Now Investors Are Worried That a Single Trader Could Take Down the U.S. Stock MarketCallie Bost and Joseph Ciolli
There are enough reasons to lie awake at night without having to worry that a single trader can take down the U.S. stock market from a London suburb, fund managers said.
U.S. authorities accused 36-year-old Navinder Singh Sarao on Tuesday of masterminding a five-year scheme to use phony orders in Standard & Poor’s 500 Index futures to manipulate prices and book $40 million in illicit profits. Along the way, he had a hand in erasing $862 billion from the U.S. stock market -- in a matter of minutes, they alleged.
That it might have been going on for so long didn’t fill investors with confidence.
“It’s incumbent upon regulators not to be asleep at the switches,” said Donald Selkin, who helps manage about $3 billion as chief market strategist at National Securities Corp. in New York. “They have been, time and time again.”
Sarao was arrested in Britain and the U.S. is seeking his extradition, according to the Justice Department, whose complaint is the latest to portray America’s all-electronic stock market as vulnerable to predators with software. Regulators said Sarao’s activity worsened buy-and-sell imbalances that caused the May 6, 2010, flash crash.
According to the Commodity Futures Trading Commission, Sarao’s firm placed orders and traded in the smaller version of S&P 500 futures on at least 800 days between 2009 and 2014. It engaged in a bait-and-switch tactic known as spoofing where orders are placed with no intention of being executed on the “vast majority of days” it was active.
“Things like this don’t build a lot of confidence,” said Timothy Ghriskey, the chief investment officer at Solaris Asset Management LLC in New York, who helps manage about $1.5 billion. “It’s a risk that regulators are always going to be a step behind. That’s why they should be more aggressive.”
The CFTC said the actions show how far it will go to safeguard investors.
“Protecting the integrity and stability of the U.S. futures markets is critical to ensuring a properly functioning financial system,” said Aitan Goelman, the commission’s director of enforcement, according to a press release. “Today’s actions make clear that the CFTC, working with its partners on the criminal side, will find and prosecute manipulators of U.S. futures markets wherever they may be.”
According to the government, Sarao had trading software altered to let him send and modify orders to sell stock futures thousands of times a day with virtually no risk they’d be filled. That was his goal: to make it seem like orders for futures were piling up so they’d fall and he could buy them on the cheap, the complaints say.
There was no mention of Sarao in the report published five months after the flash crash by the CFTC and Securities and Exchange Commission. That study said a mutual fund’s routine attempt to hedge losses set off a chain of events that caused a drop that high-frequency and automated traders exacerbated.
“It’s ridiculous, it’s the government at its best -- inept,” Rick Fier, director of equity trading at Conifer Securities LLC in New York, said in a phone interview. “It really is just another one of many things to deal with, it’s extremely frustrating. We’ve seen flash crashes and we’ll see them again and it’s definitely disconcerting.”
While Sarao’s strategies employed special software and were conducted over data lines, analysts disagreed on whether his tactics constituted high-frequency trading. That’s the term made famous in Michael Lewis’s 2014 book “Flash Boys” and which is used to describe automated firms such as Virtu Financial Inc., which went public this month.
According to a definition on the CFTC’s website, high-frequency trading usually uses algorithms instead of humans to decide when and where to place orders, ultra-fast technology to cut response times, computers housed at or near exchanges, and high-speed connections and message rates, among other things.
“The term’s just become meaningless at this point; it’s just a boogie-man,” said Dave Lauer, president of Kor Group, a market structure lobbying and research firm.
“There are high-frequency market-makers, there are high-speed proprietary traders who don’t care about making markets and I do think there are predatory high-speed traders and manipulative high-speed traders,” Lauer said. “What this guy was doing was using computers in a manipulative, high-order-volume manner.”
Sarao’s tactics, known as spoofing and dynamic layering, were “particularly intense” in the hours before the flash crash plunge that knocked the Dow Jones Industrial Average down about 1,000 points, the complaints alleged. Just before stocks went over the edge, his sell orders were nearly equivalent to all the buy orders in S&P 500 e-mini contracts, it said.
The activity created “persistent downward pressure” on the price of the contracts during a period when they fell more than 3.6 percent, the complaint said. Sarao said in an e-mail cited by the Justice Department that the majority of his net worth came from trading on no more than 20 trading days when volatility was high.
“On the surface, the headline isn’t comforting, but perhaps it provides the avenue to prevent something of this nature from happening again,” said Walter Todd, who oversees about $1 billion as chief investment officer for Greenwood, South Carolina-based Greenwood Capital. “I’m glad we know definitively how it happened, but at the same time, the headline isn’t a great thing.”