Navinder Singh Sarao pleaded guilty last Wednesday in a US federal court in Chicago to criminal charges previously brought against him by the Department of Justice for allegedly engaging in manipulative conduct through spoofing-type activity involving E-mini S&P futures contracts traded on the Chicago Mercantile Exchange between April 2010 and April. 2015, including illicit trading that contributed to the May 6, 2010, “Flash Crash.” On the same day, the Commodity Futures Trading Commission announced that Mr. Sarao and Nav Sarao Futures Limited PLC, a company he controlled, settled civil charges it had brought against the two defendants related to the same essential conduct. Mr. Sarao and his company both were publicly charged by the DOJ and CFTC in April 2015. (Click here for details regarding the criminal and CFTC civil allegations against Mr. Sarao in the article, “London-Based Futures Trader Arrested, Sued by CFTC and Criminally Charged With Contributing to the May 2010 Flash Crash Through Spoofing” in the April 22, 2015 edition of Between Bridges.) Following the filing of the criminal and civil actions against him, Mr. Sarao fought extradition to the United States from his home in the United Kingdom, but recently lost his last appeal before the UK High Court. He was physically extradited on November 7. (Click here for details in the article, “Alleged Flash Crasher Navinder Sarao Loses Final Effort to Avoid US Extradition” in the October 16, 2016 edition of Bridging the Week.) Among other things, the CFTC and DOJ claimed that, during the relevant time, Mr. Sarao principally employed two automated trading programs to effectuate his spoofing-type trading activities. The federal regulators alleged that, on the day of the "Flash Crash," Mr. Sarao entered numerous spoofing orders “that represented well over 20 percent of all E-mini sell orders visible to the market” in E-mini S&P Futures. (The “Flash Crash” refers to events on May 6, when major US-equities indices in the futures and securities markets suddenly declined 5-6 percent in the afternoon in a few minutes before recovering within a similarly short time period.) To resolve his CFTC charges, Mr. Sarao proposed to disgorge profits of over US $12.87 million, and pay a fine of over US $25.74 million, among other sanctions; the US federal court in Chicago must formally approve the CFTC settlement. A status hearing on Mr. Sarao’s criminal action is scheduled for February 9, 2017, while Mr. Sarao and the CFTC are formally scheduled to present his settlement agreement to the court for its approval this week.

Legal Weeds: In his proposed CFTC settlement, Mr. Sarao admitted that, in order to effectuate his spoofing activity, he arranged customization of an unnamed “off-the-shelf” trading platform. The CFTC had charged that, in working with computer programmers on this customization, Mr. Sarao evidenced “an intent to use two algorithmic trading programs to place orders (1) with no intention of executing those orders; and (2) with an intention to affect E-mini S&P market prices.” Importantly, in charging Mr. Sarao and his company, the CFTC did not reference the actual source code underlying his customization; rather, it quoted from email between Mr. Sarao and his programmers to show instructions for them to develop functionality to allow him to engage in his illicit layering and spoofing activity. The CFTC also described the behavior of the two trading programs principally employed by Mr. Sarao. This is consistent with how the CFTC approached its settlement with Michael Coscia, who ultimately was also convicted of spoofing by a jury in a federal court and sentenced to three years imprisonment following the filing of a criminal action by the US Attorney’s Office in Chicago. (Click here for details in the article, “Jury Convicts Michael Coscia of Commodities Fraud and Spoofing” in the November 8, 2015 edition of Bridging the Week.) In its Order Instituting Proceedings and Making Findings against Mr. Coscia, the CFTC described the behavior of an algorithm he used “designed to rapidly place bids and offers in the market and to cancel those bids and offers prior to execution.” There was no reference to source code. (Click here for a copy of the CFTC’s Order against Mr. Coscia and Panther Energy Trading LLC, a company he owned and controlled.)

My View: It appears that the CFTC is well-equipped using its existing arsenal of current laws and regulations to investigate potential market manipulation and other disruptive trading, including potential spoofing, without any greater access to source code as it currently seeks under proposed Regulation AT.