'Flash crash' arrest raises new questions

The arrest on Tuesday of a trader from a London suburb on charges that he manipulated futures markets and contributed to the "flash crash" has raised questions about his role and previous explanations of what really happened on May 6, 2010, when the Dow Jones Industrial Average fell 600 points and bounced back within 20 minutes.

Is Navinder Singh Sarao to blame for the flash crash?

Aitan Goelman, enforcement director for the US Commodity Futures Trading Commission, called Mr Sarao a "significant factor of the market imbalance" in May 2010. But US regulators also say there are multiple factors that caused the market plunge, including several billions of dollars worth of trades that were quickly executed - a level of activity well beyond what Mr Sarao could have done. Furthermore, Mr Sarao was not submitting real bids and was instead entering phantom trades that were never meant to be executed in a technique known as "spoofing". Authorities allege that Mr Sarao manipulated the market for futures linked to the S&P 500 both before the flash crash and years after it. The futures exchange, the Chicago Mercantile Exchange, said on Wednesday that it and regulators had concluded that the flash crash had not been caused by the futures market though it welcomed new information if it has come to light.

The CME contacted Mr Sarao to complain about his pattern of trades as early as March 2009. Why was he allowed to keep trading?

It is still unclear and the CME has declined to comment on Mr Sarao's case. But according to the criminal complaint against Mr Sarao, the CME wrote to him on the day of the flash crash saying orders are "expected to be entered in good faith for the purpose of executing bona fide transactions". A few weeks later, Mr Sarao said he had called the CME to tell the exchange to "kiss my ass," according to the complaint. He allegedly continued spoofing the markets through at least 2014.

The CME, like other major exchanges, is known as a self-regulatory organisation, which means it enforces rules, reporting requirements and other regulations for its members to protect against fraud and market manipulation. But because the CME makes money from its members, there are concerns it may have a conflict of interest around policing market participants. Yet cash-strapped regulators such as the CFTC rely on self-regulatory organisations because they do not have the resources to fulfil all of their enforcement duties.

Why did it take so long for authorities to arrest him?

It is unclear when Mr Sarao appeared on the radar of the CFTC and the US Department of Justice. An anonymous whistleblower, who spent hundreds of hours studying the flash crash, brought original analysis to the CFTC that led to Mr Sarao, according to Shayne Stevenson, an attorney for the whistleblower and partner at Hagens Berman law firm in Seattle. But Mr Stevenson declined to say when his client brought the information to regulators. The criminal complaint against Mr Sarao was filed in February, but it was not unsealed until this month. US authorities say the full story will be revealed when Mr Sarao faces justice in a US court. But he is fighting his extradition from the UK, so that may take a while.

Does this mean past theories on the flash crash are wrong?

Authorities have been scratching their heads to explain the 2010 event for years. Initial theories focused on a "fat finger" trading error. Months after the flash crash, a report by US regulators said that it was sparked by a rapidly executed $4.1bn sale of stock index futures by a single institutional investor that was unnamed in the report, but money manager Waddell & Reed has acknowledged making such a trade. Since Mr Sarao's arrest, some market experts have expressed scepticism about his alleged role, especially because he had supposedly been manipulating the market for years, but only one flash crash occurred. ?Regulators said the arrest of Mr Sarao did not mean that their report was wrong or that other players, such as large money managers, did not play a role. US agencies also do not plan to revisit the 2010 flash crash report.

Are our markets that fragile?

Since the flash crash and the 2014 publication of Michael Lewis's Flash Boys, which claimed the markets are rigged in favour of high-frequency traders, regulators have been working overtime to show US markets are robust. However, they have also acknowledged more work needs to be done to improve transparency and resiliency, and they have instituted new rules, including circuit breakers that stop trading when prices fall too fast.

Authorities say Mr Sarao used "off the shelf" software and modified it to implement his strategy. This could be a problem for those concerned about market stability because, if prosecutors prove their case, it suggests that other lone traders could also cause big market swings.

© The Financial Times Limited 2015. All rights reserved.
FT and Financial Times are trademarks of the Financial Times Ltd.
Not to be redistributed, copied or modified in any way.
Euro2day.gr is solely responsible for providing this translation and the Financial Times Limited does not accept any liability for the accuracy or quality of the translation