarao, 37, of Hounslow, a borough in London, has been charged in a criminal complaint with fraud and commodities manipulation, according to a statement from the Justice Department’s Criminal Division. U.S. authorities are seeking his extradition from England.

Tuesday’s announcement of an arrest came as something of a surprise nearly five years after the “Flash Crash.” Regulators had no clear answer for the cause in the weeks and months after the event shook investors faith in mostly-automated securities markets. At first the cause was thought to be a single trader with a “heavy thumb” who could have mistakenly caused the crash by inattentiveness.

U.S. regulators led by the CFTC and the Securities and Exchange Commission, after spending five months studying the crash, eventually released a report citing a handful of potential causes, none of them being a single high-frequency trader using computerized trading program to manipulate markets.

Sarao was also charged Tuesday in a civil complaint filed by the Commodities Futures Trading Commission.

Sarao was charged in February with one count of wire fraud, 10 counts of commodities fraud, 10 counts of commodities manipulation, and one count of “spoofing,” an illegal trading practice used by high-frequency traders to deceive markets that a stock or futures contract is moving one direction or another.

In “spoofing,” numerous bids and offers are made through an electronic program, giving the impression that a stock or futures contract is about to move higher or lower. The actual trades are never executed, however, as the bids and offers were used solely to trigger other computerized programs into responding.

And that’s what happened on May 6, 2010, as one computerized program run by algorithms triggered another and another and another and so on, causing stock markets to plunge lower for no apparent reason.

According to the complaint, which was unsealed today, Sarao allegedly used an automated trading program to manipulate the market for E-Mini S&P 500 futures contracts on the Chicago Mercantile Exchange.

E-Minis are stock market index futures contracts based on the Standard & Poor’s 500 Index and one of the most popular and liquid equity index futures contracts in the world.

Sarao’s scheme earned him “significant profits,” according to the Justice Department’s statement.

Sarao used a sophisticated trading scheme known as “dynamic layering” to affect the price of E-Minis, the Justice Department said. By allegedly placing multiple, simultaneous, large-volume sell orders at different price points 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.