Navinder Sarao pleaded guilty to roughly $13 million worth of spoofing on his first visit to the United States in November 2016. Wearing leg irons and an orange prison jumpsuit in a Chicago federal court, Sarao was freed on bail pending final sentencing, which occurs today, January 28, 2020.
While Judge Virginia Kendall and the attorneys were tying down some of the conditions of Sarao’s bail that November day, they telephoned Sarao’s parents who were putting up their home as surety. When the judge told his father that Sarao was not to imbibe to intoxication, his father told the judge that his son does not drink, not even tea or coffee.
Navinder, their son, who was in his late 30s, still lived with them. He had first been diagnosed with Asperger’s syndrome the previous year when he was examined while in prison in London. He kept to himself, trading quietly in his Hounslow bedroom.
Good at his job
Good at pattern recognition, Sarao found himself bargaining with the U.S. criminal justice system. He had experienced a ten or so year run of electronic futures trading during which he had made about $70 million. When he was arrested in 2015, he told the English court, “I have not done anything wrong apart from being good at my job.” According to the U.S. Department of Justice’s 2020 sentencing memo, however, Sarao did acknowledge his culpability a short time later when U.S. investigators talked to him about his trading practices.
Because of the charges that were brought against him and also against the software developer Jitesh Thakkar, who customized some software for Sarao, there are some detailed, real-life descriptions of how Sarao spoofed the E-mini S&P 500 futures market in the public record. They show Sarao was an expert at spoofing, good at his job.
The DOJ’s complaint relates how on April 27, 2010, Sarao layered five sell orders “nearly simultaneously,” above the best ask of $1,200.00: (1) 500 contracts at $1,200.50; (2) 600 contracts at $1,200.75; (3) 600 contracts at $1,201.00; (4) 500 contracts at $1,201.25; and (5) 500 contracts at $1,201.50 in the E-mini S&P 500 futures. Sarao modified these orders many times. Two of the orders were canceled and immediately replaced by identical orders which were then modified in their place. In total, Sarao modified the orders 1,967 times (approximately 393 modifications per order), the modifications occurring when the market price changed. As Sarao chased the market down (DOJ would say “pushed’’ the market down), his lowest offer stayed two or three ticks above the best ask.
Sarao canceled all of those orders, without having executed any of them. It took less than seven minutes once he started his layering. By then, the prevailing market price of E-mini S&P 500 futures was $1,192.00, about eight points lower – a better time to buy.
According to the complaint, Sarao repeated this conduct 60 times that day alone. He bought, in total, 95,229 contracts and sold the same number in a total of 17,775 transactions that day. According to his brokerage statements for the day, Sarao racked up more than $821,389 in profits.
A similar story was related by Lisa Pinheiro, a statistical modeler and quantitative analyst at Analysis Group, which was hired by the DOJ to provide expertise in its case against Thakkar.
In this case, Sarao used the “back-of-book” software enhancement, which, when turned on, would automatically modify spoofing orders to keep the most aggressive one at least three ticks away from execution by modifying an order whenever it was too close to execution. According to CME rules, an increase in order size automatically eliminates the order’s time priority, moving the order to the “back of the order book.”
According to Pinheiro, Sarao had sold 1300 E-mini S&P 500 futures contracts on February 25, 2013 at an average price of 1504.17 before he activated the back-of-book software. While the back-of-back feature was activated, he was able to buy 1300 contracts at three lower prices, 1503.75, 1503.25 and 1503. During the less than five minutes that the the back-of-book software was activated, the original sell order for 571 contracts was modified 27 times before it was cancelled. His profit, according to Pinheiro, was $63,000.
The idea that a lone rogue trader caused the U.S. stock market to crash, albeit briefly, had the resonance with the public that the prosecutors must have anticipated.
Sarao quickly became identified as the “Flash Crash Spoofer” after his arrest, as both the DOJ and CFTC complaints against Sarao provided detailed descriptions of his trading before and on May 6, 2010, when the U.S. stock market briefly crashed and then rapidly recovered almost fully. In the five minutes after 1:42 p.m. that day, the Dow Jones Industrial Average fell about 600 points, having already lost 300 points earlier. The CME intervened in the E-mini S&P 500 and other futures market trading and by 2:00 p.m. the Dow index and most stocks had recovered.
Sarao had been trading that day and on the few days before hand. He had been layering in sell-side spoof orders throughout the period but, according to the DOJ, his activity intensified on the morning of May 6. By 1:15 p.m. he had placed six sell orders in the market with a total of 3,600 contracts offered and he modified them 19,000 times.
Sarao cancelled all of the layered orders, without any of them having been executed, at 1:40 p.m., before the market crashed. Beside those orders, Sarao also engaged in other sell-side spoofing in the period before and during the first part of the flash crash – until 1:45 p.m. At any rate, the DOJ estimated that he made $879,018 that day.
The prosecutors noted that Sarao’s spoofing behavior from May 4 to May 6, 2010 was largely on the sell side, and they alleged that it contributed to the volatility of the stock markets. Their assertion did not address, among other things, the fact that Sarao did not trade the underlying stocks, just index derivatives.
Neither of the government’s 2015 complaints against the “Flash Crash Spoofer” mention the markedly different conclusions regarding the causes of the flash crash set out in the October 2010 joint study by the Securities and Exchange Commission and the CFTC. The allegations against Sarao prompted the CME to make the following statement: “Following the Flash Crash on May 6, 2010, together with other regulators, we did a thorough analysis of all activity in our markets during the Flash Crash, and concluded – along with regulators – that the Flash Crash was not caused by the futures market.”
Both the DOJ and the CFTC never said why it took them almost five years to nab Sarao, whose spoofing – supposedly – helped crash the largest and most liquid stock market in the world. At the time of Sarao’s arrest in 2015, the Wall Street Journal and Reuters reported that the government’s investigation was significantly helped by a still anonymous whistleblower who is not mentioned in the court filings. It may have taken the government five years to find Sarao because they did not even realize they should look for him.