U.S. authorities accused a lone trader based in a house under the flight path of London’s Heathrow Airport for intensifying the 2010 global markets shock known as the flash crash, part of an alleged pattern of cheating dating back as far as 2009.
The trader, 36-year-old Navinder Singh Sarao, was arrested in the U.K. on Tuesday, and the U.S. is seeking his extradition, the Justice Department said in a statement. He earned almost $900,000 trading futures on the Standard & Poor’s 500 Index on May 6, 2010 -- when investors saw nearly $1 trillion of value erased from U.S. stocks in just minutes -- and a total of $40 million from 2010 to 2014 buying and selling the contracts, according to the U.S. government.
Although the U.S. says Sarao’s illegal activities spanned from at least June 2009 through April 2014, the government gave special attention to what happened during the flash crash, which damaged perceptions about the safety of global markets. The trades by Sarao, a resident of Hounslow, England, took place on an exchange run by Chicago-based CME Group Inc. He was charged on Feb. 11 with wire and commodities fraud in a criminal complaint filed in federal court in Illinois.
The Justice Department and the Commodity Futures Trading Commission, which filed a separate lawsuit, said Sarao engaged in illegal trading strategies known as “layering” and “spoofing,” including on the day of the flash crash.
Search for Answers
That plunge left regulators and investors searching for answers. The CFTC and Securities and Exchange Commission released a report almost five months after the decline pointing a finger at a jittery market during the European debt crisis, a mutual fund’s large trade and high-frequency traders accelerating their buying and selling and then withdrawing from the market.
Sarao was “a significant factor in market imbalance,” CFTC Enforcement Director Aitan Goelman said on a conference call with reporters Tuesday. “Market imbalance was one of the chief conditions that allowed the flash crash to occur.”
Spoofing and layering involve submitting market orders with no intention of filling them, with a goal of pushing prices in a direction favorable to a trader’s strategy. Sarao traded E-mini futures on the S&P 500, the benchmark gauge of U.S. stock prices. The contracts, listed exclusively by CME Group, are among the key ways investors bet on American equities. CME declined to comment on the situation.
Sarao “effectively tethered his orders to the market price, constantly modifying them so that they moved up and down with the market, remaining several ticks above the best offer,” according to the Justice Department’s complaint.
The strategy “virtually ensured” that his orders wouldn’t be filled and Sarao almost always canceled his bids without executing them, the complaint said. Sarao ran a trading company called Nav Sarao Futures Limited Plc, according to the CFTC’s complaint.
After the CFTC and SEC examined the flash crash in 2010, their joint report said a mutual fund’s routine attempt to hedge losses set off a chain of events that caused the drop. They also said high-frequency traders, also known as automated traders, exacerbated the plunge.
The U.S. government’s complaint said Sarao used automated trading software that included rules for posting orders in such a way that they were never executed.
Sarao created a new legal entity in April 2010 called Nav Sarao Milking Markets Ltd., the Justice Department said.
On May 6, 2010, CME contacted Sarao to remind him orders placed on the exchange’s Globex system “are expected to be entered in good faith for the purpose of executing bona fide transactions,” according to the Justice Department complaint. CME also sent the reminder to Sarao’s broker, who wasn’t identified by the U.S. In a response later that month, Sarao told his broker that “he had ‘just called’ the CME ‘and told ’em to kiss my ass.’”
Tuesday evening as planes roared overhead, nobody answered the door at the Hounslow address Sarao listed in documents. A neighbor in the working-class neighborhood, Harmesh Johal, said a “very nice family” lived there and that a lot of people entered the house around 12:45 p.m. Tuesday.
(An earlier version of this story was corrected to fix a date in the final paragraph and to adjust Sarao’s age after Department of Justice corrected it.)