The US Department of Justice filed a formal indictment against Navinder Singh Sarao in a US federal court in Chicago on September 2, 2015, alleging that he engaged in commodities fraud, manipulation, attempted manipulation and spoofing, in violation of federal law, in connection with his trading of E-mini S&P 500 futures contracts on the Chicago Mercantile Exchange between approximately January 2009 through April 2014 (although some charges relate to conduct only from April 27, 2010, through March 10, 2014).
Mr. Sarao was previously accused of engaging in the same unlawful activities in a criminal complaint filed in the same court by the Department of Justice on February 11, 2015, and made public on April 21. This occurred shortly after Mr. Sarao was arrested at his home in the United Kingdom on April 21, in connection with his US criminal charges.
Since that time, Mr. Sarao has been opposing extradition to the United States in hearings in the United Kingdom.
In a civil lawsuit filed in a US federal court in Chicago on April 17, 2015, but made public on April 21, too, the Commodity Futures Trading Commission also charged Mr. Sarao and his trading company, Nav Sarao Futures Limited PLC, with engaging in the same core wrongful conduct as did the Department of Justice. The CFTC alleged that Mr. Sarao’s disruptive trading netted him profits in excess of US $40 million between April 2010 and April 2015
The Department of Justice and the CFTC claimed that Mr. Sarao engaged in layering activity on multiple occasions on the sell side of the market with the intent to mislead other market participants and artificially lower the price of E-mini futures contracts. Mr. Sarao accomplished this, said both the Department of Justice and CFTC, utilizing an automated trading program that frequently placed and cancelled large sell orders at a set increment away from the prevailing best bid price. Mr. Sarao typically sold E-mini futures contracts at a higher price and bought them back at a lower price in conjunction with his supposed “dynamic layering technique,” realizing profits, claimed both the Department of Justice and the CFTC.
In the indictment, the Department of Justice provided greater insight into its version of Mr. Sarao’s alleged wrongful conduct. Among other things, the Department of Justice referenced specific emails where Mr. Sarao expressly discussed his desire to “spoof [the market] down;” his need to have software to enter orders of different sizes to avoid other traders becoming aware of his activity and “rendering my spoofing pointless;” and contacting a programmer to know whether he could make software adjustments “because at the moment I’m getting hit on my spoofs all the time.”
The Department of Justice also alleged that on approximately May 21, 2013, Mr. Sarao’s then-clearing broker provided him with a copy of the CFTC’s interpretive guidance and policy statement regarding the Commission’s anti-market disruptive practices authority published just a few days previously. In response, Mr. Sarao allegedly responded to his clearing broker, “Lol, guarantee if I switch on my computer I’ll see the same people breaking all those rules, day in, day out.” (Click here to access a copy of the CFTC’s interpretive guidance and policy statement regarding its anti-market disruptive practices authority.)
Both the CFTC and the Department of Justice claimed that Mr. Sarao’s conduct contributed to the May 6, 2010 “Flash Crash.” (The Flash Crash refers to events on May 6, 2010, 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.)
(Click here for additional details regarding Mr. Sarao’s alleged wrongful conduct 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.)
My View: I continue to struggle how an individual might have known what is “commonly known to the trade as spoofing” – one of the specific activities prohibited by the federal law that outlaws market disruptive practices (click here to access the relevant law, Commodity Exchange Act §4c(a)(5)(C))– prior to the release of the CFTC’s interpretive guidance and policy statement in May 2013. Even today, prohibitions on disruptive trading practices are not uniform among exchanges. Moreover, it seems to me likely there are many legitimate reasons to place orders with the intent that they be cancelled before execution. For example, a trader might place a stop loss order or an order for a deep out of the money option far away from the current market solely as catastrophic insurance with the intent (and prayer) that it not be executed. Although it could be argued that such an order is legitimate because it is “the intent of the market participant that the order will be executed if the specific condition is met” (click here to access the answer to question 8 to CME Group’s Market Regulation Advisory Notice RA1405-5R, “Disruptive Practices Prohibited”), a trader engaging in purported layering might equivalently argue that it was his/her intent and expectation to be filled if his/her orders were hit – and he/she set aside the financial resources to demonstrate that. Mr. Sarao’s choice of words in his electronic communications may come back to haunt him, but it will also be interesting to see whether his language has been taken out of context in the criminal indictment.