The Hounslow headquarters of a market crash? Really?

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The Flash-Crash Trader's Kafkaesque Nightmare

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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How do you prove you don't have $35 million of ill-gotten gains parked in an offshore account? That's the dilemma facing Navinder Singh Sarao, known variously as the "Flash-Crash Trader" and the "Hound of Hounslow" and currently residing at Her Majesty's pleasure in London's Wandsworth prison.

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Sarao is accused of contributing to -- but not causing, mind you; the Commodity Futures Trading Commission is adamant about that -- the so-called "flash crash" that briefly wiped $1 trillion off the value of U.S. stocks on May 6, 2010. You can read the U.S. Justice Department's case here. He faces a maximum prison term of 20 years for wire fraud, 25 years for commodities fraud, and 10 years for market manipulation and spoofing.

The case against Sarao smells strongly of scapegoating. First, there's the issue of whether the misdeed he is accused of -- "spoofing" the market -- is a crime at all, as my colleague Matt Levine has explained at length, including here and here. (Importantly, if a London judge decides it's not a crime in the U.K. to rapidly trade and cancel $3.5 billion worth of futures contracts in the space of two hours, then Sarao can't be extradited.) Second, there are the financial machinations that are keeping Sarao in a prison cell, bringing to mind Franz Kafka's novel, "The Trial."

A U.K. judge has declared the 36-year-old a flight risk and set his bail at $5 million, which is roughly what Sarao says his net worth is. The problem is that his assets are frozen and the judge refuses to accept his family home as surety, meaning Sarao may end up languishing in prison until he is extradited to the U.S. to face his accusers, which could take years. What's more, the CFTC is convinced he's got money hidden away that he hasn't declared.

The regulator says Sarao made more than $40 million of profit, which is "stashed in a variety of offshore accounts and vehicles, as well as other apparently speculative foreign business ventures and are in danger of being concealed and/or dissipated."

That sounds pretty damning -- until you get to the financial evidence presented in the U.S. complaint. A change in U.K. tax law created a heavy tax liability under his existing offshore accounts. To mitigate that, he created something called International Guarantee Corporation in 2012 in Anguilla in the British West Indies. (He also had a company, Nav Sarao Milking Markets, which he had set up two years earlier in Nevis.) Sarao seems to have been borrowing money from his company to fund his trading and reinvesting the profits in the company -- a perfectly legal structure some of my wealthy friends have used in the past.

There's some tedious correspondence about how that company gets structured to diminish tax liabilities. Sarao also refers in e-mails to something called his "IXE Account" along with a Swiss bank account with Hinduja Bank. The key sentence cited by the U.S. Justice Department, though, bears repeating in full. It's in a letter from IXE to IGC dated Aug. 20, 2012:

We would like to confirm that as per date, your asset allocation in relation with Account Number 8210073 at Hinduja Bank (Switzerland) is in the value of 16,999,946.84 USD. Your participation amount into the Physical Commodity Trading is in the value of 15,299,952.12 USD. The commencement of your investment is August 21, 2012.

So in August 2012, Sarao seems to have had about $32 million available. That tallies with an undated diagram, which appears to be from 2013, that says IGC had assets of 22 million pounds, which would have been worth $34 million using 2013's average exchange rate. It's still not $40 million, but it's enough to go on the lam with, I guess.

But by October 2014, the picture had changed. Sarao writes to the administrators of his companies, saying, "I am proposing that the loan be reconsidered for 4.25 million pounds, leaving 1 million pounds in the account." At the then-prevailing exchange rate, that's a total of $8.4 million -- a lot closer to the $5 million Sarao says he currently has than the $35 million the CFTC accuses of him of hiding.

Now, maybe Sarao has spirited away tens of millions of dollars. Or maybe he just had a bad run and lost a ton of money. But there's no way of telling from the documents appended to the Justice Department accusations, which don't amount to a hill of beans in demonstrating the scale of his wealth, hidden or otherwise.

Sarao's solicitor, Richard Egan, declined to comment when I approached him on Thursday at Westminster Magistrates Court, where details of Sarao's September extradition hearing were due to be thrashed out. I didn't get to lay eyes on Sarao. When they tried to start his hearing soon after 10 a.m., officials couldn't work out whether he was still in Wandsworth prison, belatedly on his way to appear before the judge, or in the basement cells of the courts -- symbolic of the limbo the bedroom trader now finds himself in. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Paula Dwyer at pdwyer11@bloomberg.net